In my 20 years in the real estate business and the real estate finance industry, I saw a few bubbles, both local, and national. And I’ve seen a few busts, both as a market participant and as a market analyst.
I know a housing bubble when I see one, and I’ve spotted a giant one that you’re definitely not looking at right now – but it’s poised to destroy you.
So let me tell you a story.
My “Bubble Savvy” Saved Me From Foreclosure in 2006 (And It’s About to Save You)
I sold real estate in the late 70s. I was a mortgage broker for part of the 80s during the buildup of the S&L crisis. I saw the shenanigans first hand. It was sickening. Some of the guys I worked with, particularly the bosses, were high on cocaine much of the time. One, that I know of, went to jail for cheating borrowers.
In the late 1980s until 2001 I worked as a commercial real estate appraiser and market analyst. I wrote honest appraisals that sometimes killed deals. It was bad for my career for a little while. Once you kill someone’s deal they tend not to hire you again. To paraphrase Jason Kelce, “They didn’t like me. I didn’t care.”
But when the1989-92 bust came, I got to do all those appraisals again for the FDIC and the RTC (Resolution Trust Corporation), which was the Federal agency cleaning up that mess. Guys went to jail because of their criminal behavior in that bubble. That’s as opposed to the more recent bubble, where the Fed gave all the criminals a bonus, and the Obama Administration gave them Get Out of Jail Free cards.
Back in the S&L crisis days, many banks also came back to me for reappraisals of properties they had foreclosed. I saw the causes of all the failures. They are always the same – crooked or idiot bankers, crooked developers, and dumb investors, many of them foreign, all driven by greed.
And then I saw the results – properties that were often worth 35 cents on the dollar and sometimes even less. Some shopping centers were even worth less than land value only. The buildings had no value, and the demolition costs had to be deducted from raw land value to get to the as is value. That happened more often than I care to remember. A 200,000 square foot indoor outlet mall that I appraised did end up being torn down. The property is now a Lexus dealership.
I even appraised a foreclosed property in West Palm Beach that had been developed by a schlepper named Donald Trump. A big bank lent him millions to develop a waterfront high rise condo property. The prices he set were ridiculous for that location at that time. So of course, the units didn’t sell. The bank took it back.
But do developers care? Hell no. They use other people’s money for the equity and borrow the rest. Then they take a big development fee up front out of the initial development loan disbursement.
It was all ugly as hell.
I started publishing in the Wall Street Examiner in 2000 just as the great US housing bubble was lifting off. I wrote about it for years. In late 2004 I forecast that the bubble would peak in about 18 months. I became so concerned that I sold my house in Florida in June 2005. Sales volume dried up in Florida later that year. Buyers disappeared. Prices topped out a year later.
But there was a problem with those rising prices in 2006. The problem was that it wasn’t a real market. Nobody could sell. If you sold your house that year, it was like winning the lottery. The year before, in 2005, I was one of the few people to foresee what was coming, and I extracted the phony equity that had built up in my property by selling. I took the money and ran.
Many homeowners thought that they were extracting equity by refinancing and taking out ever larger mortgages. But they really weren’t extracting their equity. They were just taking on extra debt. It was often debt that they could not afford to pay back because the banks were offering them liar’s loans, no questions asked.
Isn’t it funny (not) that the Fed did exactly the same thing with QE and the stock market from 2009 to 2014? When the Fed stopped that, then the ECB took the handoff and started its own QE program in 2014 with the added wrinkle of negative interest rates (NIRP).
Back to our housing bubble of the early 2000s…
Nationally, the market dried up in the second half of 2006 and prices began to fall in 2007. Because trillions in debt were collateralized by the phony equity that the housing bubble had spawned, the entire financial system and markets collapsed within a year after the housing bubble began to deflate.
Housing bubbles are nothing new. In recent years the Fed and their equally delusional fellow central bankers around the world have made housing bubbles a tool of monetary policy. Drive mortgage rates through the floor and housing prices through the roof, and somehow that’s supposed to stimulate economic growth via a ‘wealth effect” and trickle down. Central bankers seem to forget the fact that while they never need to repay their debts, ordinary borrowers do. They forget that trying to create a “wealth” effect by increasing debt creates both a credit AND a debit! Sooner or later the owners of that debt want their money back and the other side of that original accounting entry comes home to roost.
Every person who extracts housing equity for spending purposes incurs a debt, and that debt has to be repaid sooner or later. The ever-growing debt is a ticking time bomb. Fictitious capital inflated by easy credit and printed money is a mirage with a limited shelf life. The illusion can’t be sustained indefinitely.
In a housing bubble, skyrocketing home prices far outstrip household earnings growth, leaving more and more people off the “property ladder.” Soaring home prices also tend to pull rents up too, further putting the squeeze on poor schnook, wage-earner tenants. They can’t get decent raises, but they need to pay more rent.
So they have less disposable income to spend on other stuff. The economy suffers as a result. Landlords get richer and the middle class gets squeezed, and the economy gets mired in slow, uneven growth that benefits only those already at the top. Without broader participation, the economy sputters.
Ultimately those processes reach a breaking point and the bubble turns into a bust. There’s a limit to how much rich landlords and rentiers can spend to support a growing economy. Meanwhile, the middle class can’t service its debt, rent can’t be paid, and the real estate collateral falls below the value of the loans encumbering it. Left with no equity, debtors default, either willfully, or because they can’t pay. That came to pass in 2007-2009.
And we’re about to see that same sad drama replay itself – on a front that you might not be expecting.
I’ll have the next installment of this tale for you tomorrow (and show you how it’s about to impact your portfolio).