Felix Salmon

The next real-estate bust

By Felix Salmon
January 8, 2010

Now that Roger Lowenstein has published an article in the NYT Magazine headlined “Walk Away From Your Mortgage!”, I think we can safely stay that what started as a controversial and minority stance has at this point become thoroughly mainstream. (The corollary is that arguments in favor of paying one’s debts are now contrarian.) It’s a credit to Mark Gimein that his blog entry from 14 months ago, entitled “Morally Conflicted About Walking Away? Don’t Be“, was not only one of the first places to make this point, but still stands out as one of the best expressions of the argument.

Similarly, I felt decidedly contrarian when I started arguing against homeownership in September 2007; that view now seems to be moving into conventional wisdom as well.

I’m not actually convinced that real Americans, as opposed to the chattering classes, have moved so far so fast. But it’s clear which way the wind is blowing — and it’s blowing in the direction of continued house-price declines. Houses are still more expensive to buy than to rent, in most of the country, and of course financing is all but impossible to come by, except for that provided by the government, which means that if and when the government prop is taken away, prices are liable to plunge. If that happens, expect a lot more walking away into cheaper rentals than we’re seeing right now, and a whole new vicious cycle of price declines and foreclosures.

Noam Scheiber has been waxing lyrical about the success of the stress tests, but it’s worth remembering that banks’ balance sheets haven’t been subjected to a really tough test since then — and also that those balance sheets are still full to bursting with toxic mortgage-backed assets, as all government attempts (TARP, PPIP) to relieve the banks of those assets have failed to do so.

There are lots of ways in which the US economy could see another sickening downward lurch, and residential real estate is probably not even the most likely. But it’s a nasty possibility, all the same, and one worth being alive to.

23 comments so far | RSS Comments RSS

A lot of people watch the indicators like it’s the stock market on a 1-3 year time scale. We slide and then have an energy drink and the purveyors of perception prop things up for a little while, but why is it not clear as day to everyone that we’re headed into the dirt? What we make, we’re making less and less of. The feedback loop is murder.

Posted by Uncle_Billy | Report as abusive

Whoa! Plunging prices? Unlikely! Prices have *already* crashed. Calling for a crash on top of a crash? Some call!

Here are some bullish points for real estate, long term:

* Inflation in the long run a certainty given how far budgets are from balance. Consider how much pain would need to be inflicted to bring budgets toward balance and how little will there has been to inflict even any pain at all. Gold and other commodities are in a big bull, suggesting long term inflation. Houses too are a commodity, in the same category. Further, Bernanke is fairly open about wanting inflation.

* Houses are built with materials and energy, both of which have reset at permanently higher levels because of China and other developing nations.

* The American population is growing strongly, both from births and steep immigration. When we look at Japan’s long house price decline, we must never forget that household formation is *the* primary driver for housing demand. Their net household formation is negative, while ours is strongly positive.

* Keep in mind that Fannie and Freddie have already been authorized to absorb massive new losses so Congress has sidestepped a political fight right there.

* Quantitative easing is straight-up, Zimbabwe style money creation. Thankfully we haven’t done it limitlessly, but them’s some real guns. Calling for price falls?

* From what I’ve seen, rents are already in line with the cost to buy in most parts of the country.

* That said, I expect New York to have it’s own personal real estate crash coming up, while the rest of America slowly recuperates. NY never really had a good crash like most of America did, even though they had every bit of the runup.

Posted by DanHess | Report as abusive

Alyssa Katz in “Our Lots” notes some of the reasons why home ownership may not be the greatest thing since canned cheese.

Highest levels of home ownership in Europe: Greece and Ireland. Lowest: Germany. Go figure.

Posted by Buce | Report as abusive

“Houses are still more expensive to buy than to rent, in most of the country, and of course financing is all but impossible to come by,”

Financing is impossible to come buy?? Since when? Maybe to slackers, losers, scum bags and those who SHOULD NOT OWN A HOME. Check your credit score. Why should someone with a 500 score OWN A HOME? Why should someone with no job OWN A HOME?

No one has the RIGHT to own ANYTHING.

Posted by t-add | Report as abusive

Felix, comb your hair.

Posted by t-add | Report as abusive

Regarding DanHess’ comment:

” The American population is growing strongly, both from births and steep immigration. When we look at Japan’s long house price decline, we must never forget that household formation is *the* primary driver for housing demand. Their net household formation is negative, while ours is strongly positive.”

With a population density ten times that of the U.S., Japan also relied on “household formation” as “*the*” primary driver of their economy for a long time, and look where it got them. Their overcrowding has so badly eroded domestic consumption that they’re utterly dependent on exports to keep their economy afloat. Economic growth through population growth is cancerous growth and a dead end. There are no more Americas out there to absorb the exports needed to support our economy if we grew ourselves into the same boat.

Those who champion population growth as an engine for economic growth don’t understand the relationship between rising population density and declining per capita consumption, and its consequences for rising unemployment and poverty.

Posted by Pete_Murphy | Report as abusive

Did you see Krugman’s chart–on his blog–showing the commercial real estate price run-up (bubble), which is now beginning to burst. THAT is scary.

Posted by DonCoffin | Report as abusive

I think the housing market will be soft for some time to come. I went through this in Oregon in 1984 and in Alaska in 1989. I lost a house in Oregon, but weathered the storm in 1989. Too many people rely on housing because our Government moved a large percentage of our manufacturing overseas, so the action went into an overheated housing market. It is tough to buy and sell right now, but not just in housing. What we had was a false confidence in a false economy, and that will take some time and a change in leadership to begin recovery.

Posted by fred5407 | Report as abusive

Housing will start to recover when interest rates start to go up. People will become fearful that they’ll never see today’s low rates again.

Posted by oldschool | Report as abusive

Sometimes you have to zoom out and look at the big picture.

with the nearly 28 trillion dollars the Fed snatched from Treasury (last year) and dumped into the revaluing of toxic derivatives We can expect two things: 1) the value of the dollar will slide. Expect big Inflation. 2) taxes will increase in order to combat the inflated costs of civil services, also to tackle the new interest standard that accompanies a 28 trillion dollar deficit.

Summary: higher taxes + money is worth less = a big net loss to the economy (people will have less money to spend but they will need more money to survive)

If you’re measuring modest gains in the average hourly pay, but you’re neglecting to factor in the offset of inflation you’ll miss the point. You might also miss the boat.

If you expect the economy will recover on the strength of overly positive media coverage you’ll likely loose your shirt.

A continued crash is to be expected in may sectors, because consumers have less to money to prop up the consumer culture we’ve built our cities on. We’ll be taxed more which will inhibit us in the future, and we’ll rely more not less on borrowing.

Crashes will increase in magnitude and frequency. At least until we address the cause of our financial distress. Which may happen sooner than later (within the next decade or two) the unemployed have time to research these things and they’re serious when they act to correct systemic problems.

Posted by owensuppes | Report as abusive

The house that we have been pursuing is a “short sale”. Let me tell you there is nothing short about this experience. The aggravation we are going through is enough to make us want ot call it quits!

Anymore BS, and we’ll stay in our apartment, you can keep the house.

Posted by jk718gp | Report as abusive

Maybe smarter buyers will now develop in stead of paying whatever RE agents ask as the “market price.”

Posted by Cybs | Report as abusive

I wonder if, with increasing job instability, large regional and sectoral shifts in employment, and lots of homeowners underwater, we won’t see a secular shift to prefer renting for the flexibility it allows households in the labor market and in adjusting expenses.

Posted by Brad9999 | Report as abusive

If you are looking for a real estate crash, Felix, look to Britain. They had a stunning run-up and very little of the downside so far. Prices there are quite out of line with rents still. Australia too.

Prices really have come back in line with rents in most parts of America. Except of course New York, where rents have dropped almost of much as prices, correcting little of the relative overpricing. Then again, some of the ownership market in Manhattan consists of status symbols by the uber-rich from all over the world, while renting is utilitarian. Is that quirk enough to support high Manhattan apartment prices?

Posted by DanHess | Report as abusive

It’s a funny conundrum, this rent or own option. Things are not always as clear cut as they at first seem. For the first 15 years of our marriage my wife and I always rented. We were what is sometimes referred to as academic nomads. Three years here, three years there, so the reality of renting always seemed the way to go. Then we (or she, actually) got a permanent position and we finally committed to buying a house. It seemed so right, so American, and we have no regrets. But, looking back on our wandering years I have come to realize that we always had more disposable income then than now, even though we earned less than we do today. After all, we only had to pay the rent, the basic utilities and the phone bill. Even water and trash pick-up were included in the rents. Whenever anything broke, which invariably happened, the landlord sent someone over, and like magic it was taken care of (I’m only talking about responsible landlords mind you, not the other bozos.)

As a homeowner you quickly learn that there’s a lot more to factor in than just the mortgage (which includes property taxes and insurance). If the toilet goes into permanent flush mode, it is I who has to run to the hardware store and buy the repair kit and get a crash education in the intricacies of indoor plumbing. The same is true of the heating/cooling ducts in the crawl space. Who knew they could separate at the seams? When the thermostat let out a puff of smoke and died, you got it, another trip to the store. And, if something major goes, say the washer or drier or water heater or air conditioner, you have no choice but to call a professional. Now, that’s real money!

So, when I read these articles on whether one should walk away from an onerous or underhandedly contrived mortgage that is eating someone alive, I shake my head and laugh. Sure. Walk away. Your credit will be trashed for a number of years, but that will pass. And you will find that your money woes decrease dramatically. One word of advice though, make sure your car is paid off. It will be some time before you’ll ever be able to finance one again.

Posted by IntoTheTardis | Report as abusive

Can anyone else imagine how much better off we would be today if we had simply let all the banks fail in 2008? Yes, 2009 would’ve been a horrible year – more wretched, I am sure, than it was anyway – but by now capital would be flowing to real opportunity, and entrepreneurs would be out in force creating the restored America of the future.

Instead, however, we assured Lloyd Blankfein and friends some extended comfort, and most assuredly assured ourselves the total destruction of our nation.

Thanks a bunch, Congress. Thanks a bunch.

Posted by JackMack | Report as abusive

* Houses are built with materials and energy, both of which have reset at permanently higher levels because of China and other developing nations


Permanently higher levels? When someone says prices can’t/won’t go down I instantly discount the value of that person’s input to zero. Ah, silliness. This somehow leads me to ponder the TV and radio commercials – paid for by the folks currently holding lotsa gold – telling the rest of us to GET OUT THERE AND BUY LOTSA GOLD RIGHT NOW!!!…because, you know, they have lotsa gold that they’d like to sell before the bubble pops.

Posted by rdavi | Report as abusive

lol, “Dan Hess,” you’re not fooling me…I know your REAL identity is former NAR economist David Lereah.

ha ha, give it rest, Dave.

Posted by PatMcGroin | Report as abusive

@rdavi –

Is your house built of gold? Because that is awesome!

Actually I am talking about oil, which is the basis for many building materials. If you think oil is going back to $13 as it was a few years ago, I’d be happy to take the other side of that bet…

All this bearishness about housing is brilliant. It’s like like showing up at the scene of a car crash and saying there’s about to be an accident. A little late on that call.

Posted by DanHess | Report as abusive

You do the math, toxic derivatives own the better part of 600 trillion dollars worldwide. Lehman brothers owned near to 90 trillion of those bets before falling. Falling equals instant default on bets they couldn’t cover(the world couldn’t cover those bets). So the derivative bubble bursts, but not on the balance sheet. That’s why banks won’t lend to each other. They don’t know what horrors lurk off the balance sheet of a bank with it’s hand out. So guess what, there’s no help there and you can bet that the house of cards is still falling…the car crash is due for a lengthy pile up. That’s why expecting housing prices to continue their retreat is “good call”. Oh the suckers will rally, but for the next few years prices will feel around for their true value. The commercial prices are due for a tumble too.

How can anyone predict a solid housing rally? The average Joe is under water, the levels are rising and his neighbors are out of work, so they won’t be buying Joes product, which will pummel his profit margin, and his civic taxes are due to rise, his domestic debt is out of hand..etc. So where does the market find enough buyers to create a sellers market? Where does the nation do to find it’s confidence in home equity after all this pain?

And all of the factors that brought the house of cards down are still in place.

Posted by owensuppes | Report as abusive

Why is the onus of ‘bad behavior’- walking away, placed solely on homeowners? Today’s business ‘ethics’ have folks walking away from mortgages, business loans, and a host of ill-conceived loopy get rich quick schemes. What goes around comes around. Not that I encourage irresponsible behavior.

Posted by Anonymous | Report as abusive

@Owensuppes –

I agree that the economy is a mess and then that a lot of folks are financially flat on their back. I also think unemployment will stay awful. That is why prices have **already collapsed**.

The historical housing affordability index seems to be around 125. It plummeted to 100 as house prices shot up during the bubble. Now that prices have collapsed (and interest rates remain low), affordability this November clocked in at 167. These are near record levels. Regionality matters. Affordability in the northeast and on the west coast are around 135, decent but not incredible. Meanwhile, in the south and midwest affordability was recently at 173 and 211 respectively. Incredible values there.


http://economix.blogs.nytimes.com/2009/0 1/30/housing-affordability-at-record-hig h/

http://www.realtor.org/wps/wcm/connect/d ceb370040dbafbf94cd9d88cdadd79a/REL0911A .pdf?MOD=AJPERES&CACHEID=dceb370040dbafb f94cd9d88cdadd79a

There is groupthink on the way up and on the way down! The irony is so rich! Suddenly the prevailing worldview is that house prices can only go down!

Posted by DanHess | Report as abusive


I would like to see the effect on the banks and the banksters’ bonus!!

Want to stick it to the banksters .. you cannot get a BETTER WEAPON…

Posted by killben | Report as abusive

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