Ignoring the Past is leading to the Bursting of the U.S. Housing Bubble 2017
Joseph Stiglitz, Nobel laureate in economics and poster boy for the liberal left, wants more taxation on real estate. He says this is especially important for vacant real estate. If Stiglitz is correct, a U.S. housing bubble 2017 is inevitable. Stiglitz’s prescription might not be popular, but he has a point.
But raising taxes, much less real-estate ones, is not on President Donald Trump’s radar. Thus, the question beckons: is the U.S. headed toward another housing market crisis? The market signals suggest that a housing bubble burst 2017 is forthcoming. The risk of a new crack in the housing market should certainly worry the American middle class, still wounded by the housing bubble of 2008.
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Real estate bubbles are as old as history. The first known bubble occurred 2,600 years ago in modern-day Turkey. The infamous King Midas, who turned everything into gold, flooded the market with diluted gold coins. He triggered a property boom and prices of villas on the Anatolian coast rose to rival Mount Olympus itself.
Prices collapsed as people caught on to what Midas had done to the mint. We might compare the real Midas effect—that is, fake value—to Trump. The U.S. president might even welcome it. But, a closer reading of his legend shows that all that he touched eventually turned to dirt rather than gold. In that sense, the modern-day equivalent of Midas is cheap credit.
Whether it occurs through disingenuous traps set up by lenders with sub-prime mortgages or low nominal rates for stimulus, eventually the bill arrives. When it does, the costs are higher than anyone expected and a crash is inevitable.
The U.S. housing market is on that very brink now. An excessive expansion of the money supply, coupled with historically low interest rates, has led to the real estate bubble. It’s not a black swan event if you can predict it. And the U.S. real estate crash of 2017 is all too predictable.
The Housing Bubble Burst is not a Black Swan
Black swans are, by their nature, unknown events that analysts recognize only in hindsight. The triggers of the subprime crisis of 2008 were black swans to those who had not noticed what was happening. Insiders knew though. The next housing crash is anything but a black swan, because we have seen this all before.
Meanwhile, consumers could boast about owning their very own house. The politicians, those who were aware what was happening, kept quiet too. Happy and proud consumers meant more voters, while economists were forced to concede that decades of steady deregulation from both Reagan Republicans and Clinton Democrats were working.
Unfortunately, parties share the downside that lurks beneath any enjoyable activity that lasts for a protracted period. They end. Some crash. When the subprime borrowers had to pay back the mortgages around 2004–2006, as the interest rates became too expensive (it was in the fine-print after all), they could neither repay nor refinance.
In 2007, well over a million real estate properties went on the auction block for insolvency. Meanwhile, the debt was scattered throughout the financial system worldwide. Banks stopped lending to each other, prompting the credit crunch. The rest (including the $435.0 billion that banks lost by July 2008) is history.
The financial system might be better protected against this financial bubble…for now. But the real estate bubble in 2017 could end abruptly. Just as the subprime borrowers were unable to pay back their mortgages once interest rates increased, current mortgage owners might be unable to pay back the lenders as the Fed raises interest rates.
The end of cheap mortgages could also halt speculative real estate investments, other than ultra-high net worth buyers, who pay upfront. Average investors, encouraged by dozens of investment gurus, who mesmerized audiences with the prospect of using other people’s money to buy real estate.
They won’t be needing that super-comfortable mattress bought on sale on President’s Day. They bought real estate through leveraged transactions, or through seemingly low-cost loans that have driven property prices artificially, some might say toxically. Make no mistake: the symptoms of the coming rate hike are like those of 2007–2008.
That’s when the subprime hole led to the outbreak of the housing bubble and the beginning of the Great Depression. If you think you’re safe because you were wise to take up a minor mortgage, consider this. Those who lost the most (relatively) in 2008 were the small borrowers who fell first to fear.
Beware the U.S. Real Estate Bubble of 2017
During the 2016 presidential campaign, neither of the candidates had much to offer on the matter of a U.S. real estate crash in 2017. Yet, Americans have reason to fear it because U.S. mortgage rates could move push many homeowners beyond the brink, just as during when the housing bubble of 2008 burst.
Nationwide, property prices continue to rise. Some estimates suggest that prices have been increasing a five percent annual rate on average. In hotter markets, such as New York City and San Francisco, the price increases are difficult to determine. They have risen beyond reason. (Source: “Popping the Housing Bubbles in the American Mind,” CNBC, February 10, 2017.)
Investors have no doubt appreciated Donald Trump’s plans for a massive stimulus program and tax cuts. Trump confirmed as much during his speech to Congress on February 28. The president expects to spend a trillion dollars on public and private investments to upgrade U.S. infrastructure. He also wants to stimulate economic growth by reducing taxes across the board.
There’s no doubt that the American middle class will love the program. But there are doubts as to how this can be achieved, especially when Trump wants to boost defense spending by several tens of billions. Who will pay for such growth if taxes are going down for everyone?
Meanwhile, the Federal Reserve, whose job is to ensure that inflation is kept in check, will have something to say about it. Because of Trump’s growth policies and the combined risk of inflation and an overly high dollar, the Federal Reserve interest rate is bound to increase. That means U.S. mortgage rates will go up.
Americans might get a deja-vu feeling about the housing bubble of 2008. Many analysts and investors will be scratching their heads now, trying to determine whether Trump’s stimulus is better or worse, given the all-but-confirmed Fed rate hikes in 2017.
This increase in inflation will inevitably lift bond interest rates and, in short sequence, other interest rates, especially mortgage interest rates. Basically, the shift upward in the Fed rate causes upward pressure on other interest rates. (Source: How quickly will the Federal Reserve tighten?, The Economist, March 1, 2017.)
Be Afraid of the Next Rate Hike
If that has not raised your level of concern, this refresher on the housing bubble of 2008 should hit the spot. The market is headed for a housing market crisis not unlike the one that happened 10 years ago. Here’s why. The financial crisis of 2008 was triggered by a housing crash, which had low interest rates as the root cause.
In the early 2000s, banks lured many new home buyers with the subprime mortgages. These came with a low interest rate for the first year. But, and here’s the big catch, the rates would rise sharply in the second and successive years. The banks probably left those risks in the fine print.
But, just to be sure, borrowers were assured they could refinance their mortgage in the coming years to maintain their low, initial, interest rate. The result was a literal “mortgagefest.” Any economist who would dare warn about the risks to the mortgage takers—and the banks—would be booed out of the party.
Indeed, responsible economists were a bit of a pain in the festive atmosphere that reigned in the U.S. housing market. Too many people were making money thanks to cheap housing loans. Apart from the financial institutions, construction companies, real estate agents and building materials companies were raking in the big bucks.
Is the U.S. in the Middle of a Housing Bubble?
They sold their properties at laughable prices to loan sharks and banks at fractions of their value. In Detroit, there were rumors that some home “owners” let go of their homes for a few dollars. (Source: “13 Detroit Houses You Can Buy For Less Than $100,” Business Insider, February 12, 2012.)
This sad scenario is up for an encore.
As was the case in the last housing crash, the real estate bubble of 2017 will burst because of a sudden rise of interest rates. The source of the hike might be different, but the effects on the housing market could be the mirror image of 2008. Check the chart below:
The housing bubble burst potential exists. This is especially true in certain areas of the United States, for example in large cities. In New York, Miami, Chicago, Los Angeles and Boston, prices have taken off because of demand. Meanwhile, the low cost of mortgages has manufactured demand.
The risk is that if the Fed does not act quickly to increase interest rates, the U.S. real estate crash of 2017 will be as deep as it was in 2008. President Trump, who is, after all, a real estate mogul, has advocated massive deregulation of the real estate market. At current interest rates, too many will be tempted to use “other people’s money” to invest, generating unsustainable levels of risk.
It’s true that predicting is not a science. It’s not possible to say with any degree of certainty that mortgage rates are going up by a full point, for example, after the Fed rate hike. But Trump has been incredibly skilled at persuading Congress and the American people that his policies will boost growth. There is confidence in the air; perhaps too much confidence.
That’s when an unknown and unforeseen risk, a black swan event, to use the concept conceived by Nicholas Nassim Taleb, can wreak havoc. The Federal Reserve may have been too soft at its last meeting. This has left the impression that risk of a housing crisis is low. After all, Janet Yellen left short-term rates unchanged.
But, after Trump’s welcome inflation-prone plan—a little inflation is a sign of economic health—the Fed will intervene sooner or later, raising interest rates. Mortgages will not wait to go up in response. Don’t be fooled by the fact that there is real demand for housing. Indeed, the real estate market, seen independently of other factors, could see robust demand for years to come
But the U.S. housing market forecast for 2017 remains robust so long as mortgage rates remain at four percent or lower. For all of Trump’s promises, most working Americans have not seen a proper salary raise in years. That means interest rates will go up before most can afford to borrow in the first place.
Meanwhile, because of demand, home prices have been increasing faster. Home sales have soared since 10 years ago. (Source: “Existing-Home Sales Jump in January,” National Association of Realtors, February 22, 2017.)
In sum, the combination of stagnant wages and higher home prices with the prospect of higher mortgage interest beckons is a crisis waiting to happen.
