What is a "bubble?" A bubble is like a pyramid scheme. In a pyramid scheme there is a product. You buy the product from someone with the idea that you can sell it to someone else. Then you sell it to someone else who hopes THEY can sell it to someone else etc. In order for sellers to make a profit, each seller must increase the price at which the product is sold. Sometimes value is added to the product and sometimes not. There comes a point somewhere along the line when the price of a product exceeds any buyer's perception of its value. That is when the bubble "pops." The person left holding the product will have to lower the price and accept a lower profit, a break-even price, or price lower than the purchase price just to recoup the loss.
The property bubble is a phenomenon with multiple causes and elements. In a nutshell, property buyers were willing in droves to take out high-interest mortgages on the assumption or the hope that they would not be holding it for long, but would sell it quickly for a much higher price that would net the seller a profit and offset any value added labor & materials or monthly payments they would have to make. As prices went up, first-time buyers panicked at the idea that the price of homes was going up so quickly that if they didn't jump aboard, they would miss their last opportunity. They also had to take on high interest, low down-payment options to afford the rising prices. There were many speculators, many hastily thrown together real estate buying companies. That was one level.
The banks lending mortgages traditionally analyzed the deals and investigated the credit, identity, and other means of buyers. In the frenzy, some of these details were overlooked. That was another level.
Banks could afford to overlook the details because they were not holding the bag for long. They quickly sold their individual stakes in these mortgages to hedge funds. In passing the hot potatoes, they were guaranteed a profit and assumed none of the risks associated with foreclosure. The hedge fund managers were eager for the high returns from these mortgages. As long as they were being paid these high interest rates, they wagered they could weather some minority of foreclosures that might result. That was another level.
The ratings agencies whose job it is to rate the risk of an investment were handed bundles of mortgages. The bundle was miscellaneous. It might have a whole bunch of high interest mortgages relative to low interest (more secure) mortgages or the other way around. The way these bundles were put together was relatively random, but there were many more high interest mortgages on the market than low interest ones. Accustomed to "pure" security instruments, the ratings agencies were flummoxed. There was no way to know what was in a bundle. Without that information, there was no mathmatical guide for assessing risk. Experience had shown that for some years, high interest mortgages were earning and for the most part were being paid back. Rather than "punish" the bundles which historically had performed well, the ratings agencies decided to give them the highest rating, that which is given to the lowest risk investments. That was another level.
End investors which included a large number of European and Chinese banks bought up these too good to be true investments which supposedly had amazing returns and low risk of default. Pop! Since long-term buyers who are logically the last buyers of a property could no longer afford or refused to pay higher prices for properties, the market demand decreased. If you picture a small number of speculators, buying selling, buying selling, while home builders respond to this artificial demand or hope to be at the first level of the pyramid too, it produced a glut. Buyers could then be more choosy and were in a better position to bargain. Speculators who could not sell defaulted. Some may have sold at a loss. Worse, long-term buyers who bought mortgages they could not afford defaulted and lost their homes. Many more defaults and foreclosures than had been anticipated crashed the housing market and cost security investors billions. The Federal Reserve Bank paid back the foreign banks who were threatening to sue over the misclassified securities. Foreign central banks are now reluctant to invest in any sector of the U.S. Market which has led to the dollar's decline in value against other currencies.
The Housing Gap
Between 847,000-3,470,000 people are homeless in America, according to the National Alliance to End Homelessness. Current estimates suggest that of fixed residence dwellers 60% rent and 40% own their primary residence. Wages have stagnated over the last 30 years resulting in an inordinate gap between what workers earn and the location and type housing they can buy. People will strain to afford a house. Homelessness is a disaster few people could easily overcome. Incentives have been added to make defray some of the costs of homeownership. For example, mortgage interest is partially tax deductible. People can borrow against the equity in their homes.
Since the 1980's wages have remained stagnant, labor's bargaining power has diminished, so that more and more economic aspiration has been placed on homes. The home seems to give back more than what is put into it so that for years, appreciating home values offset deteriorating income and became the primary wealth instrument for lower and middle income Americans. As income continued to decline, desperation for homes increased. The demand led to higher prices, but also to a greater number of predators. High prices signify not only higher demand and an attempt by those in command of a lower supply to slow the demand, but a buyer can make a distress purchase just as a seller may have to make a distress sale. Distressed buyers are easier targets for predatory lenders. They are more easily manipulated into unfavorable contracts and may risk everything for the chance to live in a home. Now, the final ownership of homes is unlikely to ever accrue to most homeowners.
Now that the bubble has "burst," some might be tempted to say that former boom areas are now buyer's markets, but that would be oversimplifying. Home prices have gone up in my area by a factor of 10 in the last ten years. If prices fall by 3% that is nowhere near enough to make homes more affordable for most people. It may enable distressed buyers to be more cautious in their mortgage negotiations. Some of the speculating frenzy may diminish. The buyers will largely be middle class medium-term buyers and speculators. Few long-term buyers will buy under these conditions.
The incentives for "security" buyers is diminishing. With home Prices so high; interest compounding, soaring property taxes assessed under bubble conditions, and pay still stagnating, it is unlikely for most home buyers today to ever fully pay off and own their own homes. The security and income discretion that was at one time the main impetus for home buying is drifting further and further out of reach. This used to be one of the things meant by "The American Dream," that via ownership of one's home and land, an individual was less dependent on the production economy and had greater liberty to pursue his or her own dreams and/or to contribute more of their own energy, ideas, and money to the common good. Those who spent their lifetimes paying off their mortgages, were assured that in their old age, they would at least have their homes. They could not be evicted when their social security benefits didn't cover rents.
As homebuying exploded, the rental market softened. Rents in Salt Lake City, one of the most vigorous boom areas, did not go up in the recent years of the boom quite as fast as single family homes. Older rental stocks could continue to offer lower rents. Newly purchased properties had to be priced above market and had a hard time attracting tenants. As of this writing, rent is still high relative to income, especially for single parent households. Still, as rents stayed somewhat lower and home prices soared, the difference between monthly rent and monthly mortgage payments plus interest, property taxes, maintenance etc... started at double.
Homes as wealth instruments functioned for a long time very well for speculators, but as housing security and as assets, their usefulness and availability are declining. Lower income prospective buyers would fare best in this market at bank auctions of foreclosed properties, putting as high a down payment as possible. Those who are not in a position to do this will instead want to keep saving for a down payment. It might be necessary to buy in a part of the country that is not one of the inflated areas. To purchase a home for reasons of housing security, the real estate of the future will have to be paid for with real money.
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