How bad is this housing bubble, when will it stabilize and how will the economy react?

At this point it is certainly safe to say that there has been a housing bubble in the US and that it is now bursting. I started looking at homes in 2003 and determined that the prices were simply too high with respect to incomes and that at some point it had to come down. I did not, in my wildest dreams, forsee the craze that followed. People were putting 0 down and merely telling brokers how much they make with no proof (ALT-A, “Liars Loans”). If you could walk into a loan office and scribble on paper, that was good enough for a million dollar loan!?!?! It basically got to the point where people were buying homes for $500,000 in areas of southern California like compton where equivalent homes would rent for less than $1000/month! I like the series “Real homes of genius” at the drhousingbubble blog, this spoof on Budweisers “Real men of genius” comedy commercials is hilarious and scary at the same time.

So people speculated and went absolutely bonkers, thereby preventing real buyers from affording their first homes. This speculation shot the value of homes up in some areas by 2, 3, 4 or even as much as 5 times their value before the boom. The very simple problem here that I have been telling my friends all during this housing boom is that this is unsustainable because salaries were not increasing sufficiently to match these home prices. Homes are not a magical source of unending wealth, their are a place to live and people must be able to afford them on the basis of their salary.

Median Home Prices vs. Median Household Incomes 1992 - 2005

There are a few simple solutions here. The first solution is that home prices fall to their inflation adjusted levels before the boom to resume their localized home price/median income ratios. This is approximately 2-3:1 for rural, 3-4:1 for suburban and 4+:1 for urban depending on the locale. The second solution involves a mild drop and stagnation in home prices like the one that happened after the 80’s housing boom and subsequent bust here in the US.

US Homes Prices 1975 - 2005

I would however argue that this bust cycle we are in now is significantly worse than the late 80’s boom/bust. The US housing boom follows the bust of the dot com bubble. To mitigate the dot com bubble, Greenspan reduced interest rates at the Federal Reserve to record lows and the result was a large economic boom based almost entirely on housing. This created record numbers of new construction and due to speculators, record numbers of vacant homes (typically homes purchased as investments or lost due to foreclosure). As this process is rapidly slowing and the housing market is falling out and returning to lower values or stagnating, we are beginning to see the ripple effects. If our economic growth was based almost entirely on homes, then what happens when the demand for homes drops precipitously? Suddenly, our drop in home prices doesn’t look like the 80’s boom/bust anymore, not it more closely resembles the Japanese boom/bust of the 90’s.

Japanese land values

The first hit is losing the loan officers, brokers and realtors which is a loss of a small but nationally significant white collar loss of jobs. The real effects will hit when all those well salaried, blue collar construction jobs and the entire industry supporting construction and remodeling comes to a crashing halt. All the people who did the framing, roofing, tiling, electrical, plumbing, paving, landscaping, sheet rock, painting, flooring, etc. will soon be at risk of losing their jobs. Then all the places selling the necessary products to those construction workers, then all the businesses manufacturing the products necessary for those construction workers. This was a major part of the US economic growth. Once this all starts falling through we will see large increases in unemployment, falling wages, increasing foreclosures, falling home prices (thereby falling wealth) and general chaos. The dollar will weaken and if the fed does lower interest rates, the dollar will deteriorate even further. It seems likely that a strong recession is coming and most people are still in denial and have not yet connected the housing bubble with the larger state of the economy. What makes this worse are the international consequences of a deep US recession and the possibility that other markets face a similar fate. Below is evidence that the UK is likely heading for a housing disaster deeper than the US.

Evidence of UK housing bubble

Here is an interesting forecast which, if you believe, implores you to put your assests in commodity business and classic bust valuables like gold.

Peter Schiff has a similar forecast that basically says this bubble needed to burst because of irresponsibility and that the government should not intervene because it will merely slow the necessary market correction and use up government resources in the process (which I agree with):

I really have to put this video below which has the same “doomsayer” explaining in 2006 why the market will crash who is talking in the above video, Peter Schiff.

I believe this housing bubble will lead to larger problems and the larger economy will suffer. If the international economy also suffers it is possible that we could be looking at a real depression similar to the 1930s. At the very least we should expect a dramatic housing correction, housing stagnation for a long time and a large loss of jobs in the US that will need to be filled. When might the economy begin its recovery? I believe there are two major issues surrounding the recovery. The first is that we are really still on the high end of the fall and are not even close to the bottom. We still have to see the job losses in the construction sector and the influence this will have. We have yet to see if investors will completely pull out and the US will be left with thousands of unfinished homes and if areas like Miami, with MASSIVE investments in condos, will turn into a condo ghost town like Bangkok Thailand.

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