As someone who has missed most of the real estate booms in his lifetime, I should hardly be qualified to write about this one’s coming collapse. Nor is there any law of averages or economics that says property prices should start to fall, just because the Federal Reserve is pushing short-term interest rates up. But I got interested in the real estate bubble on a trip last spring across the United States. In short, I made a long circle from New York to Los Angeles, by way of North Carolina, Alabama, Mississippi, and Texas, and all anyone wanted to talk about was how much their house was worth.
A friend of mine in LA, a school teacher, said his central-city ranch house was worth a million dollars, and my friends with New York apartments spoke like the late Senator Everett Dirkson, who remarked about the federal budget: “A billion here, a billion there, and pretty soon you are talking real money.” In between, the real estate market seemed neatly divided between tear-downs—houses on attractive lots that could be torn down and replaced—and MacMansions, Gatsby-like homes with turrets, columns, six bedrooms, endless family rooms, basements, Jacuzzis, weight rooms, and plasma-screen televisions, that are usually lived in by a couple, often thinking of getting divorced. In the Hamptons, on New York’s Long Island, I think a trailer—not even a doublewide—would sell for $5 million, provided the seller managed to throw in long-term parking. Needless to say, everyone I met agreed that they had become home millionaires.
Looking at the housing figures, I suppose many of them are right. In 2004 median prices of New York condos were $888,000, and since then prices have jumped another 25 percent. On either the East or West coasts, a million dollars buys what in Brooklyn we used to call a “shell” or what my sister called a “see-through.” According to Paul Krugman, the New York Times columnist and a Princeton economist, in the last five years housing prices in New York have increased 77 percent, those in Miami 96 percent, and those in San Diego 118 percent. At the same time, the stock market, where many people have their savings, has been either flat or lost money, and when many homeowners get their raise at work, it has been in the realm of 2 percent and a firm handshake for all those late nights and weekends answering e-mails. So where do people get the money to bid up prices in real estate?
Easy. They borrow from the equity they have in their existing houses, or will have in their houses. Home equity loans in the U.S., according to one published source, now amount to $398 billion, and 40 percent of this easy money (“Honey, where’s that checkbook on the house?”) is pegged to adjustable rates. Other houses are bought with nothing down or with so-called “no-doc” mortgages, where you don’t have to tell the bank that you got laid off six months ago, while drying-out, after all that bad luck in Vegas. As The Economist magazine once wrote: “When it comes to making mistakes, commercial bankers are hard to beat.” Now with fewer merger and acquisition deals out there, little commercial growth, and thin margins in trading, most big banks are betting their balance sheets on branch business—sending pre-approved credit cards to deadbeats and encouraging strangers to take out a mortgage. As Charles Ponzi found out, so long as your customer base is growing, or in this case real estate prices are rising, you can continue lending against invisible equity in houses. By the time interest rates rise, prices on housing fall, and panic selling sets in, it is usually too late to buy that plane ticket to Brazil.
I often wonder how the government publishes inflation figures, because in the last several years, we have had an explosion in the cost of housing, oil has gone through the roof, gold is selling up on the charts, and then, when some august body reports on inflation, they announce it is in line with low expectations. I think this is largely the effect of falling wages and salaries, as jobs ship overseas and big companies like General Motors decide to walk on their pension liabilities. (That will teach those union people to get old.) But one reality of the housing market is that real estate, over the course the last three or four hundred years, has only ever managed to keep abreast or slightly ahead of inflation. In his new book on the housing bubble, Robert J. Shiller reported that between 1628 and 1973, real estate had returned an average of 0.2 percent a year. So much for flipping condos in Newport Beach, at least if you did it for 350 years.
What will choke off the easy money in real estate speculation? I would bet my money on the large banks, which will suddenly find, in an economic downdraft, that their property portfolios are underwater. As they raise rates and call in bad loans, the forced collateral sales will drive down the markets, with vacation homes, cheap condos, and MacMansions in corn fields leading the way south. Independent of the banks, Fed rate increases will also increase the cost of carry on all the paper that is tied to housing: adjustable-rate mortgages, term mortgages, home-equity lines of credit, etc. In those cases, it will be easier for speculators to dump marginal properties, or properties bought on margin, than to sell shares or dip into other savings, especially as much of that money is already tied up in paying for the concierge over at Dolphin Bay.
The problem for most people is that, even when they believe the real estate market is headed for a dive, they find they have fallen in love with their properties and can’t imagine selling them as they would junk bonds or penny stocks. Plus everyone feels wonderful living in a house that has doubled in value: having your cake and watching television in it too. At that point the only strategy is to diversify the rest of your portfolio, buying investments that today look unromantic next to time-shares at Pebble Beach. That might be the shares of large companies, with solid cash flow, that the market is overlooking; that might be funds that will buy distressed securities after certain markets have tanked; or that might be short-dated bonds that you can roll-over as rates increase. I will explore some alternatives in a future column. But in the meantime I am open to ideas as to how to short the real estate market without calling the movers.
