Tuesday, May 31, 2005

Blowing Bubbles

Over the past few weeks it has been impossible to follow any news outlet at all and remain completely in the dark about the looming financial crisis...dun dun dun... the housing bubble. Doesn't sound very scary and economists are mixed about the timing, damage estimates and economic impact. But like a California earthquake, ready or not, here it comes.

Economic blog Calculated Risk links to several excellent articles if you are interested in trifles like housing vs. renting ratios, foreclosure rates and advance-buying, all indicators of financial trouble ahead. My own information is more anecdotal in nature. I noticed a few years ago how well people seemed to be living compared to me. As our household income is fairly average by industry standards, and we live in an industry town, it was a puzzle. At the time I had never heard of interest-only loans. In fact five years ago, neither had anybody else; they accounted for less than 2% of mortgages. Today they are the loan of choice nationwide. 60% of all mortgages are either flat-rate interest-only, or adjustable-rate balloon-payment type. Either way it spells trouble for the country when so many people are living above their means.

In San Francisco the average home price is $500,000. To afford a home, most have to take out yearly interest-only loans and then refinance. Interest rates are low, so it is doable, keeping the cost of housing inflated. Here's the problem: what happens when interest rates rise? People can no longer afford even the interest-only loans and must sell quickly, before they are foreclosed upon. When this happens the market gets flooded, prices drop and no one can sell for anywhere near the purchase price. The Chinese have been supplying our insatiable desire for cheap money the same way the OPEC has historically met our need for oil. Times they are a changing.

The fed started manipulating interest rates to stave off inflation five years ago, just after the tech bubble burst. Cheap interest fueled housing starts, jobs and consumer spending. Despite nagging unemployment figures, things look okay on paper. When asked about the housing bubble, Fed Chairman Alan Greenspan claimed there is no single bubble, just little pockets, bubblets, around the country - California, NY, DC and Florida. Pretty big bubblets, if you ask me. And I told you, it's happening here in Houston too.

I stole this line from somewhere, can't remember, and I only remember the last line. Cream rises to the top, but scum does too, in the form of lots of tiny little bubbles.