March 9, 2006 at 8:54 PM #6405
Ok, since we all seem to be preaching to the choir in here I thought I’d paint an alternate scenario as to how this housing bubble could play out. I think its a very plausible solution that our government and central bank has in its arsenal and I’d be curious to why you think it can’t play out like this.
As you all know, we as a country (both our government and individually) have gotten ourselves fixed with a lot of debt. If we were a country like Argentina who had its debt tied to the dollar, we’d be really screwed. Fortunately, we owe the world dollars and as the owners of the official dollar printing press, its really preposterous to think that we’d ever default on paying our debts when we have an easy solution, and that is simply creating a ton more dollars to pay off our debts.
So here’s what happens. We crank up the printing press, inflation takes off back to double digits and before you know it, a million dollars barely affords you a one bedroom trailer home in Riverside. The housing crash never happens, because inflation has devalued both the dollar and the dollar debts.
In hindsight, the people who made out was everyone who locked in fixed rate interest loans at the low rates of the early 2000’s on the biggest home they could afford. All these people who were crying bubble missed the boat and instead had to buy houses, which did become more reasonably priced in terms of income to price ratios, and real prices, but nevertheless were more expensive in nominal terms.
So check it out, you could buy a million dollar house now, say you finance 90% of it, $900k, and inflation takes off. Suddenly your 900K fixed debt loses 75% of its value. Your debt to asset ratio suddenly is looking pretty darn good.
Instead of crying housing bubble, maybe we should be crying debt bargain of the century!!!
There, I talked myself into it, I’m going to buy the fatest beach front house I can qualify for, but I will make sure I get a fixed 30 year loan.March 9, 2006 at 9:17 PM #23631
The Fed keeps talking about containing inflation. If they are serious, and not lying, then they will keep raising interest rates to contain it. They state the tight labor market raises inflation concerns, so they must keep raising interest rates.
They also must keep interest rates high to keep foreign investors and central banks interested in buying dollars, T-bonds.
Furthermore, they don’t care about a housing bubble collapse. They’ve pretty much said so (“we think the impact will be negligible”, “we can’t predict asset bubbles”). Their rich friends won’t be hurt when housing busts, so why should they care? It’s more important to keep dollars flowing into the country than to keep Americans out of bankruptcy. Besides, anyone who bought more than 5 years ago won’t lose money, unless they sell. Housing will eventually go back up. They didn’t bail out anyone when the stock market tanked. Economic cycles happen.March 9, 2006 at 9:18 PM #23632Jim BrubakerParticipant
This is quite possible. This is what happened in Germany in the ’30s. It took a million marks to buy a loaf of bread. Then an Austrian by the name of Hitler took over the worlds leading democracy and turned it into a dictatorship.
The same thing could happen today, we have an Austrian named Schwartznagger as Governer who people want to run for President. It comes eerily close to history repeating itself (tongue in cheek).March 10, 2006 at 12:24 PM #23638BugsParticipant
Let’s ignore the fact that our economy is tied to the world and a devalued dollar would cause us more problems than it could cure.
Let’s talk about the different between “price” and “value”. Those two terms are related but they aren’t the same. Regardless of the actual price, we have a value imbalance wherein people are spending 50% or more of their gross incomes to debt service their mortgages. If the feds try to inflate their way out of the price imbalance they still won’t make a dent in the value imbalance, except to make it worse. It’s true that the current debt holders won’t have to spend as much of their income to service their debt, but it’s also true that the dollars they net after eventually selling out their positions won’t have as much “value” as the dollars they spent getting in. So they still lose and they lose just as much as if there were no inflation and the market just does it’s thing.
And this is still based on a best case sceanrio that requires making a huge assumption about wages keeping pace with inflation, which they pretty much never do. Think about it. If all their other expenses for living go through the roof but their mortgage payment stays the same, they still need more dollars to make it through to the end of the month. Unless they’re making those big wage gains to match, they’re facing the same kind of dollar deficit that would cause them to default on their house payment. For that matter, if we could count on wage gains of any type to begin with, we wouldn’t be considering the current price structure to be overvalued in the first place.
The inflation alternative would easily prove to be more of a problem than the problems it would be intended to solve. And that doesn’t even begin to address the equity of bailing out the least deserving debtors – who are a minority – to the detriment of those people who had handled their money more responsibly. Think about the people who bought earlier, who did earn some equity; inflation cheats them out of the profits they legitimately acquired. Where’s the social justice for that?March 10, 2006 at 3:35 PM #23640uncle_gitParticipant
The Fed is the Banks – why would the banks want to deflate their assets to bail out the consumer ?March 10, 2006 at 4:26 PM #23641
He was suggesting the Fed prints more dollars so they can pay off the debt.
They don’t care about the consumer, but they don’t want the debt to spiral out of control. I bet they are looking forward to a housing bubble collapse, so consumer spending slows, leading to reduced imports and a lower deficit. But what about the national debt? The printing dollar theory seems plausible as a method to reduce the national debt, because that’s the only way to pay it off. But, there are downsides to being the holder of debt, regardless of the debt’s deflationary valuation. Say the bank goes under and recalls its loans and you have to get a new loan but can’t because the interest rates are too high. Or deflation leads to job loss and you lose your job and can’t keep up with the payments. Oops, there goes your house. Possible? It just feels wrong to me to take on huge amounts of debt in the hope that this debt might be worth 10% or 20% or 50% less. I still have to service it. Maybe I’m way off base.March 11, 2006 at 8:24 AM #23648picpouleParticipant
I love Governor Arnold! I hate it when people say mean things about him!March 11, 2006 at 8:59 AM #23649LukeAJParticipant
Good luck with your beach house…March 11, 2006 at 10:33 AM #23650
Here are the arguments I’ve gotten against an inflationary wash of the housing bubble:
1. The Fed keeps talking about containing inflation. If they are serious, and not lying, then they will keep raising interest rates to contain it.
RESPONSE: I think its worthwhile reading the mission of the fed, as they state it on their website:
I agree that in general the fed views inflation as a bad thing, but it’s not their only goal. I also think the fact that our government has a lot of bills to pay is going to neccesitate the printing of a lot more money.
It seems to me higher interest rates are also a sign that inflation is on the rise.
2. Bugs raises several good points, many of them about wether or not an inflationary scenario is a good solution.
My Response: I agree with most of what you say, and I don’t view the iflationary scenario as a “good” solution overall, but merely as a one that has a good chance of occuring. As happened in the 70’s, the inflationary envrionment, makes debt’s cheaper and hard assets more valuable. All other things being equal, this would be a net benefit to people who have a high debt to asset ratio.
3. The Fed is the Banks – why would the banks want to deflate their assets to bail out the consumer ?
The bank’s assets aren’t dollars. The bank’s merely need a spread between assets to make money. Inflation is not a necesarily a bad thing for banks at all. Especially considering that most banks have packaged and sold all their mortages.
Overall, I’m not sure what the bank’s view of this is and what the pros/cons are in their view, but faced with a choice of an inflationary evironment or collapsing real estate market, I’d think they would pick the former.
4. Say the bank goes under and recalls its loans and you have to get a new loan but can’t because the interest rates are too high.
30 year fixed loans cannot be recalled unless they are in default. If the bank or entity that is holding the loan goes under they will sell that loan off to the highest bidder of that debt. The debt markets are very liquid and large nowdays.
There is no doubt if we did have an inflationary argument, having a fixed 30 year loan will grow in value.
My conclusion. I need to look into this scenario more and I’d be very curious to here Rich’s take on how this might play out. Overall, I think there are a lot of interests lining up (consumer, govt, etc.) for an inflationary environment and I for one want to be ready to take advantage of that.
I do plan to buy TIPS (Treasury Inflation Protection Securities) these are T-Bills that tie the principal repayment to the CPI. They could be a great bet if inflation does come into play and if it doesn’t the small premium you pay for them is a small and worthwhile price.March 11, 2006 at 12:52 PM #23651
RightSide, as the Fed is printing money to pay off the debt, and simultaneously raises interest rates to control inflation, what would be the outcome? Regarding the idea of stocking up on debt, it comes down to assessing whether deflation exceeds the drop in housing values. Do you see it this way too?
I remember reading the Wall Street Journal while I got my MBA in the early 1990’s, and at that time, there was a column where monkeys competed against mutual fund managers and stock pros for the best stock picks. The WSJ asked the experts to select their favorites, and then gave the monkeys darts to throw at a stock chart. Some period of time later, the WSJ tracked the profit/loss of each team’s selection. Most of the time, the monkeys won. Eventually, the column was phased out. I suppose it was too embarassing for the humans. My guess is the monkeys were ready to keep playing.
The reason I write this long story is to make the most important point of investing: no one can predict with certainty the future of a stock, the markets, direction of interest rates, deficit. No one can predict how these forces will interact.
I will never forget this lesson. Later, as I read more, I realized how this happens to the pros. You buy 10 shares of BiotechAsthmaDrug, because they were just approved by the FDA for a breakthrough asthma treatment. The stock soars. You pat your back for having made such a suave move. A month later, the people taking the drug get really sick, and some die. Lawsuits mount, and the company faces bankruptcy. The stock plunges before you have a chance to sell, and now you lost your money. The expert picked BioTechAsthmaDrug because he has extensive knowledge of the drug market. The monkey didn’t. Some event can happen and throw a monkey wrench in your most well-thought out plans.
There are those who have predicted economic armageddon for years, and perhaps they are wrong, or perhaps their timing is off.
I love reading all these diverse viewpoints, and am open to changing my mind, yet for now, I am happy to be without a mortgage, with most of my money in CDs, money market funds, low-risk stocks (UPS, Berkshire Hathaway, stuff like that), and Vanguard index funds. I have lost very little money in this way, unless I lost due to inflation. I laughed at the tech stock boom, and couldn’t believe people were buying overvalued stocks. I bought Lucent after it dropped from $90 to $5, but then lost half because it had still further to fall, to $2.50. That was my only tech stock gamble, and it was a gamble, because I bought it without knowing anything about it, except that it seemed cheap. I will not make that mistake again. I will only buy stock in a company I understand, with good fundamentals. My method worked in the current economic environment, but may not serve me well if inflation rises and gold were our only friend.March 11, 2006 at 1:46 PM #23652
Poway writes: RightSide, as the Fed is printing money to pay off the debt, and simultaneously raises interest rates to control inflation, what would be the outcome?
I think that is the key question. I just don’t know and I think using past examples of how this plays out is risky, because there are so many things different this time around.
My plan is to keep an open mind to all points of view and not get stuck on any one conclusion. Personally, I have found that most people who lose money investing do so because they become emotionally involved in their decisions and let their egos take over. There is a great book that just came out called “Mean Markets and Lizard Brains” on this subject.
I do believe that evidence points to a “day of reckoning” at some point in our near future and I’m planning to profit from this when it happens. Its starting to feel like a crowded trade and when ever I get that feeling in the stock market, it usually turns out that the crowd is wrong. This may be because I’m spending all my free time reading about the bubble, but honestly, I’ve found not a single person I could have a rationale discussion with that disagrees there is a housing bubble now. I mean even Rich Dad himself, the great real estate proponent who has sold millions of books based on making money in real estate is calling this a full blown bubble and telling everyone to sell their real estate.
I also wonder what are other people’s motivations for following the housing bubble here in San Diego? If houses crashed by 50% are people here planning on stepping in and buying? Is anyone else like me planning on shorting housing futures the first day they trade?
Why are you all here?
PS. What’s Poway like? I’m looking at Carlsbad, Encinitas and Carmel as possible locations, but I haven’t checked out any other areas. I’d like to find a good family friendly neighborhood that has some character. I have a 2 1/2 yo and another one on the way…March 11, 2006 at 3:01 PM #23653
Poway was built mostly in the 1970’s and 1980’s, so you’ll find plenty of ranch style homes, larger properties, mature trees. Poway has maintained an extensive system of horse trails, and most neighborhoods, even the high-end ones, are zoned for horses. Lots of open space and preserves. I go running in the trails in the hills behind my house (the hiller, the more I love it). Poway is known for its schools, and the City of Poway has a budget surplus. No traffic congestion, except 2 main roads get a little backed up at rush hour. An excellent place for families, although the pricing has resulted in eliminating younger families and elementary school enrollment keeps dropping. About 1/3 of Poway is low-income, thus you see the low median price in the DataQuick results; those houses are in South Poway and their schools’ test scores are lower than the rest of Poway. We moved here for the schools, and we couldn’t afford the higher prices in Carlsbad, DelMar, and other good school district. You can find rentals in any neighborhood, as investors have bought houses all over town. We rented a 2500 sq ft house on 1/4 acre in a very desirable part of Poway, for $2500/month. So the prices are less than on the coast. We were the only renters on that street. Everyone else had lived there forever.
I am reading this for fun, and we plan to buy when the market hits bottom. My daughter is upset that she’ll have to go through high school living in a rental. I am interested in shorting housing futures, and am on their mailing list. I am also waiting for a good time to make a transfer in the retirement brokerage account, from the money market to some stocks. The stock market multiples are too high.March 11, 2006 at 7:29 PM #23655
- You must be logged in to reply to this topic.