Monday, July 30, 2007

Housing Death Knell for the Economy

Between January, 2005 and today, 16 million houses have been sold. Let's figure that the new owner probably paid double of what is was worth. So a 100k to 300k house was purchased for 200k to 600k. Figure that the new market price averages out to 300k.

Multiply 16 million homes by 300k and you end up with 4.8 trillion dollars worth of homes that have mortgages with less than desirable collateral. The owner paid too much and is struggling to hang on. So 50% of that total is about 2.4 trillion dollars. This was money added to the economy that no one had to work for, AKA bubble money.

In the past, the yearly appreciation of the home meant that the money extracted never had to be repaid. Now, the house has ceased to appreciate in value. To the over extended home owner, this change of the rules is just not logical. Everyone knows that housing always appreciates.

The US census lists the total number of housing units in the United States as 125 million as of 2005. How much equity was pulled out of all of the remaining units (125-16=109 million)? You really don’t know where to even start. We could double what was calculated for the 16 million homes purchased and call that an estimate of what the housing owners extracted from their new found equity. That would put the amount of bubble money introduced into the economy at 5 trillion dollars. This money flowing into the economy has stopped. Coincidently, the total United States budget for the last 2 & ½ years was also 5 trillion dollars.

When you realize that the last time we had something this bad in the housing market, it took 5 years to get where we are at now, and we’ve done this all in one year. Talk about over achievers, we’ve outdone ourselves!

The economy is what will be hit and hit hard. It may take time, but what is about to happen, is now more than obvious.

On the lighter side, here is some good news; Congress is going to pass a law to double the number of feet in a mile from 5,280 to 10,560. This will cut our distance to work by half thus decreasing gas consumption by 50%, God bless them!


Anonymous said...


I have followed your posts for the last year. I just wanted to say thanks for the interesting and sometimes very comical jabs at our doomed economy. I share your belief that the US is headed for a major depression. Most Americans are blind of the current situation, in which the US economy is a speeding bullet train that derailed the end of 2005 and many of it's passengers are still comfortably sleeping, unaware of their impending financial demise. Keep up the great work!

GD2006 Believer

Anonymous said...

Great blog, great post. I have been thinking that the housing market was too good to be true for five years now. Didn't foresee how it would effect the stock market and banks though.
Keep up the great work!

Jim in San Marcos said...

Thank you both for your complements. It means a lot to me.

Take Care


Anonymous said...

Although I agree there will be major implications from the housing run up, I disagree with your numbers.

Maybe 1-5% of the 16 million homes are double what they are worth.

I lived in Florida and my home doubled in price from 2001-2006 (I know this because I sold at the peak). However, Florida was undervalued in 2001 ($185K for a 4 bedroom with a beautiful pool with waterfall hot tub overlooking a pond in an A+ school district was much less expensive than in other areas such as Pittsburgh/Cleveland/Minneapolis/etc) So when I sold it for $360K, yes I sold it for more than what it was worth. However, it may have been worth $300K to $320K, which is what is could sell for right now (according to the sales prices of similar homes in the past few months)

So exclude Florida, where it isn't double. I can also guarantee you every non-bubble state wasn't double. So the numbers just don't add up like you wrote. Many cities like Pittsburgh/Cleveland have been stagnant for 5-6 years. I know California is out of whack, not sure it is double since 2005, but it is possible (anything is possible in California)

In reality, all the bubble states are probably were probably purchased 10-30% over what they should have been (of course, some maybe double). However, in all the other (normal) states, they are probably right on.

Anonymous said...

While I agree with your economic stance, I do have to point out that if Congress passes the feet in a mile law. It won't save any guess. It just means our cars get less miles per gallon. Which also means that every car dealer in the US will have to rewrite all of their specs and change all of there computer systems to accomodate the new law. End result, no gas saved, lots of extra work added. I'm sure high school distance runners aren't going to be happy about this either.

Jim in San Marcos said...

Hi Anon 7:40

A lot of the housing has doubled whether it was undervalued or not. Where did the additional money you sold your house for come from? It was not earned. True the person who bought your house will have to earn every dollar that you received. 200K houses in our area are going for 1.2 million. I chose 300k as an real low ball estimate.

If you examine the markets, most real estate won't even show a positive rental cash flow at 50% of present value

Jim in San Marcos said...

Hi Anon 5:51

The Congress feet in a mile law was just a joke jab at the general approach that Congress uses to solve our problems. I try to put a little humor in each article.

At the same time it illustrates that even the most solid arguments some times have holes in them.

Russ said...


Thanks I enjoy your blog. Its informative.
I sold my real estate but was wondering if you had any opinions on the risks of holding cash / dollars.

Some have opined that the FEd would run the printing presses in overdrive to counteract the recessionary economic effects. The dollar is worth so much less than it used to be vs, for example the euro. However gold is experiencing recent price drops this week.

I'm thinking cash will be king as this situation de-leverages and distressed sellers unload various assets, but that at some point inflationary effects will become more pronounced reducing the purchasing power of the US dollar. (Even further). If all this paper bubble money has evaporated, why is the dollar still faring so poorly?

In an earlier post I think you recommended short term bonds with only 10% gold/silver?

Thanks for your blog: Russ

Russ said...

maybe i answered it here: the difference between credit and debt

Anonymous said...

Hey Jim, I guess what I am saying is that there are some extreme markets that were sold at double what they are worth, (and I'm sure there are absurd markets in California that sold for 4x what they are worth), but most of the country was the normal 1-5% per year.

Anonymous said...

Your point is well taken; only the coastal states saw crazy valuation growth on real estate. That doesn't minimize the damage of this bubble on the rest of us though. For example, I live in Fort Worth, Texas and paid about $120K for my relatively new 4-bedroom in 2003. Yes, Texas homes are really that cheap. However, for-sale signs have become the new state tree and homes are stagnating. A look at recent sales are showing houses similar to mine selling for around $100K. The Zillow estimates are laughably high. Our homes have effectively dropped 17% in value, but we never saw the upside of the bubble.

Anonymous said...

I live down in San Diego, where houses are priced a minimum of 60% higher than they are actually worth. Nobody in their right mind could buy, and when I moved here apparently companies have been having a hard time finding people because the cost of housing is so high and the income just doesn't match. I literally can't buy anything within 10 miles of where I work, so I rent.

Some claim only coastal areas are affected, but this is just not the case - I moved from a totally land-locked inland state where I couldn't buy a home, either. I was priced out of that market sometime in 2001, and it's an area that is still increasing in price for no sensible reason (plenty of land, abundance of houses, etc). My parents own a place there that they bought for 118k in 1998, and with what I made there, a house twice that price would have been well within my reach, but now that house is supposedly worth over 300k, and that's just more than I could bite off there. Here, I just laugh, because that house would be over a million. So, yes, the coasts are far over the point of no return, but the rest of the country is still contributing to the increases. I'd say at least 50% of homes in this country have price tags of over double what they are worth (such as here, where they are about triple), but most of the country is at least 25% over what a house should be worth, even in the most depressed areas.

Anonymous said...

I read a lot about "what a house is worth."

It was worth what somebody will pay for right now. Tomorrow it is worth what somebody would pay for tomorrow.

If a house worth $200K is selling for $1.2 million, that it is worth $1.2 million. The house may only cost $200K to build, but the land is worth $1 million.

Anonymous said...

I think that's only true if you are paying cash. If you are borrowing, your offer on a house usually depends on the interest rate and the monthly payment you can make. For a monthly payment of about $1,075 a month, you can afford $225,000 of house at 4%, but only $180,000 of house at 6%.

So people can bid up house prices when interest rates are low. Then economic dislocation occurs when interest rates normalize.

It's utterly predictable.

Jim in San Marcos said...

To the last 3 Anon's

I need to redirect you to the focus of the article. It has nothing to do with housing prices.

If you purchase a pet dog for 500 dollars and then someone offers you one million dollars for it, and borrows the money from the bank to pay you, The amount of money in circulation just increased one million less the $500 you originally paid for the dog.

If you examine that point in time, the million you received for the dog was not earned money, it was speculative money loaned by a bank that you received.

The increase money introduced into the economy was not the result of building a new Television or auto, nothing needed to be created for the increase.

This million dollars is very spendable. When you realize that 5 trillion dollars of additional money has been added to the money supply and no one had to produce anything in order for it to be created, the problem becomes visible.

The money introduced into the economy by those who were lucky enough to sell, is a tremendous amount added to our money supply. Its about equal to all government expenditures.

In retrospect, if the housing market collapses, this bubble money disappears the same way it appeared. The only thing different, is that someone else is caught holding the bag!

Anonymous said...

Jim, you hit the nail squarely on the head, with the buying a dog analogy..

Anonymous said...

Jim: your dog analogy is not quite correct.
Total amount of loans outstanding in any bank at any point in time is determined by amount of deposits in that bank. Read up on "fractional reserve banking". Just because someone chooses to take out a loan for $1,000,000 to buy a dog does not mean that some money is being created. Total amount of money stays the same, it just goes to your buyer (and, from him, to you) instead of some business trying to take out a loan. Quite generally, banks don't create money, at least not on their own.

The situation is a bit more complicated with housing, because loans don't stay on bank's books forever, they get resold. Even so, no new money gets created unless the US government and the Fed get involved. For instance, an MBS containing your mortgage may be sold to a German bank. German bank will have to buy some dollars in the forex market and pay them for the MBS. This has the effect of temporarily propping up the exchange rate of dollar, but total amount of dollars worldwide stays the same.

Anonymous said...

by the way, there's an article on Federal Reserve web site with equity withdrawal estimates for 1991 - 2006. Net equity withdrawals in 2005 were around 750 billion dollars.

Anonymous said...

To summarize, if you bought a house for $200k and later sold it for $500k to some poor subprime sucker who later foreclosed, net effect for the economy is that some rich guys (investors of hedge funds that were holding MBS when s**t hit the fan; some of them possibly foreigners) essentially gave you $300k of tax-free cash for your personal consumption, instead of (say) investing them in stocks or using them to start a company. They did this because they were counting on the subprime sucker to pay them 8-10% for the rest of his life.

Now that the MBS industry has collapsed, they'll stop giving money to lucky homeowners and move on to the next big thing that promises them 10% "guaranteed" income. If this "thing" is here in the U.S., we'll be fine. Money will flow into a different segment of our economy. The problem is, serious investors are increasingly diversifying into European and Pacific economies ...

Jim in San Marcos said...

Anon 3:02

I disagree with your statement that the fractional reserve banking system doesn't create money.

Take the person who received the one million for the dog. He now goes to Bank B and deposits the Million. Bank B using the fraction reserve system can (assuming the reserve rate is 5%)loan out 950k to Joe Six pack for a yacht. The Yacht dealer in turn deposits the 950k into bank D which can now loan out 900K to someone else. In a normal market, failure of any part of the chain is remedied by the sale of the collateral involved.

The Dog seller is selling something with implied value. The boat dealer is selling an item with implicit value that can be easily be determined by adding up labor and materials.

The other thing not mentioned much is the velocity of money going through the system. With the real estate market alone, we were in Star Trec Warp speeds. Now with the velocity of money approaching zero, the foolishness in the real estate market seems quite apparent.

Anonymous said...

The bank that lent a million dollars to pay for the dog had excess credit. It could have lent that money to dog buyer or to a startup company. The startup company would have paid salaries, bought computers, etc. putting the money back in circulation.

This is tangential to the topic of housing bubble, because housing bubble money largely did not come from fractional reserve system. It came from private and institutional investors who thought they were getting AAA-quality high yield bonds in exchange for cash. These investors are not subject to fractional reserve rules. As a result, during the last few years we had much more credit going around than could be normally expected.

Early 2007 it finally dawned on those investors that people who borrowed their money could stop paying interest at any time; that their money was long gone, sometimes recirculated into the US economy, but often went overseas to pay for iPods and BMW's; that the collateral for those loans was sometimes worth barely 80% of the amount of loan, and they'd have to go through foreclosure (6-12 months ) to get even that; and, finally, that US legal system severely limits the ability of mortgage creditors to go after debtors' assets in the event of upside-down foreclosure (even if debtors have any assets).

Naturally, as soon as the message got through, all these investors pulled out of the market, and now we're moving towards the situation where the only serious buyer of mortgages left standing is Fannie Mae, and the only mortgages one can obtain are those conforming to Fannie Mae's standards (up to 417,000, 20% or more down, unless you're willing to pay mortgage insurance, bank must be willing to buy back the loan if borrower defaults during the first 3 years). It does not mean that there's less money to go around - just less credit.

Velocity of money is a whole different subject...