Housing Bubble Induced Severe Recession

“HOUSING BUBBLE INDUCED SEVERE RECESSION”

Hugh Pavletich
Co author
Demographia International Housing Affordability Survey
DEMOGRAPHIA
Christchurch
New Zealand

October 16, 2008

Ms Albrechtsen of The Australian (House of cards built with good intentions | The Australian and Not Everyone Should Own a Home - WSJ.com) is right to a degree – but she fails to take a further step back to the land use regulations – and in how artificial scarcities created by restricting fringe land supply and inappropriate infrastructure financing – provided the “scarcity foundation” for these urban housing bubbles to get underway.

Bubbles cant form without scarcity or perceived scarcity –a concept too many economists do not appear to adequately appreciate.

Little wonder - when many of them don’t appear to know the difference between “inflation” and “growth” – a “boom’ and a “bubble” – and unbelievably - referring to the “wealth effects” of housing inflation and in acting as “cheerleaders” for inflating bubbles. Automobiles, computers, household appliances etc seemed to be able to “withstand” the era of easy money without inflating in price – something economists have failed to point out as well.

What Australia and New Zealand have largely experienced these past few years have been “phony booms” – driven in the main by housing bubbles. We all thought we were getting rich flicking houses to one another – at ever inflating prices.

The evidence is clear, overwhelming and irrefutable. We only have to compare the performances of Texas and California to understand the root cause of the problem. Texas housing stayed at about 2.5 times annual household incomes through this period – with California blowing out to in excess of 9.0 times and Los Angeles a stratospheric 11.5 times annual household incomes.

Have we seen any studies yet of the average foreclosure costs and quantum of them in relation to the quantum of mortgages for the States of Texas and California for example? By my rough guess – the quantum of Texas foreclosure losses are only about 5% of those of California. We need to see research on this issue with urgency in my view.

It would appear to me that if Texas land use regulations were replicated throughout the rest of the United States – we would likely not have had this severe “credit crisis’ we are currently experiencing. And likely too – the United States economy overall would still be growing strongly (refer Dallas Federal Reserve – “Boom without a bubble - Neither Boom nor Bust: How Houston’s Housing Market Differs from Nation’s - Houston Business, January 2008 - FRB Dallas - Milken Institute - Best Cities - Houston, New York Has a Problem by Edward L. Glaeser, City Journal Summer 2008”).

It is “enlightening” too - how the “Bubble States” in the United States are the ones generally (Georgia a mystery – but the Rust Belt understandable) that are getting themselves in to serious fiscal problems as illustrated within “States that cant pay for themselves - Businessweek” following the recently released report from the “Center on Budget and Policy Priorities”. It will be interesting to observe the basket case of California digging itself out of its fiscal mess over coming weeks.

California’s “digging” is at the very early stages – something New Zealand and Australian politicians should watch with close interest – because that’s exactly where they are heading. They will rightly be judged on how they manage this.

For lending institutions to maintain market share through the inflating California bubble – they had no option other than to engage in “distorted lending” (“Herb Greenberg » Blog Archive » Straight Talk on the Mortgage Mess from an Insider”) – where in essence - the lending had to mirror the Median Multiples of individual markets (refer “latest Demographia Survey”). These matters are covered within numerous articles on Scoop New Zealand (Scoop New Zealand Search “Hugh Pavletich” and “Demographia” and “Getting performance urban planning in place” (“United States Planetizen Version”). Professor Peter Gordon of the University of Southern California Planning School deals with these issues within this weeks Planetizen Op Ed Economic Thinking is Job Number One | Planetizen.

It is difficult to accept that the United States finance sector was “completely blind” to the risks involved in lending in to the inflating bubble urban housing markets of California and elsewhere – and was probably acting responsibly in endeavouring to protect shareholders interests – in securitizing this “inflation based lending” - so that others could bear the risks of it.

Of the approximately $US14 trillion of US household debt –some $US11 trillion of it is mortgages – and of that – some $US7 trillion of it has been securitized. It would appear that the securitized product is currently only worth around 10 to 20 cents in the dollar – which would suggest that about $US6 trillion of it has been wiped out. There is a lot of work to do going forward “unbundling” it, in an endeavor to restore some value to it. There have been some suggestions made that around $US2 trillion of it has been “burnt up” in fees – as the Masters of the Universe (as the 29 year old geniuses referred to themselves) thought they were “adding value”.

Any mortgage debt out there that exceeds three times annual household income, should be considered “problem debt” – and as it works its way up through the Multiples – an even greater problem. Something of course the New Zealand and Australian finance sector has been in no hurry to enlighten us about (as we have to endure the “fundamentally sound” rhetoric from the Reserve Banks and the Banks themselves).

It is “remarkable” how the New Zealand Banks are so sound – with around 32 New Zealand Finance Companies having “tipped up” here over recent times.

Ms Albrechtsen is indeed correct in that this homeownership issue needs to stop being a “political play thing”. The reality is that it should be just as easy for people to purchase houses (with longer term financing), as it is for them to purchase automobiles.

The reality is that Bill Levitt got affordable housing figured out after World War Two – with single earner households it needs to be noted - (refer “TIME Magazine Cover: William J. Levitt - July 3, 1950 - Real Estate - Law”) and this is still being achieved through most of middle North America (refer Demographia Surveys). Since 1950 – the United States (and to a lesser extent -we in New Zealand and Australia) has had no problem providing housing at between 2.0 to 3.0 annual household earnings generally (as the Harvard University Joint Center for Housing Studies “Median Multiple Tables” clearly illustrate as well).

Ms Albrechtsen then sails in to the failings of “non recourse mortgages” (where lending institutions are only allowed to use the house as security) – but for reasons that are still remain unclear, this did not work in restraining the finance sectors “overgenerous” lending as the bubbles inflated. It would appear that the market pressures through the inflating bubbles – overcame what should have been disciplines imposed by “non recourse lending”.

There are merits in non recourse lending - in acting as a restraint on lending institutions – and it could well be that this may have acted as a “dampener” on even more excessive lending. There is obviously a need for urgent research on this issue.

After all - “limited liability” is a good idea with respect to companies. Banks in any event surely don’t want to be put in the position of “wiping out” foreclosed homeowners (with children to care for as well) other assets and leave them absolutely destitute. Better to have the mortgage lending structured sensibly (if local government will allow this without artificially inflating housing) in the first place.

Ms Albrechtsen then goes on expressing concerns about the American 30 year fixed interest rates on mortgages – but really - this is very much a side issue. What is rather surprising is that Banks have failed to be “truly innovative” in structuring mortgages that are better linked to the reality that household incomes increase over time – so that they are more affordable at the early stages. Even by being moderate and conservative in allowing for a 1% to 2% annual increase in household incomes – would assist in allowing more to access homeownership.

Ms Albrechtsen is correct in stating that “pre payment penalty restrictions” are counterproductive and in clearly articulating the negative impacts of former President Jimmy Carters 1977 Community Reinvestment Act. And she is “spot on’ about those “dinosaurs” Fannie Mae and Freddie Mac. New Zealand rightly shut down the State Advances Corporation years ago.

Isn’t it remarkable how something as simple and (what should be) low risk as “house mortgages” should get so screwed up - to the extent of bringing the global financial system to its knees. A remarkable feat by urban planners and the finance sector.

And it is very helpful indeed that she quoted the Australian Deregulation Minister Lindsay Tanners wise comments “improving regulation doesn’t necessarily mean more regulation”. Poor quality regulations at the National and Local levels are quite clearly “the root of the problem”.

The finance sector globally could hardly be accused of being “socially responsible” through this whole housing bubble fiasco. Indeed as these bubbles were “inflating” they acted as “irresponsible cheerleaders”. I cannot recall one instance where a senior Bank officer warned of what should have been the obvious sheer destructiveness of these inflating and deflating housing bubbles.

Globally – many within the finance sector will pay the price for this as the “Masters of the Universe” are transformed in to government employees as their institutions are increasingly regulated, bailed out and nationalized in varying degrees – and Banking generally reverts back to utility status.

Getting the recovery process underway – the focus must be on sorting out urban fringe land supply and appropriate infrastructure financing arrangements in place. The problem will not be solved until households do not have to spend any more than three times their annual income to house themselves.

ENDS

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