In part because of the gyrations of the stock market, many people are thinking favorably of real estate. "It may pause but it never really goes down." or "They're not making any more of it," etc. To many people right now it looks like the ultimate safe and profitable investment.
In my opinion, real estate is due for its own severe fall. Why? Because prices have entered a classic bubble phase where prices rise exponentially, but even more because the only thing holding up real estate prices at this juncture is very low interest rates.
For reasons that we'll examine in a moment, interest rates on mortgages are due to rise a long way, and when that happens real estate will very probably fall proportionally.
When the bottom is reached (probably in 2010 or 2011), the housing market will probably have lost something like 80-90% of its current value. This seems like a fantastical figure at the moment, I know, but an 80% loss is no more than what happened to housing nationally in The Great Depression.
Furthermore, the economic collapse that we're ultimately heading into will, in my opinion, probably be an order of magnitude larger and deeper than the one in the 1930s.
The collapse in real estate will be part of a larger collapse encompassing other bubbles such as stocks and bonds and the mother of all bubbles, credit. The fall in real estate markets will apply to all sections of the country and to both commercial and residential properties, although the areas that have risen the farthest, such as both U.S. coasts, will fall the deepest, probably 90%.
This real estate bubble is not confined to the U.S., but is also occurring in many other areas of the world, and is the largest real estate bubble in history. But as the Japanese discovered in the 1990s, when a large real estate bubble collapses it can be catastrophic indeed.
Except for the very elderly, no one alive can recall a time when real estate was not going up. Sure, it may pause from time to time, but then resumes climbing again. Three generations now have never known anything else. Though real estate now seems one-directional only, within a few years we're likely to discover that real estate is indeed a two-way street.
Right now, as stock markets gyrate, people are moving increasingly into real estate as a "safe" investment. But the amount of wealth represented by real estate is roughly double the wealth represented by stocks. Thus a real estate collapse will be that much more consequential.
The deep story of the real estate bubble is the story of the Great Global Credit Bubble, which has created various daughter bubbles. And the ultimate reason why bubbles fall is because they rose too far. Nature likes symmetry.
But the proximate story of the real estate bubble is about historically low long-term interest rates and ultra-easy credit, which have made mortgages much more affordable and obtainable than ever before. When long-term interest rates rise, as they inevitably must, this sea of debt will become unsustainable and the piercing of the real estate bubble will be at hand.
Why must long-term interest rates rise? There are lots of different pressures that will eventually bring this about. For example, one potential cause is the rise of inflation again, a phenomenon related to unrelenting monetary and credit expansion that is happening more or less under the radar now but will soon enough burst to the surface.
Another potential cause is a precipitous fall in the dollar. Briefly, the U.S. is running enormous budgetary and current account (foreign) deficits which will eventually dampen the ardor of the rest of the world to buy U.S. government debt paper.
Currently, 80% of the world's savings per year is going to finance the spending patterns of the U.S. government and consumer, but that is an unsustainable situation. The U.S. has entered the arena of the "banana republics"—crushing debt burdens which sooner or later cause a collapse of the native currency.
When inflation becomes virulent again the Fed will be forced to raise interest rates further and further to try to "contain it." (A joke if there ever was one, because its own enabling of monetary and credit expansion is the inflation itself.) And if/when the dollar falls, long-term interest rates—which determine mortgage rates—will have to rise in order to to attempt to attract capital back into U.S. government bonds and notes.
Because the real estate market is debt-leveraged as never before, when real estate prices fall there will be a huge need to raise cash. Houses, buildings, malls, apartment complexes, etc. will all come on the market in increasing numbers, creating a self-reinforcing process that will only exacerbate the decline.
There is a strong tendency to say, "But this can't happen here in the U.S. Our productivity, our entrepreneurial spirit, our businesses and financial institutions, etc. are fundamentally too strong for that to happen."
We'll see. I believe the world is at a historic series of tops —first in stocks, then in bonds, real estate and credit—occurring in the years from 2000 to 2005. These tops, in my opinion, will mark the end of a protracted rise which in some ways can be traced back a millenium or more to the economic bottom reached way back in The Dark Ages around 950 AD.
—jim sloman, 8/17/02 for Aug 17
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