Apr042012

Why should we prevent housing bubbles?


Part of living in California is deciding whether or not to play the California housing lottery. If you win, you could gain hundreds of thousands of dollars. If you play, you could spend hundreds of thousands of dollars and endure the consequences. If you lose, you could lose hundreds of thousands of dollars and end up homeless, destitute and bankrupt. But just like gamblers flock to the casinos, everyone believes they can be a winner, and now with our bailout culture, nobody believes they can lose either.

In the Great Housing Bubble, I noted this about bubbles:

Why should anyone care about financial bubbles? The first and most obvious reason is that the financial fallout is stressful. People buying into a financial mania too late, particularly in a residential housing market, will probably end up in foreclosure and most likely in a bankruptcy court. In contrast, stock market bubbles will only cause people to lose their initial investment. It may bruise their ego or delay their retirement, but these losses generally do not cause them to lose their homes or declare bankruptcy like a housing market bubble does. In a stock market collapse, a broker will close out positions and close an account before the account goes negative. There is a safety net in the system. In a residential housing market, there is no safety net. If house prices decline, a homeowner can easily have negative equity and no ability to exit the transaction. In a housing market decline, properties become very illiquid as there simply are not enough buyers to absorb the available inventory. A property owner can quickly fall so far into negative territory that it would take a lifetime to pay back the debt. In these circumstances bankruptcy is not just preferable; it is the only realistic course of action. It is better to have credit issues for a few years than to have insurmountable debt lingering for decades.

The real problems for individuals and families come after the bankruptcy and foreclosure. The debt addicted will suddenly find the tools they used to maintain their artificially inflated lifestyles are no longer available. The stress of adjusting to a sustainable, cash-basis lifestyle can lead to divorces, depression and a host of related personal and family problems. One can argue this is in their best interest long-term, but that will be little comfort to these people during the transition. The problems for the market linger as well. Those who lost homes during the decline are no longer potential buyers due to their credit problems. It will take time for this group to repair their credit and become buyers again. The reduction in the size of the buyer pool keeps demand in check and limits the rate of price recovery.

Those are the consequences for individuals, and we are seeing this play out today. However, there are other ways housing bubbles harm people, and today’s featured article from Rich Toscano details the broader problems.

Why Bubbles Are Bad

I’ve often discussed how the three industries that I refer to as the “housing bubble beneficiary sectors” took the brunt of the recessionary job losses.  In this post, I have updated some graphs showing the enormous degree to which this is the case.

The bubble beneficiary sectors, so named because they grew like weeds as a result of the housing boom, are: construction, finance (which includes real estate transactions), and retail (not directly related to housing like the other two, but a bubble beneficiary nonetheless as a result of vigorous home equity-financed consumer spending).  In the graphs below, I have grouped these three sectors together as the “Housing Bubble Sectors” and charted the change in their size alongside that of the non-bubble private sector industries and government.

For evidence of the connection between retail and HELOC abuse, consider the impact of the million dollars worth of HELOC spending the owner of today’s featured property pumped into the economy (see below).

I took these graphs all the way back to the beginning of 2007 because the bubble sectors started to deflate alongside the housing bubble even before the recession officially began in December of that year.  In order to avoid seasonality problems, I started and ended the graphs on the same month (January 2007 through January 2012).

This first graph shows the number of jobs lost in each of these three categories:

In the five years since January 2007, the non-bubble private sector has lost 5,400 jobs, and government employment has actually risen by 9,600 jobs.  The housing bubble sectors, in contrast, lost 62,700 jobs.

Since employment actually rose in aggregate between the government and non-bubble private sector categories, this means that the bubble sectors accounted for over 100 percent of all job losses since that time.

For anyone working in real estate, the sad fact is apparent. I know many people who are still out of work five years after the bubble burst. Further, the prospects for employment in the industry are still grim.

Housing bubble sector jobs accounted for less than 25 percent of San Diego employment as of January 2007, so in order for the bubble sectors to cause all the region’s job losses, they had to take a huge hit in terms of size.  This is represented in the next graph, which shows the percent change in size in each of the three employment categories:

Since our starting point at the beginning of 2007, government employment grew by 3.5 percent and the non-bubble private sector shrank by .7 percent.  The bubble sector industries — construction, finance/real estate, and retail — fell between them by a brutal 19.8 percent.

The reason why we are nowhere near getting back to 2007 levels of employment is that those housing bubble beneficiary jobs are not coming back.  They were created during an unsustainable frenzy of home building, real estate transactions, mortgage borrowing, and debt-financed overconsumption.  The construction, retail, and finance sectors grew to sizes that were far too large to be supported in the absence of a housing bubble.

Those excess jobs are gone for good, now that the bubble is no longer with us.  They never should have existed to begin with.  We would have been far better off if all the labor and resources that were squandered on the housing bubble were instead put to uses that could have generated a sustainable increase in society’s long-term prosperity.  As a bonus, we would have avoided a big crash, too.

And that’s why bubbles are bad.

Rich Toscano is a financial advisor with Pacific Capital Associates*.  He can be contacted at [email protected].

I wholeheartedly agree with Rich’s assessment. We would have been far better off without the temporary stimulus. We diverted scarce resources into unproductive assets, and that diminishes us all.

More than $1,000,000 in HELOC abuse

The further up the property ladder people were, the more HELOC abuse lenders enabled. The HELOC abuse at the high end was truly remarkable.

  • Today’s featured property was purchased on 6/5/1992 for $205,000. I don’t have the purchase records, but assuming a 20% down payment, he used a $164,000 first mortgage and a $41,000 down payment.
  • On 12/30/2002 he obtained a $875,000 first mortgage.
  • On 4/2/2003 he opened a $150,000 HELOC.
  • On 8/31/2004 he got a $250,000 HELOC.
  • On 4/11/2006 he refinanced a $1,300,000 first mortgage and a $97,500 HELOC.
  • Total mortgage equity withdrawal was $1,233,500.
  • Wells Fargo processed the foreclosure quickly once they filed the NOD.

$1,233,500 is a lot of money. How long would it take to earn that kind of after-tax cash? This guy got it without having to do anything.