patrick.net

"Where prices have risen far faster than underlying incomes, only two possibilities exist. Either prices have moved to a higher equilibrium level, in which case future purchases will have to save more and consume less."

This is something I've wondered about for years. I can use myself and many my age as an example. I do not buy new cars, stereos, Tv's, appliances, or really anything else. If I do buy clothes, they come from the Goodwill or flea markets. My truck is 10 years old. My wife's car is 17 years old.
It isn't that we can't afford any of the above,even nicer things. but we are in the same mindset which is that it would be better to save for the future. At least my conclusion comes from the events around us. Unaffordable housing, a lack of security and trust in an economy controlled by the rich and powerful, which produces very little real products, a huge national debt, and so on. If homes are going to be very expensive, then we will have to basically keep living like we are- save save, and save some more. If EVERYONE does this, then the economy will suffer because retail sales will drop like a rock. This happened in Japan in the late 80's for the same reason, and it can easily happen here. Take away security, and this is where your economy goes down the John.

Housing price bubbles as a form of income redistribution? A potentially interesting subtopic of conversation. In fact, when a bubble maintains high prices for long enough, and then is followed by a long, soft landing, dramatic amounts of wealth are effectively redistributed from young to old.

The reason is simple. The older you are, the more likely you are to (a) own a home, (b) have a home with a basis, or book-value priced pre-bubble, and (c) the more likely you are to be in a position to bank your returns, now priced in bubble-terms.

The opposite is true of the young. They must surrender ever larger portions of their income in order to buy. A large portion of this income is going to the old as capital gains.

If a long, soft landing deflates the bubble, then it will need to take much longer than the run-up to unwind (or it will not be a soft landing). By some measures, it would need to take from 2.5-3.5 times longer or about 25-35 years. If you are in the two generations that bought in during the boom, then you may never see significant real-price appreciation in your home during this period, thus forcing you to sell when at the same point in life as today's "old" for little to no real gain.

This is textbook free-market income redistribution at work. Much more nefarious than the stock-market bubble (which didn't redistribute but barely a fraction of what the RE bubble is accomplishing), this real-estate bubble is probably causing global income redistribution on a scale not seen in over 100 years.

namadtoons,

I think it was you who pointed out Bulgaria and other Eastern Euro countries a while back as similar to low-price areas in the US. The data from this article shows this affect dramatically. Looking at Bulgaria, or Manchester versus London highlights the enormous differences in price and affordability that are being caused by the RE bubbles.

The interesting thing about Europe is they are *far* less willing to move country-to-country than Americans are to move state-to-state. This may be our only salvation as our bubbles should deflate more naturally whereas theirs are causing very severe pressures, political, monetary and fiscal.

Randy,
What worries me is that while the NE, West Coast, and a few select number of cities in the US had a pheonominal bubble, there were a LOT of areas that DID NOT have any appreciation, very little, and in the case of TX, actual errosion of their values. Now I'm seeing the trend of people investing in these areas. I'm concerned that the US actually has a signifigant amount of wiggle room as far as fufilling a nationwide housing bubble, one which has already gone full-blown in California and New York as well as Florida. People are going to try and find the "next thing" just like they did after the tech bust. I'm certain that most investors already know the game is over in Ca and NY, but they're seeing green in other regions. I hope that the media helps to convey the negative effects of a regional housing bubble implosion to discourage this kind of rampant out of control price elevation in the so far unaffected areas. The Key word right now seems to be " North Carolina". I hope other states in the area aren't next.

This generational war for resources does bring some interesting game theory into play. In cases like Japan and high priced parts of the US, we're seeing more and more young people who either depend on their parents to help buy a home or live with their parents. That means there's some transfer back to younger generations.

On the two unpleasant choices. I think I'd rather go with a bubble burst scenario that eventually squeeze RE prices back to 1996 real price levels(with a combination of inflation and price deflation). For people who bought and got trapped, well, that's the price of being blind to risk. A dramatic drop will also focus public scrutiny on lending practices and RE business, and finally force through some necessary changes.

As I see it, America has a major problem with confusing home with investment. I found Owneroccupier's discussion yesterday on Japanese RE to be quite refreshing. The Japanese treat homes as a durable good, almost like you would treat a car. (high end RE functions as vintage car while other homes are separated into Hondas/Toyotas and Fords/GMs) That completely takes out the speculative aspect of home purchases. People buy there because they need the space and feel comfortable buying it. People in this country used to think like that, only 5 or 10 years ago, it would be good if they remember again.

nomad,

I thought you felt the entry of coastal money and talents into other parts of the country as a good thing. Most of the country doesn't have buildable land constraints of the core bubble areas, so I doubt they would rise too much in price.

I'm more concerned about the type of buildings builders have put up in those parts of the country in the last 5 years. The layout and built quality aren't there. I fear the country has spent a lot of money on houses won't make it to their 20th year of service.

nomadtoons,

In the HSBC US bubble-finding publication, they concluded that Indiana was the most undervalued, having lost the most in real-price terms during the past 20 years. Rent yields were the highest there, and affordability the highest. The PITI-to-Rent ratio there is actually below 1.0, which is somewhat rare (if I recall, it was still over 1.0 in Texas and other likely candidates). California and New York were up towards the top, but not the worst bubble states. DC was by a long shot the worst. Then came other constrained places like HI.

I'd say that if specuvesting ever hits IN enough to turn around their figures, it is an definite, absolute, no denying it at all alarm bell for a national bubble. That is, barring us finding some new found source of pure-wealth generation that the entire country profits from (but the rest of the world doesn't).

nomad,
Unfortunately, your scenario is exactly what the evil NAR is hoping for. They (specifically Learah) have been yammering on about a "rolling boom" for a few months now, and if your prediction comes true, this is exactly what will happen. The saving grace may be that if the coastal bubble areas crash hard enough, the loose credit/capital of investors from these areas will dry up, and on top of that there will be apsychological shift away from speculating, even in currently down areas.

astrid,

The problem with your theory of eventual re-redistribution back to younger generations (today's young to today's old, to their children):

This is still a narrowing income redistribution function. It causes dramatic wealth concentration, and is a mechanism by which the market is "taxing" those not fortunate enough to be born into a "wealthy" land-owning class. I'm not really encouraged by the notion that they'll pass their bubble-confiscated wealth on to their trust-fund children. Especially given that this will create very real social implications: where different classes of people can live, what schools they can attend, what colleges they can afford, etc. Land Barons, courtesy of the "free market", and defended by fair-weather free-market fundamentalists.

If you have to live off of your parents, then something is seriously messed up with the system. Randy,While I do see a benefit to the non-bubble regions as a result of the runup in prices elsewhere, I worry about the quality of people moving in. Basically, anyone in FL,CA, NY, ect that sold a home, whether they're a Wal-Mart worker, Ex-RE investor, etc ect, can go to TN, NC, GA, and buy what would basically be a mansion in CA after swapping their tiny studio condo or 1 bedroom stucco box from where they came. So the whole wealth equation could potentially be reversed in these places, where people who might have built wealth with traditional means by building a business could be replaced by any johnny come lately from any of the above mentioned states. Imagine Joe garbage collector owning a 2 story, 3,000 SQ ft mansion. That's the kind of thing my folks see day after day.These people are coming in and gorging themselves on land because they never had anything worth spitting on back in their own regions.This kind of overblown gluttony is what might transform the SE region from being a lasting bastion of healthy middle income prosperity into the convoluted, misbalanced system that exsists in CA. I would HATE to see this happen there.

Randy H, Astrid,

I follow the logic: RE housing wealth redistribution > inter-generational wealth transfer > concentration of wealth. But I suspect that the US has sufficient welfare state/safety-net mechanisms, and democratic input in decision making, as well as strong middle class tradition, to moderate the effects of the concentration of wealth. The recent proposal for universal health care coverage in Massachusetss is a good recent example. The WPA and New Deal are the classic historical examples.

nomadtoons,

I actually don't see benefits to the disparities (even if for slightly different reasons than you, which we've debated before). We're in agreement here that it is bad, at least at ground level (which is where real people live).

The saving grace to the US is that people can and often do move with very little friction. So, as what you describe starts disturbing local economies/cultures/norms, the old residents will move out -- actually the children of the old residents will start moving out. I'm not making any statements about whether this is good or bad as a value-system, but it does make the US _way_ more competitive and resilient than almost every other region of the world. We can adjust to change, even unpleasant change, relatively quickly.

If I recall, the Eurozone is the next most mobile region behind the US (although I forget how Oceania ranks). Yet, Americans are something like 20X more likely to move more out of their birth-regions than Europeans.

I think you're right anon,
If the wealth situation in the US becomes too severe, there will be a lot of noise being made by the general population over it. Taxes will be raised, laws created, and provisions added to dumb down the power of the upper 10%. Whether this is fair or not is another topic, but americans do not like anything close to a third world social structure, which in my opinion is becoming more of a reality every day. The best saving grace is that of the myriads in the non-wealthy category, the majority are well educated. Educated people make changes when they feel threatened.

astrid,

Another problem in this country with the idea of wealth transfer is the increasing costs of retirement for boomers and younger generations. As nomad pointed out (previous thread), many Boomers have a dream of early retirement. What I think many don't realize is in addition to retirement savings for living expenses, health care costs are getting out of control, and this spiraling affects old people the most, as they consume the most health care dollars per capita. A scary statistic in the medical literature a few years back was that something on the order of 60-70% of US healthcare dollars are spent during the last 3 weeks of life. IF Boomers are counting on Medicaire to cover this, think again - they and the rest of us will be screwed by a bankrupt system. On top of that, life expectancy is increasing, so that retiring by 50 means 30-40 years of no work - a lot longer than ever before. I wonder how many Boomers and impending retirees have thought that one out.

Nomad and Randy,

I'm not particularly happy with the outcome of the scenario either. It has already happened in major Chinese metropolitan areas with pretty ugly results.

Pre mid-1990s, almost everyone in urban China lived in state owned housing. They paid a small rent and usually got poor to mediocre apartments in return. In the mid to late 90s, the market was liberalized and tenants were allowed to buy their homes for pittance. The vast majority of families did so. Some of the families also sold their homes and bought into pre-inflated larger homes for a relatively reasonable price.

The people who bought in in major cities before 2003 and their children have an overwhelming advantage to people who came later. In Shanghai, the homes are now worth 600K-1M+ RMB in value. The current wage of an average recent college graduate is about 20-30K RMB a year.

In China, the kids now simply can't afford to buy a home by themselves. The rental market is small and still very expensive relative to wage. They either live with their parents or live in homes bought by their parents. This situation is eccentuated by the one child per couple policy foisted on my generation. Parents and children all treat the parents' property as the natural right of the child and creating large castes of haves (luck ones whose family bought in on time) and have nots (late comers or unlucky)

nomad,

I don't think children living at home is such a bad idea, provided they're working and not mooching. This is how people in most countries with high RE price relative to wage deal with the situation.

Skibum,

:/ Thinking about this country's healthcare system makes me want to pull up and move to Canada or Australia. This country seems to have designed a medical payment system that maximizes waste and minimizes efficiency and usefulness to patients.

Did any of you read this story in the SF Chron yesterday?
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2006/04/16/BUG78I9BTT1.DTL&hw=JPMorgan&sn=003&sc=086

It quotes this guy from JPMorgan - San Francisco branch about how rising short term interest rates have not hurt the liquidity of banks.

"If the Fed is so tight, why is there so much damn money out there?" he said. "There's no liquidity shortage of U.S. dollars anywhere in the world. Banks are chock-full of U.S. dollars. They're running through the stock market, the bond market, the commodities market, exploding through the housing market. One reason corporations haven't borrowed any money in this cycle is they don't need to because they've got so much cash in their balance sheets."

The aritcle doesn't mention anything about M3 being hidden from public view. I think I am finally understanding a fraction of how the whole economic engine works. The corporations have a lot of liquidity because there is a lot of money being printed, so it doesn't matter if the gov. tightens its monetary policy. Other countries gobble up the printed money and make it easy for large US corps to borrow. Did I guess right? Is this how inflation starts while being hidden by Uncle Sam? I think banks increase their mortgage interest rates to hedge against inflation and they are telling us there is inflation while Unlce Sam is telling us sheople to stick our head in the sand. Could this perpetuate the "rolling boom" that none of us want to see?

The homes prices I've been tracking in the El Cerrito/Berkeley area have been stagnating, so housing is not staying on its upward climb in some places.

I agree with the arguments that the traditional values of the middle-class are a benefit to the US, especially given the high education level. I have proposed previously that the Middle Class as we know it is being split into two: the Educated Class and the Working Class. Only time will tell if this shift is merely semantic, or material. I can foresee a future where the Educated Class is positioned with _just enough_ wealth, and _just enough_ property so as to keep their relative position to the True Wealthy, and increase their distance from the Working Class. Being that it is the Educated Class that votes, not the Working Class, this trend would counteract the historical "backlash of the middle class" effect which has saved us before.

No matter what the outcome, I think it's safe to say that the bubble and its income & wealth redistribution will strain the system, even if it doesn't break it.

The idea that the fundamentals and wealth has concentrated has has never made any sense to me, at least with respect to RE. The homeownership rate is 70%. How can anyone say that wealth is becoming concentrated into a class of "landowners" when 7 in 10 Americans are "landowners" by this measure? It is a tautology.

If wealth were really becoming concentrated, we'd see wealthy individuals, like Bill Gates, or wealthy entitites, like huge multinational real estate investment trusts, buying up tract homes by the dozens for use in order to add them to a portfolio of income properties. But this isn't happening. The only people buying up dozens of tract homes are amateur flippers, and the last thing they \intend to do is rent their properties out.

There is clearly a generational gap; right now, all of the wealth is in the hands of the Boomers, and they are not eager to share.

But IMO this problem will resolve itself, and very quickly. Why? Becuase the Boomers are prolifigate. They won't be able to hang onto their homes even if they try. A whole lot of them will still have mortgages when it is time to start collecting Social Security. They have no savings to speak of, even a minor financial disaster will break them. When the time comes to sell, they're going to have to dump the house fast. Moreover, there is the simple issue of supply and demand; the Boomers outnumber the X'ers, when the time comes to sell the McMansion or retirement home there will be half as many buyers. This will benefit the generation who are now in their teens and early to mid 20's, as they will be able to get into the market much earlier than the X'ers did.

Yes, this could take a few years to play out. But the leverage and specualtion, along with the Boomers' lack of savings, will speed the crash considerably.

Finally, even if prices do somehow manage to stay high in the bubble areas, there are still plenty of places that young people seeking affordable homes can move to. Texas, all of the South save Florida, and most of the Midwest are still very affordable. Even if speculative money does start flowing into these areas (and a lot of these areas are already expericing declining RE markets, so it's a little late for the speculators, IMO) there is still plenty of time for younger people of home buying age to get out. The Boomers will be dying off by the time the people in their teens and early 20's are looking to buy, so they will be okay too.

While the housing bubble has been a source of tremendous pain for me personally, I am still optomistic about the long term future. The Boomers have saved nothing. Once they stop working they will be unable to continue screwing the young. In just a few years now they will have to start selling off their assets at fire sale prices beucase they won't have enough cash on hand, and a lot of them will enter retirement still in debt. I see no possibility that they will be able to create a new "landowing" class or continue to redistribute wealth, at least in the RE market.

At some point the Boomers will start raising our taxes to pay for thier Social Security and Medicare, that's a whole other ball of wax. But real estate will be affordable again, no doubt about it.

When all is said and done, I always have to stop for a second and think about my situation: I am living in THE MOST EXPENSIVE part of the country. The complete, total, out of control extremes are not typical anywhere else, and the results of this expense affects everything up and down the list. The poor are more poor, the poverty is more extreme, the rich are richer, and the housing costs are into the stratosphere. Living here for years can make you lose all site of reality. I tell myself this ever day. I and everyone else has a choice. Things are bad in parts of the country, like here. But they don't have to be if you change the scene. Hard evidence is that of all the people that visit the many blogs I've used on this subject, NONE of the users are from any of the non-bubble states. Thus it is safe to assume that there are more Americans are doing just fine without the problems California has, and will continue to do so as long as they too don't catch RE disease. Just stating the obvious, that's all.

Scott,

I agree - this Chronic-le article is poorly researched. Not only is the M3 issue not addressed, but in a related fashion, no mention is made of the Fed's claim that long-term rates are being clamped by large Bond purchases from foreign investors, specifically from Asia, and hence their lack of concern for an inverted yield curve. Seems like we'll have to wait to see who is right on that one...

Also from this article:

Even the recent surge in unconventional mortgages hasn't caused problems, he said. People with interest-only and adjustable-rate mortgages potentially could get walloped when interest rates rise, but so far that hasn't happened. "Underwriters have been fairly disciplined in the type of folks they issue those mortgages to," Walker said.

Talk about living with your head in the sand. Hear no evil, see no evil, speak no evil!

Joe Schmoe,

Hands down the best explanation of how things will play out yet. I really hadn't stopped to think just what an impact the boomers lack of savings will have. If they were cash flush (and they're not) prices would indeed have the "stickiness" that RE Bulls love to flaunt. I mentioned some time back to keep the faith and I feel that my daughters will have a fighting chance as they move forward in their lives. The only negative that I see as the bubble plays itself out is already evident. Smaller, lesser priced homes (often in great shape) are often the only ones in the listings that are selling! As I flip through I'll notice all kinds of "high end" high dollar stuff that just isn't moving. Yet all of the lower end of our inventory seems to be moving reasonably well. In truth the "stall" may have hit here in OR before it hit SoCal and the BA.

Joe,

I've mentioned this previously, but I agree with you re: Boomers and their impending screwed state. Yes, home price decline is imminent right now, but after this cycle runs its course, wait until the next cycle, about 10-15 years from now, when the huge bolus of retiring, downsizing Boomers all decide to sell at once. It's going to be ugly, and if you are poised to buy with good credit and a sizable down payment, you will be golden.

Joe Schmoe & DinOR,

I agree with all this if there is a hard landing, which is really what you guys are predicting. I tend to agree. What worries me most is that there is a huge vested interest by the powers that be to try everything possible to engineer a soft landing. A protracted (it would have to be) soft landing will not result in many of the things you describe, and would cement as permanent the current decade of wealth and income re-distributions.

Joe,
I think adding fuel to the fire, the fact that TONS of people took out those exotic loans will accelerate the fall. As obvious as this is, the callers I heard on the radio show yestreday were ALL people who had taken out such loans and were already in a world of trouble. One caller claimed that he had enough to stomach one- maybe two months more at his current rate, then he would be in trouble. I think these people will push the "start" button on an accelerated crash, right along with overleveraged boomers.

nomadtoons2,

I wish I could have heard that radio show! If they are already experiencing trouble I'm having difficulty visualizing a soft landing. What's also interesting to note is that if we were to check Zillow or "comps" or whatever we'd probably find that the caller's residence is actually "appreciating". Well that can be of little comfort to this guy b/c the simple truth is that he can't keep up the payments! Game, Set, Match.

Randy H,

Even a "soft landing" will not prevent much of Joe's scenario. The unavoidable demographic/population trend will be Boomers retiring, and a significant portion will not want to live in a 4000sf McMansion or other home that they raised their kids in until they die. They will want smaller utility bills, closer proximity to vacation areas, retirement/active adult communities, or whatever. The soft landing scenario will only drag the downtrend part of this current cycle we are about to see into the next phase of Boomers selling en masse.

Randy H,

That is exactly what has been so frustrating about this bubble! EVERYBODY has a "vested" interest in seeing this thing continue on a 45 degree ramp, and if not what can be done to stem the tide on the damage control side? I swear it's like the teacher letting the class decide if they want to go back inside or spend the rest of the day on recess! Tether Ball anyone?

Randy,

What would be the mechanism to "engineer a soft landing"? What levers would the "powers that be" pull, and who are they? I'm not asking facetiously. I really want to know what you think. Is it hyper-inflation? Or long term moderate inflation? And what specific monetary tools do they use to try to reach that goal.

skibum,

Harry Dent has written about the effect which you describe at length. One of the impacts he details is the generations following the boomers not being able to go to the "equity extraction" in home ATM Machine b/c he visualizes a protracted controlled crash. He also said the DOW would be at 30K by decades end and I think he is wrong here. A hard landing is what's right. It's what's fair. We owe our children nothing less than a smoking whole with unrecognizeable smouldering fragments strewn across a swath of 6 western states! Incoming!

For Sacto's recent foreclosure, pre-foreclosure and bankruptcy trends go to:

http://sacramentohousingbubble.blogspot.com/

The other point to keep in mind is that yes, those with vested interests may attempt to "engineer" a soft landing, but who is to say they will be successful? IF, as many of us believe, the current financial and housing situation is in crisis mode, the Fed/government can inflate all they want, but they won't be able to avoid some form of financial meltdown. It's just a matter of how fast, how severe, and specifics of who and what gets screwed. Let's just hope it isn't savers/bears that get f'ed by hyper-inflation.

Garth,

I realize you addressed this to Randy b/c he started it but where do I even begin?

Obviously realtors, lenders, appraisers, mortgage brokers, builders and part time employees at Home Depot all have a stake in this and would be perfectly happy to see this wonderful "economic engine" keep humming along!

Other than playing patty cake with int. rates doing penny ante hikes for about two years signaling to even the most oblivious among us what the FED's intentions were so each specuvestor could time his exit?

Other than playing a shell game with listings to show them as "New on the Market" when they in fact had been trying to sell them for over six months?

Other than appraisers "hitting the numbers"?

Like I say, where to start?

Randy-

I have worried about that too. I don't know much about economics, so I have no opinion on the tools that the government might use to engineer a soft landing.

However, I do know two things. First, government moves slowly. If they intend to enact some kind of RTC-type bailout scheme and begin buying up defaulted mortgages at pennies on the dollar, this will take a long time to propose, pass, and implement. If Joe Flipper's sheriff's sale is 82 days away, the relief will come too late for him.

Second, government bailout schemes tend to promise much and deliver little. "Disaster relief" after an earthquake or a flood pretty much consists of giving you a low interest loan to fix your house, not a cash subsidy. I can see a government bailout of housing involving similar unappeal terms. Maybe the government will offer to extend the term of the mortgage on your McMansion to 50 years or something. A lot of people will just bail on their homes if this happens, much like the New Orleans refugees who have decided that they aren't coming back.

Finally, this problem may simply be too big for the goverment to solve. I can't see the government, say, doubling the size of the national debt in order to bail out the Boomers. This is possible, but strikes me as unlikely.

Still, I really know nothing about economics or the tools that the goverment can use to manipulate the economy so I would be interested to hear your thoughts.

Finally, and I know that not everyone here will agree with this one, I don't think that karma will allow the Boomers to escape their just desserts. Some twice-divorced 50-something driving an SL500 with hair plugs/breast implants and living in a McMansion -- this person will not escape paying for his or her sins. I just know it in my bones.

I believe that should read "smoking hole"

Garth,

The levers are relatively simple: liquidity and credit standards (which are largely related to liquidity and velocity).

Hyperinflation need not be the outcome, just some moderate inflation, even if accompanied by recession/low growth -- stagflation, this would reduce the risk for creditors allowing them to continue to extend weak credit in a low rate environment. Continual tightening and loosening by the Fed over say 25 years, add in a couple of minor but significant cyclical (not secular) bull stock market trends, and a slow erosion of what is the "accepted" unemployment rate, and you have a long-run soft landing.

The main ingredient is that the Fed can dramatically impact the base-component of the discount rate that all the creditors use to determine their risk-management formulae. If money is easy, then you can afford to write risky loans. In fact, you can't afford _not_ to write these loans.

Who are the powers-that-be? I don't believe in conspiracy theories. WE are the powers-that be, in that we don't vote and those who do elect (either purposefully or out of ignorance) legislatures and executives who are aligned with these intentions.

Joe Schmoe,

Five to One baby

One in Five

no one here

gets out alive!

Okay, I know this is basic stuff, but the discount rate is what the fed charges the member banks?

Do they also somehow regulate the money supply by buying and selling government securities? I really am new to all this.

While we're at it, what is the federal funds rate? Send me a bill and I'll charge it to my continuing education account.