Pop Goes the Bubble

CNN/Money posted a great article today on the state of the housing market. Though it looks at the market on a nationwide basis, Orange County gets a special mention:

Last week, real-estate tracker DataQuick said home sales in Orange County, Calif., the No. 2 U.S. market, slumped 17 percent from a year ago. The No. 3 market, Riverside-San Bernardino, Calif., was holding up very well, thank you, but sales fell in San Diego and Los Angeles, No. 4 and 5, respectively.

The article also notes that home sales in Las Vegas, previously the hottest market in the nation with a 52.4% increase in a single year, are “suddenly dead in the water“.

I look at this as a positive thing. With any luck, it will slow the rampant speculation that’s been driving home sales lately. There’s nothing more dangerous than an millions of Americans tapping equity in their overpriced homes to buy more real estate. It’s nuts. Have these people never heard of “buy low, sell high”? Okay, if it’s your primary residence, that’s one thing. It’s not an investment, it’s your home. But folks seem to be falling all over themselves to leverage their way into as much real estate as possible, and at any price. It’s pure speculation. And that is the white elephant no one’s been willing to acknowledge for the past four years.

It seems that individual investors have learned little from the 2000-2003 bear market. Only this time, if anything, it’s worse. At least with equities, you could diversify. With real estate, there’s no way to do that. You can buy $5,000 of Enron, but you can’t buy $5,000 worth of real estate. It’s more like $500,000 — at a minimum. Own just two properties and you’re looking at a million bucks worth of exposure to the real estate market. This wouldn’t be so bad if the average LTV ratio were at 50%. But it seems like it’s more like 95% these days.

Most economists doubt there is a national housing bubble about to pop. There seem to be bubbles in hot markets such as Vegas and Orange County, but most analysts hope the declines in those markets will have little impact on the rest of us, aside from maybe making their TV shows a little less glamorous.

They “hope”? Those economists are idiots. Southern California is the economic engine that drives the entire state. And if the state economy takes a serious dive, you can bet the rest of the country will follow suit. I think such a malaise is less likely now that the state budget has stabilized, but we’re far from being out of the woods here.

Paul Kasriel, chief economist at Northern Trust, has noted that U.S. banks are heavily exposed to the housing market, with about 60 percent of their assets tied up in home financing of one sort or another, the highest since World War II.

“If the U.S. housing market goes bust, the U.S. banking system is likely to fall on very hard times as the value of all that housing collateral drops,” he wrote in a recent note. “History suggests that as goes a nation’s banking system, so goes its economy.”

Bingo. If it wasn’t for the fact that Freddie Mac will buy as many loans as a bank wants to resell, some financial standards might have remained in place to prevent things from getting so far out of hand.

There have always been ups and downs in the markets. But for the last quarter century, the amplitude has been increasing exponentially. The inter-generational transfer of wealth to baby boomers is partly behind this. If you think the tech sector has created a lot of money in the last decade, you wouldn’t believe how much money is changing hands through the simple passing of time.

More than half of all wealth in the United States is held by people over the age of 55 — 37% of the population. This segment of the population has 300 billion dollars in discretionary income. They spend more than a trillion dollars annually. And they’ll pass on about $11 trillion in wealth to the new generation of investors, who are looking for a place to put it. In the last decade it went into the stock market; now it’s going into real estate.

Does history repeat itself? We’re about to find out.

Again.