Housing and Economic Decline/Recovery

[dgriffin]

Can someone give me a succinct explanation as to why our economy's decline and potential recovery depends on housing? I've heard a number of politicians, from Obama down, make that assertion.
I wonder how that could be. Indicators in the past included manufacturing output, mining of natural recources, etc.
And evidently, it's the MARKET value, not the real value of homes upon which our economic survival depends?
As you may notice, I'm no economist. I need an explanation.
Or at least a discussion.
Thanks.

[dgriffin]

Interesting article in Harpers.


The next bubble:
Priming the markets for tomorrow's big crash

By Eric Janszen


Nowadays we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives and debt securitiztion, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.

A financial bubble is a market aberration manufactured by government, finance, and industry, a shared speculative hallucination and then a crash, followed by depression. Bubbles were once very rare—one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences. After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid “raising or pretending to raise a transferable stock.” For a century this law did much to prevent the formation of new speculative swellings.

"That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle."


www.harpers.org/archive/2008/02/0081908

[dgriffin]

Obama: "When the housing market collapsed, so did the availability of credit on which our economy depends.

Treasury Secretary Timothy Geithner told reporters here that the plan would not only awake the slumbering housing market, but would also help reignite the broader economy.

"By helping keep mortgage rates down, and helping reduce monthly payments, you are putting money in the hands of Americans, in that case it acts like stimulus."

In 2008, there were 117,000 foreclosure notices received in Arizona, making it the third worst-hit state in America, according to the online realty market firm RealtyTrac Inc.



Obama takes aim at housing crisis

www.smh.com.au/world/obama-takes-aim-at-housing-crisis-20090219-8bmd.html?page=1

Sidney Morning Herald
smh.com.au

[frankcor]

Dave, I'll give a shot at explaining how housing caused this bubble to burst.

Some greedy bankers weren't satisfied with the profits being made by making sensible loans to sensible people who could afford them. At the same time greedy politicians figured if they could help people who were too poor to afford homes (in the interest of fairness, of course) actually buy homes, the poor people would be so grateful they would continue to vote for them over and over again, thus ensuring their personal wealth and family security.

The greedy politicians got together with some greedy bankers at Ginny Mae (Government National Mortgage Association or GNMA) and Fanny Mae (Federal National Mortgage Association or FNMA) and came up with a way to get poor people into home ownership. They did it by inventing sub-prime mortgates -- mortgages with an interest rate LOWER than the prime rate which is the rate banks charge each other for huge loans. That way they could keep the total payment (interest and principal) low enough so poor people could afford to buy the house. They also loosened up some of the stupid old-fashioned rules for mortgages like making sure that people had enough income to be able to make the payments. Some folks got mortgages simply by writing down an imaginary number for their income because, they were told, (wink wink) nobody is going to check up on it. No pay stubs. No tax returns from last year. Just make up a number.

Now, you may ask yourself "How can a bank make a profit lending money to people for less interest than what they pay for the money?" Good question because they can't. Unless of course, they offer that rate as simply a teaser for a few years until the mortgage automatically changes the interest to a rate that's (usually) much higher than the prime rate. At that point, the monthly payment has to jump up.

Here's an important point: Ginny and Fanny don't actually make mortgages. What they do is guarantee mortgages for banks that make loans to qualified people. So, with these new rules, they made millions more people eligible for mortgages who previously never would have qualified.

Now, if you're a greedy banker and you can make loans to people who can't afford to buy houses without any risk to your or your stockholders because Ginny and Fanny will guarantee payments even if the mortgage holder defaults, what do you think you're going to do? You betcha, you're going to hire a bigger, more aggressive sales force to go out and sell as many of those mortgages as they possibly can.

So what happened when the mortgages escalated (payments went up to match increased interest rates after a few years)? Well, since home prices kept going up and up, most folks with these sub-prime mortgages were encouraged to refinance their homes. Because the value had increased, they could now borrow even more money, pay off the original mortgage, and even take some cash out of the deal to buy that new BMW they'd been looking at all these years.

Things worked great for 10 or 15 years. Some folks refinanced 5 and 6 times, each time with a bigger mortgage and taking some cash out of the house. They were using their home like a credit card. The greedy bankers were making tons of profits and they were sharing those with greedy politicians who kept getting elected over and over again.

That all came to an end about 18 months ago when home values started to decline. Now, as those sub-prime mortgages came due to escalate, the owners were unable to refinance for a higher amount. In fact, most of them found out that they owed more on the home than what it was currently worth.

With no way of refinancing or even selling the house to pay off the mortgage, people started defaulting on the loans. They just couldn't make the higher payments.

This brings us back to Ginny and Fanny. How were they able to guarantee the loans? In order to guarantee the loans, they were obigated to put cash into reserves to cover the possibility people might default. Where do they get that cash? There's only two ways. One is to ask congress for it. That would be very unpopular. The other way was to sell Mortgage Backed Securities (MBS) to banks as investments. They sold a promise of a share of the profits from all the mortgages they guaranteed to raise cash that allowed them to guarantee even more mortgages.

The perfect storm struck when banks all over the world realized that a lot of their investments in MBS were actually worthless as 10%, 12% even 15% of those mortgages began to default. The banks had to "write down" their values which ended up costing them billions and billions of dollars. In order to protect their stock holders and their remaining assets, they started hoarding what cash they had and stopped lending money.

It definitely isn't succinct but I think you get the idea.

[dgriffin]

That's a very good explanation, Frank, and makes it more clear. Reading the article, above, is worth the time. I'm about to give it a second read, and your explanation will help. What I got from the first reading is the author feels the banking crisis was just the icing on the cake. He charts one "fake boom" after another, saying we no longer have an economy based on real value. Instead, we cycle from one bubble to another... this time housing, the last time the technology dot com bust. Regardless, you can make money on such a bubble, if you get in and out on time.
He lists possible future booms, pros and cons, and ends with the observation that the only one really viable at this point ... and it has already begun ... is two fold: infrastructure (roads, bridges and power) and alternative engergy.

Meanwhile, we're in real trouble for 5 or 6 years, with housing values going down 6 to 7 percent each year.

He doesn't directly address it, but I can see a lot of inflation and skyrocketing taxes in the next 5 years.

[frankcor]

Thanks, Dave. I may re-write that a few more times to inject more humor and provide additional details. But for now, I'm glad it did help.

I believe alternative energy has a bright future. I'm not certain that something that provides real value, like energy production, can create a bubble. Maybe I'm wrong but energy production is akin to manufacturing -- it creates real wealth and value, unlike service-oriented activities like real estate, law and medicine that just move money from one person to the next.