Does anyone still don’t know about the housing bubble? Well, looks it has not bursted yet… but some signs are worringly clear that it will soon.
First of all: there is a bubble. Look at the rise of the prices for the last eight years: (source Mortgage Bankers Association)
The US are a good example. Prices have soared and house equity has been a great business. Well, as always, its a good business if you sell higher than you bought. And that means selling and buying, not just keeping or using.
So it might be possible that homeowners are all rich now. Or maybe they are not so rich as they owe a lot of money, and their home equity is leveraged. But any way: they have been feeling rich.
Worringly, interest rates have soared too. And they keep rising. And the prices have been so high and the gap between sellers and buyers been so wide that price rises have stopped. In some places even decreased.
It’s not that the bubble has bursted. In fact most price decreases are not in the most inflated areas, but just caused by the old and classic reasons: in places where economy is not buoyant, unemployment has rised, and not enough cash is flowing to worker’s pockets.
This graphic from Standard & Poor’s illustrates the end of the cycle. The green line are the price increases, the orange one the number of housing starts:
As you can see we are back to zero. Everything is possible from here. Even the vicious circle.
For instance: think about subprime mortgages. They have been given to people that have a larger risk of default. But they have been given extensively (20%). More buyers were needed to close the gap between offer and demand. Interest rates were very low, and defaults in their historic minimum. Economy was still flourishing and growing.
But now economy has changed. Well in fact it hasn’t changed, but the expectations have changed. Now, let’s adapt to the new expectations. Let’s stop having that risky business: let’s close the door to subprimes.
Looks like a good idea: less subprimes means less defaults. And less financial distress. It’s time to tighten the rope.
But that will mean widening the gap again. That will mean additional pressure down and lower prices. That will mean less richesse effect and less spending. That will mean less jobs, and that will mean more depressed areas. And, voilà, you have the vicious circle.
Because tightening the market for mortgages means tightening a natural exit for existing subprime mortgages: refinanciation. There’s an important percentage of house owners that need refinancing, specially among subprime owners. It’s a natural way to quit being subprime, either you get rich, either you transform your mortgage into some more bearable weight. But what if that door narrows? more defaults coming.
What will happen at the end of the year when prices won’t be stable at 0% but… I have a guess to make here… hmmm… let’s say -7%. You can see the tendency in the upper graph.
You say flatliner? Maybe… nah, I don’t believe so. Let the vicious circle begin.