There are plenty of big spenders out there that are dependent on creditors to live beyond their means. Non-discetionary spending leads to enormous amounts of debt. That behavior and all the hot air used to justify it creates abnormal financial bubbles. Bubbles burst, eventually. What have we learned from our past?
Remember the big real estate bubble only ten years ago? When the big spenders were flying high there was a lot of hot air justifying the irresponsible spending and touting a "new" normal. For a lot of political reasons, money was being lent at greater amounts and to more people than ever before. The political correctness called them "sub-prime" loans. The lenders found out that they could make money off of loans that they didn't expect paid back. They could profitably lend money to folks without the will or the ability to pay it back, so long as it didn't get out of control.
The typical bubble formation starts innocent enough. A responsible buyer finds an interesting property and performs diligence in preparing a reasonable offer. They weigh all the negatives against the positives and come up with a number. But even before they can submit their offer, another buyer quickly appears without concern for the value. With a pocket full of loaned money, they don't hesitate to make a full price offer.
The neighbors across the street take notice of how fast and how much the property sold for. They decide to list their property with comparable amenities for ten percent higher. It sells immediately. The escalation continues and the bubble is formed. Extra money in loose hands perverts the natural worth of everything.
Eventually, the loose money runs out. The early careless buyers use all of their available credit and get to the point where they need to sell their house to continue their lavish lifestyle or avoid bankruptcy. They are shocked and dismayed when they realize that nobody wants to buy it for what they paid for it. Nevertheless, it becomes increasingly important to sell, so they drop the price. When their neighbors get in the same boat, they lower their price too. Almost as quickly as the bubble was formed, it begins to break.
Before everybody realizes what is happening, their property values have dropped significantly. They don't want to continue paying on a property worth so much less than what they are paying! Daunted, they just stop making payments and the foreclosure process begins. The foreclosure system is designed so that the lenders still come out ahead, but only for a normal amount of defaults. When the rate of defaults exceeds the designed system, the lenders find themselves in financial trouble!
The business investors are among the first to see the significance. They don't want their money invested in firms that will not be able to earn a profit in the fore-seeable future. The mass hysteria from the total collapse of one sector, bleeds off into another sector. The whole "house of cards" comes crashing down.
That was all ten years ago; so what? History doesn't repeat itself, exactly. We have a lot of smart people whom instituted changes and laws so that can't happen again. Perhaps the most significant of those are contained in the Dodd-Frank bill? Aren't they currently in the process of dismantling that bill?
What is a bubble anyway? How can we recognize it? A bubble occurs whenever loose money and the hot-air accompanying it increase the value of property.
So what are some property values at today? In many of our prospering cities, the median property value is at 16 times the average local wage. If the average wage earner had the ability to pay half of their income on a mortgage, it would take about 32 years to pay it off. The average wage earner can not do that due to interest, taxes, cost of living and OTHER debts! The top three OTHER debts are classified as student loans, consumer debt and automobile debt.
Student loan debt can not be defaulted under current law. However, legislation can be created by swaying public opinion and that has been in motion for over a decade. I expect we will see some form of "foregiveness" at tax payers' expense in the next four years.
Consumer debt and credit card spending is volatile. It is currently very high and that is never a good thing. Often times, the higher levels of credit are anchored by home ownership. That indirect relationship creates a covert property value bubble.
Automobile debt has grown to second place in the typical American household. Not only is it high, but it has exceeded record levels. This is alarming in itself, but the hot air from the "experts" are quelling concern because "things are different".
Loose money for auto loans has created an obvious bubble in vehicle valuations. Consumers are borrowing more than ever for the vehicle they commute in to their underpaid jobs from their overpriced homes!
Things are different. How are these things related to the crash of ten years ago? The warning signs are more covert. The loose money is from other sources than the government subsidized sub-prime mortgages, yet the real estate bubble is still forming. The loose money is perverting valuation and that is very similar to the circumstances that led to the last financial collapse.
No comments:
Post a Comment