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|You know those ads: "With interest rates at their lowest in decades and the stock market taking more hits than Mike Tyson's speed bag, it's time! The safest investment you can make today is in owning your own home! Call Top of the Bubble Mortgage Co. right now!" Hey, a safe investment in this economy! What could be better? Let's call this very minute! Got to buy a house. Now! |
Maybe, maybe not. Maybe things really are different this time. Just because a real estate downturn has almost always followed a stock market crash doesn't mean it will happen again this time -- right? That said, perhaps this would be a good time to look at how the traditional economic cycle works before dropping what is left of your hard-earned working money into a down payment for a vastly overpriced home.
It hasn't been that long since we were bombarded with cleverly worded commercials for various and sundry brokerages, suggesting the best thing you could possibly do with your money was to put all of it in the stock market. Some of the largest and most trusted brokerages were touting some of the world's fastest-growing corporate names. It just happened several of those fast-growing corporations also had some of the world's most unstable stocks. The brokers for the big houses were telling all of their clients, "Enron! WorldCom! Tyco! Global Crossing! Invest today!" What made the hype all the worse was that, as it turned out, the brokers knew the stocks they were selling were not worth the paper the certificates were printed on.
HOW SOON WE FORGET
More often than not, those shouting "Buy!" the loudest are the same people who themselves are selling the fastest, and with good reason. Unfortunately, the biggest, baddest apples in the industry, with their leadership positions in research and their large analyst staffs, set the traplines that were eagerly run by the rest of the brokerages hunting for your consumer dollars. Could it be that an "own your own home" trap is now being set for those wishing to invest in real estate?
Why do I ask? Overpriced and/or rotten stocks or not, the stock market runup created a lot of wealth -- on paper. A lot of that paper wealth went into down payments for homes, homes that were appreciating at explosive rates.
In some of the more affluent US cities, housing prices were rising well over 20% a year. In some communities, home prices were doubling almost every year. Some areas of Silicon Valley saw neighborhood median home prices for more than $500,000. Regardless of the price, homes were being snapped up almost before Realtors could pound "For Sale" signs into front yards. Putting a house on the market often touched off a bidding war.
People who were rich on paper and getting richer by the minute in the dotcom industry were throwing money at anyone wanting to sell a home. Even when the stock market peaked and then plunged, the housing market continued its upward trip as if attached to the tail of a Saturn V rocket.
Even as the equity market began its fall from irrational exuberance, another train was on the parallel track of housing price inflation, still headed for irrational exuberance with a full head of steam. The train was the "Keep Up Appearances Special." The brochure for the Special notes that with housing prices up and the Federal Reserve cutting interest rates faster than a French chef with a new knife, this would be a great time to refinance the house. Get on board now! Take out all that inflation-created equity, and continue to spend as if there is no tomorrow. The KUA Special has become a popular excursion: The scenery is much nicer than the view on the trip to reality.
In fact, the refinance-and-spend mentality is so popular that it has been keeping our country financially afloat -- for now. According to BusinessWeek, "The amount that Americans owe on loans for houses, cars, credit cards, and other purchases adds up to nearly 100% of their annual income after taxes. That's up from 75% in 1992, after the last recession ended" [emphasis mine].
Getting a loan is easy, and no one seems to notice the unemployment numbers in some states are hitting highs that sopranos only dream of. Refinancing is keeping our country from recession -- for now. Where will it all end?
If you are about to go for the mortgage company's "safe investment" bait, you should care. At least consider some of the following before plunking down what money you saved from the stock market crash for a down payment on a home at the top of what could be a real estate market bubble.
When the prices of homes were skyrocketing and nouveau riche dotcommers were piling bundles of cash at the feet of homesellers, we heard that old refrain: "Things are different this time." But don't you remember hearing that Dow 36,000 or even Dow 100,000 was just around the corner? If you needed money to start an Internet business that washed parakeets' feet, no problem! Collateral for a house, too! Hell, those stock options had to have been worth half a million at the minimum, plus the salary for the job was six figures a year. While you were at it, you could get a little extra so the kids could go to private school in Switzerland. So far, so good.
Alas, the market for clean parakeet feet was a tad thinner than originally projected. The loans for the 6,000 square-foot house, and for the only slightly smaller SUV, were now a part of the family. With some regret it was announced that parakeetfeet.com was clean-feet-up, the stock options were worthless, and the six-figure income disappeared when the website went blank. One thing was for sure: the kids would go to public school.
With no monthly income and considerable monthly debt, it was time to: 1) think about getting a smaller car and a smaller house, or 2) just refinance the house, take out the three years' worth of inflation equity, continue to live as if all is well, and pray a job appears on the horizon before the home equity cash runs out.
Judging by the facts, it looks like many were/are living with option 2. But now it appears as if the chances of finding that new job are becoming more and more unlikely. Besides which, refinancing has about run its course and, barring a miracle, the Dow Jones Industrial Average (DJIA) is likely to end what little bear market rally it has been enjoying. In short, the well of refinancing-induced money is drying up.
If the economy were to bounce back to previous levels, the second option might even be viable, and maybe everything would work out fine. But there is an excellent chance the longest-running bull market in history will be followed by a bear market with similar lust for life. There is a considerable group of financial pundits who feel, with apologies to John Paul Jones, "We have not yet begun to fall."
Many of those financial pundits believe that Dow 5000 is a distinct possibility (Bill Gross, PIMCO Bonds and Fox News), while Robert Prechter of Elliott Wave International believes that the bottom of the bear for the DJIA will be well below 1000. In any of such scenarios, replacing the income that used to support a pre%ADmarket crash lifestyle won't be easy -- but miracles can happen.
Unfortunately, the economy is like a fish in the river. If the fish isn't swimming upstream faster than the current, it is going down the river regardless of the way it appears to be headed. Home sales may still be growing and prices still rising, but the growth rate is decreasing. SUV sales are falling off. It wouldn't take a soothsayer to figure out which way car sales in general have been trending, with the plethora of no-interest financing options now available. All of this seems to indicate the consumer isn't consuming as much these days. While it isn't making headlines, this decrease in spending cannot be considered good.
SUV AND CAR SALES? HOUSING BUBBLE? WHAT'S THE CONNECTION?
Consumers provide about two-thirds of the power that moves our economy. If the consumers are running out of spendable cash -- that is, if they no longer have either the money or the inclination to buy things -- the economy is headed even lower. If the economy slows down even more, then the jobs will not be coming back. If jobs don't come back, then once the mortgage refinancing money is spent, home loans will not be repaid. Soon thereafter there will be homes for sale all over the place.
At that point it becomes a straightforward supply-demand situation. Prices went up dramatically when the buyers outnumbered the sellers. When sellers -- in many cases forced sellers -- outnumber those who still have money left to buy, then the housing prices could plummet the way they went up. It is unlikely homes will lose value at the same rate they gained it, but lose value they will.
Here in Seattle not so long ago, "For Rent" signs were rare. Finding a decent place to live was a tedious process, and rents in the city were outrageous -- and increasing sharply every time a lease was renewed. Expensive new apartment buildings and million-dollar condos started going up faster than summer thunderheads in Oklahoma.
Now, "For Rent" signs are popping up like dandelions in spring. They are everywhere. Prices have only just begun to fall, but a glut of empty condos and apartments is forcing rental agencies to begin making some sweet move-in deals and lowering prices to keep occupancy rates up. In my neighborhood, one place that rented for $1,000 per month two years ago is now renting for $700 and the landlord is happy just to have a tenant. Other landlords will soon have to follow suit or see their vacancy rates rise faster than their rent increases of a few years back.
Granted, buying a home and renting an apartment are not one and the same, but they are definitely kissin' cousins.
HERE'S THE SCARY PART
To enable buyers to get into a home of their own even at exorbitant prices, a lot of real estate loans were made with only 5% down. At first glance that seemed like a very nice arrangement. So long as prices continued to rise, it was.
The problem comes if/when prices begin to fall. With only a 20% drop in housing prices, that 5% down homeowner would have to come up with three times his original down payment just to get a new loan! As homeowners lose their ability to make their loan payments, they concurrently inherit an overwhelming cost for escaping the payment they can no longer make.
When the oil boom was finished in Alaska in the late 1970s, it was not unheard of for a homeowner, in a similar situation, to just drop the house keys off at the bank as he skipped the state. Once prices begin to fall under such conditions, they tend to go down to a painful degree. The areas of the United States that were once bemoaning the fact that their home prices were not appreciating at the big-city rates are now enjoying the fact that, at least for a while, their housing prices aren't coming down like those in the big cities either.
As I write this, the price of housing is continuing to rise, though more slowly. Likewise, the stock market is enjoying a bounce. It is possible that everything will continue to improve, and that buying a house is absolutely the best thing you can do with your money at this time.
That said, in the very early part of 2000 everything looked even better in the stock market than the housing market looks today. Many investors thought that stock prices would continue to go up and that every minute they stayed out of the market was a minute they were losing money. It turned out that buying stocks in the markets' rise was actually the worst thing they could have done. Something else to keep in mind is that it is easier to sell a stock than it is to sell a house, if/when the respective markets turn south.
My point is not to encourage you to buy or sell a home. My purpose is to shine a broader light on the ramifications of the major decision to buy a home in view of the current economic conditions. Check out the references. The first one has many excellent links to other authoritative information on the subject. Good luck!
Bruce R. Faber is a Staff Writer for Working Money.
"Riding The Real Estate Wave," October 25, 2002
"Real Estate Prices Soaring Around The US," by Sue McAllister: June 21, 2002
"Home Prices Out Of Line With Incomes In 17 Markets," by Lew Sichelman: July 10, 2002
"More Homeowners Face Foreclosure," by the Associated Press: Chicago, July 29, 2002
"US Housing Bust Another Step Toward $1,255 Gold," by Ned W. Schmidt: July 30, 2002
"Consumer Credit: A Crunch May Be Coming," BusinessWeek: August 12, 2002
"As Economy Falters, Could Housing Be The Next Catastrophe?" by Phil Brennan, NewsMax.com: August 29, 2001
"The Perfect Financial Storm? Financial Storms Heading Toward the U.S. Economy," by James J. Puplava: October 26, 2000
Homeownership Alliance: Frequently Asked Questions
"Consumers Borrowing To Live," brief from the Center For Media Research: September 19, 2002
The Global Macro Letter: August 25, 2001
"God, Gold, The Fed, And Capitulation," by Richard Lancaster (scroll down)
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