Quit calling it a real estate bubble! Its a credit bubble.

[barnaby33]

I needed a quippy title, so there you go. I have been reading, participating in this blog and trying to research the real estate bubble since 03. What I realized after I found piggington is that the real estate bubble is really a credit bubble. Real estate just happens to be the facet of that bubble that we focus on here.

Whenever I hear someone say there is no bubble, I think hmmmm, my credit cards are at historic low rates, my car loan while not rock bottom is pretty low as well and if I had a mortgage, regardless of the variety, it too would be cheap by historic standards. So either the preceding statement is wrong, or there is ALOT of cheap credit to be had.

Now having said that, there are a couple of quick assumptions. One that if you lower the cost of borrowing, it enlarges the amount of money the average person can borrow. If you lower your lending standards you increase the pool of potential customers.

So as we have steadily seen in 2006. Credit standards are tightening, albeit slowly. Interest rates are going up, again slowly but up nonetheless.

The credit bubble is deflating. Whats left to debate is the outcome of that deflation. It doesn’t seem impossible to me to, “follow the money,” just difficult. Its easy for us to see in a macro sense that alot of this cheap credit went into housing, but where else did it go? Did it really go into things which when rescinded will cause us to tip into recession?

The credit bubble is not a local phenomenon, the cost of debt is pretty much the same no matter where in the US you live.

I am a firm believer in a huge credit bubble that worked its way into our housing market. I am also a firm believer that we have lived since September 11th on the froth of a global credit bubble. I am also a believe that this deflation will cause a recession, a rather nasty one.

I’d like to take a step back and ask the forum members, where else they have seen the credit bubble and how they think the deflation of credit will affect that industry.

I realize this question has been addressed before in parts in other forums. I wanted to ask this though in its own forum and see if we could come up with some new perspective.

Josh

[Bugs]

I think credit is one part of it, but I think if that was the primary cause then the results would be more evenly demonstrated in every other market in the U.S.. All areas of the country have equal availability to these credit terms and yet many of these other markets have not (so far) demonstrated such outsized gains.

What’s interesting is watching the investors migrate from market to market. San Diego was hot but now these guys have moved on – first to Arizona, Las Vegas and Florida; and now on to Seattle and some of the smaller markets in the Midwest and the South. They’re trying to keep the ball in play and as long as they can do that there’s a lot of money to be made.

[Anonymous]

Consumer spending and retail sales are two primary beneficiaries of the “cheap money.” As could be seen today in the employment report, quite a few jobs were lost in retail last month. This might be the first sign we see of the house ATM being cutoff. I read yesterday, that some loans will adjust to 6.5% above libor soon. Many of those loans are currently 3%. Can you imagine the effect on a household, an adjustment like that could have? The payment could increase four fold over night.

I think we are going to find that many people have put themselves in an unwise position soon. What happens after that who knows?

One other thing that has been propped up by rates is the stock market. As a trader I can tell you by my research the two things that moves stocks are rates and earnings. Earnings, often follow rate cuts for obvious reasons.

As we see bonds dropping and stocks rising like this, it is time to be cautious in stocks. These types of combinations in the past have led to some of the biggest stock selloffs in history.

Hopefully, this is on topic, as essentially the credit bubble deflating here is going to cause a stock drop, as well as a consumer spending dropoff.

[Carlsbadliving]

Bugs… I know that all areas of the country have had access to the same credit terms, but do you think that lenders have attacked all areas of the country like they have in SoCal and other bubble areas? with all the ARMS/IO, etc. I briefly considered buying last year and calculated that we could afford in the neighborhood of a $450,000 home (based on approx. 35-40% of income, 15% down payment, etc). Well, the lender called the realtor and told her that we were approved for up to $650,000. I was blown away. I would never even have dreamed of making a purchase like that. But I’m sure a majority of people would have jumped at the chance to “own” a $650,000 house.

Yet, a good friend of mine just purchased a home in Michigan last month and was barely approved for a loan of $140,000 (good credit, just a low monthly income). I think that the lenders have preyed in the areas of the country (particulary SoCal) where people will do anything to look the image. They’ll throw common sense out the window to have a bigger house than their friends. Perhaps the midwest or any other areas relatively untouched by the bubble aren’t concerned with those factors. In fact I’d argue that the only reason some of those areas have seen any increase in price is because of Californians, etc. cashing out and taking there money there.

I’d be interested to hear if people in other parts of the country are/were constantly bombarded with lending ads, home equity lines of credit, etc.

[lindismith]

I’m also interested to learn more about this. My sister’s mother-in-law got herself into serious credit card debt over the past 5 years. It was to the point where the balance was staying the same even when she was making $500.00/month payments. The solution? Refinance the house. She had only 6 years left on her home loan until it was paid, and now I shudder to think of what shady broker got her into what kind of shady new mortgage. (I will ask my sister, and see if she’s ok.) This woman has a college degree from Cornell. And she’s certainly been responsible for herself for the last 35 years as she’s divorced. But yet, she’s accumulated all this debt. I should also add she doesn’t make a lot of money, (she works in a clothing store,) and certainly she’s responsible for her own spending habits, but the lure of easy credit, and predatory lending practices have put a lot more at stake than anyone intended.

Bugs, I’m also interested in hearing more on your thoughts.

[4plexowner]

The fiat US dollar is backed by debt. New dollars are created when somebody borrows money against some asset. No new money is created unless some new debt was also created (this is true even when the US Fed prints money to buy treasury bonds for its own account – they wouldn’t do THAT would they?! LOL).

Given this constraint on the creation of new US dollars, the US government and the US Federal Reserve (which is a private corporation that we the people pay interest to for the money they create out of thin air) need some asset class to rise in value so people and businesses can borrow new money against the rising assets.

Real estate has provided this rising asset class since 9/11 – several trillion dollars worth of new debt/money has been created based on increased real estate values.

Prior to 9/11, the rising equity markets served as the recipient of new debt/money.

Because it takes money to service all the debt (interest expense) that is created, each new dollar provides less ‘bang for the buck’ in stimulating the economy. It now takes 4 new dollars of debt/money to create 1 dollar’s worth of GDP (this ratio was below 2 prior to 2001).

As of 2005, we the people are paying over $352 billion in annual interest on the national debt. That is almost $1 billion / day JUST IN INTEREST. And remember that we the people are borrowing about $2 billion / day just to keep our economy running.

So, let’s see, we are borrowing $2B per day in new debt and using almost half that money to pay the interest on the existing debt.

How long could you run your household using this type of financing?

America is headed into the Next Great Depression and most Americans don’t (and won’t) understand why.

The ‘rising prices’ that you are currently suffering from are caused by the debasement of our money supply. Prices aren’t rising – what’s happening is that your debased dollars are buying less and less. Inflation is a lie which has been sold to the public for decades – we’ve been told that a little inflation is necessary and even good. There is no inflation (short of serious supply/demand imbalances), only monetary debasement.

The coming depression will restore honesty to our fraudulent monetary system but it will be a VERY painful process.

Silver and gold are the only real money and they will serve you well as the US dollar heads towards its true value – ZERO!!!

[barnaby33]

How do you justify that those two categories are/were the largest two categories?

Why would a decline in these two then affect the stock markets in such a blanket fashion?

I can understand how tightening credit would cut off new investment but if a company has already borrowed the money, why would rising rates necessarily affect its performance adversely. (Excluding that in general higher interest rates curtail investment.)

Josh

[kgruskin]

Hmmmm, not sure what is meant by “more evenly demonstrated in every other market in the U.S.?” If you are speaking in terms of geographic location and cost of rising prices there are a few reasons why this is more pronounced in certain cities such as ones with larger populations such as DC, Orlando, San Fran, Diego, LA, etc… I’m not going to go into reasons why certain cities experience a frothier bubbly top then say Lincoln Nebraska, but there are obviously reasons.

I think you can see low credit affecting just about every part of the market currently. Look at how much car sales have tapered off recently due to tightening of credit. You have also seen the market supported by low rates. When rates are low it makes a lot more sense to risk money in a stock that after doing GAAP on it that will return 8% a year. Now if rates rise and you can get 5% in a money market is the extra 3% really worth risking. What you will find as rates go up much more is a pull back out of the market earnings be dammed.

Some affects of easy money.
1. Higher housing prices based on fundamentals.
2. High consumer debt based on fundamentals.
3. Reform on credit bankruptcy laws.
4. Reform on credit card payment laws (occurred right before rate hikes).
5. Weakening dollar do to large amounts of loans.
6. Increases in FOREX trading.

[sdduuuude]

Why are my dollars devaluating quickly with respect to home prices, and not-so-quickly with respect to rental rates?

[Anonymous]

It depends on the terms of their financing. In general, if rates rise, the ongoing bond issuances have to be paid out at a higher rate, the credit line rates which are constantly used go up substantially. Companies use debt over time, they do not just borrow x amount for the next 20 yrs at one time. This discussion could get very complex, but remember the 500 word limit!!!!!!!!

[barnaby33]

I never imposed a limit on you and the questions I asked were rather complex. I was hoping to get some in depth answers, or at least suggestions from different viewpoints.

Josh

[RightSide]

If the dollar goes to zero, the people who owe millions of them lent against their house are going to be very happy. A dollar going to zero is a good argument to get the max loan you can afford at a fix interest rate and buy the biggest house you can find.

I recently read a headline in the STAR Newspaper at the checkoutline that said, “The Coming Great Depression” in big headlines. I guess your not the only one who has got the beat on that story.

The only worse thing then the dollar going to zero and soup lines around the block, will be when the aliens land on the white house front lawn. Don’t say you weren’t warned!!!

[Author]

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