Real Estate Bubble

As I contemplate the economic turmoil we are all only just beginning to experience, I always try to wrap my brain around how it happened. I want to figure it out. How could it get so bad that the pundits now talk about avoiding a depression (which means we are already in one)? I've written some about the mortgage business and about debt and money creation, so now I want to turn to the Real Estate bubble that so many news stories refer to.

I recall , over the years, driving through many towns or cities, including the one I live in, and marveling not just at how many new houses could continually get thrown up (pun intended), but also at how expensive they seemed. On a trip to Washington DC I saw 900 square foot townhomes for $400,000! Even 2500 square foot homes in Dallas asking for the same price seemed steep. I read about $1 million condos (900 sq ft again) in Miami. 40 year old homes in LA that cost $600,000. Of course all they sold. And sold. And sold. How could so may people afford all these expensive homes, I kept asking myself. Then I had to buy my own home and I found out how. I was offered loans that allowed me to pay only $400 per month (with fine print stating that could and would change of course). I opted for a more traditional fixed rate, but at least I knew how all these people could keep buying all these expensive houses. I also figured it wouldn't last forever.

And I also know why there are so many foreclosures today too. Those Option ARMs and alt-A loans are kicking in to higher payments and worse, at a time when many people are losing their jobs. So how did all this happen. Is it just chance you may ask (like I did)?

Here is how it happened.

All the demand for homes (and cars and TV's and stuff too) was created out of thin air by the banks and government who encouraged lending to a larger and larger spectrum of people, using tools like the ARMs and Alt-As and even credit cards to get the demand cranking. With everybody in on the action and buying and flipping homes left and right, demand kept sending prices and values up. And it seemed perpetual. Hairdressers became real estate speculators. Profits were made flipping houses. Additional loans were taken out on the increased equity and spent on other things like cars and TV's and additions to the house. Which paid salaries to people who took out still more loans on homes and it was just a big neverending party!

Of course, every party has to end. And clean up is never fun. But what if every time the party seemed to end we just bought more beer and turned the music up? What if every time we seemed to go into recession, the government just stepped in with more tax breaks and "stimulus" spending and borrowed to do it? Well the party would seem to go on because everybody loves beer and music and free money from the government, don't they? So everyone would continue to hang around and buy more TV's and houses and listen tothe music and drink more beer. Would the party ever end?

Of course it would. You can avoid a hangover can you? And you can't avoid a recession either. Just like a hangover, if you treat it with more beer and loud music it only gets worse and worse and worse. Until CRASH!