This could be America's next nightmare, and possibly even worse than the stock market going down the tubes. Think about what has been the second biggest balloon of late. The NASDQ went through the roof with no profits, nothing but momentum and 'pro forma' estimates of future profits. As the old song goes, "They say a man's home is his castle, and he's like a king on a throne. It may be just a shack, down along side the track, but everything in it's his own." I wish that were true, but unfortunately, it isn't. Debt for homes have grown like stock prices did on their way up. Millions have taken second mortgages on their homes to buy stocks or pay day to day expenses, or credit card bills. I am not trying to scare anyone, but look at facts.
All things over-priced, will eventually decline, as this is the way the 'market' operates. If it costs $65 per square foot to build a new 2,000 square foot home, and the house is placed on a lot costing $20,000, with $5,000 sewer-water-utility hookups, simple arithmetical computation indicates that the cost of the house will be $155,000. In times past, it was virtually impossible to obtain a mortgage for more than 80%, or $124,000 for the $155,000 home. This meant that the buyer would have to come up with $31,000 plus settlement costs of $3,000, or $34,000, giving 20% room for economic or life fluctuations. In the past few years, that old standard has gone out the widow. Many companies will issue second mortgages totaling more than the appraised value, which may be even twice the $155,000 cost to build, thanks to neighborhood appreciation. Conservatively, we have a $155,000 house, that has gone up in value to $310,000, and the mortgage is $300,000. The payments on the mortgage are $3,000 a month, and the homeowners (husband and wife) are both working, making combined incomes of $50,000 after taxes from appropriate deductions, but before child care, food, car payments, utilities, credit card payments. etc. It's close, to put it mildly. Suppose either the husband or wife gets laid off? This is a distinct possibility, as most corporations are laying off, and when times are tough, incomes are certain to go down, for any of several reasons. This means the family is below break-even. If there was a severance fee paid when the layoff occurred, time has been bought. If credit card cash advances are available, more time has been bought. If another job is obtained, more time has been bought, but the damage has been done, and recovery may not be possible, as the chain of economic failure could have been forged. This is only a dreamed up example, but could be very real for tens of thousands of families. Bankruptcy numbers are huge, and increasing daily. There is not nearly as much room for life and economic variables, as there used to be. Tens of millions are living from paycheck to paycheck, and America has a negative savings rate.
I have a friend in a distant city, who sells for a living, and his sales are way off. Off so much, that he and his wife are contemplating selling the lovely home they have lived in and been paying on for 17 years, and moving into a community of low priced factory built homes. This would be a path to survival for them. Their equity would allow them some breathing room. Maybe their home will sell for less than they think, due to others attempting to sell also, as the depression-recession has hurt others as well. Their home will still sell for more than is owed, thanks to having lived in it for 17 years. Suppose they had mortgaged their home for a maximum amount, and the home was worth less than is owed? They would be in far more trouble.
With tens of thousands of layoffs, trillions lost in the stock market, which has depleted the retirement accounts of everyone, isn't it reasonable for homes that have gone up way more than their physical cost or value, to drop down a bit, or even a lot? Isn't it possible, that a half million dollar home, mortgaged for $450,000, might not bring more than $300,000 if no buyer can be found? In depressions, overpriced items go for a lot less, because no one can afford to buy them. If a community has had massive layoffs, who is going to buy a half million dollar home?
Tens of thousands of families in such a predicament, will simply walk away from their home, since it is worth less than they owe, ruining their credit rating. They must survive, credit rating or not. This leaves the home, with outstanding mortgage of more than the home has become worth, in the hands of the auctioneer, when foreclosure happens. Fannie Mae and Freddie Mac have trillions of dollars in mortgages and billions of net worth, which means they are insolvent, and if housing begins to crumble, they are bankrupt in actuality, and not just on paper. A headline in my local paper recently said that, "home prices may decline locally," or words to that effect. I am certainly not urging selling your house, renting, and waiting for prices to fall. Suppose they don't fall in your neighborhood? Are there areas where prices may not fall? Maybe, and these are where prices have not shot up to unreasonable levels, and places where layoffs may not happen, or violence erupts if the terrorists strike again, or there is a severe depression.
In the last deep depression, there was no welfare, no handouts, and no underclass that has grown up with the welfare state. If it all hits the fan, the inner city underclass (euphemism) will riot, burn, and loot. This almost has to happen, a-la Martin Luther King's assassination, or the Rodney King affair. The major cities erupted, and could again. Maybe they won't destroy their own neighborhoods this time. Small towns, would seem to be a safe place, but it is difficult to earn a living in them. Is there any reason why over-inflated areas will not decline in price? Telluride, Aspen, and Crested Butte Colorado real estate prices are stagnant now, and have begun to fall. If the newspaper in my wonderful town of 13,000 predicts lower prices, won't it happen everywhere? If it does happen to a greater or lesser degree, couldn't it pyramid? If it pyramids, won't it be like a run on the stock market? Isn't it possible that there will, or could be, a mad run to sell, and thus drive prices down radically? Like stocks, when there are more sellers than buyers; prices plummet.
It this happens, it could drag the entire economy down with it. Trillions have already been lost in the stock market, leaving hapless families hanging on to their one valuable possession, and that is their home and its contents. If housing dumps, and homeowners are paying on a mortgage whose value is higher than the home would bring, won't they leave, rent, and try to live another day? Won't they declare bankruptcy, and leave the credit card companies out on a limb? Won't they let the car go, and buy a used one? The human instinct to survive will not be denied, and the well-hidden despair of older folks who have seen their retirement vanish with the NASDAQ is just horrible. If housing drops, there will be a flood of used homes on the market, and new home construction will cease, with the resultant chain of layoffs, factory closings, and more bankruptcies. In an economic system, when one sector fails, it takes many others with it.
Have millions bought over-priced homes, and mortgaged them to the hilt? The potential for a housing decline, and hopefully not a crash, is no more fantasy than when we were all predicting the market's crash. I hope it doesn't happen. I hope America will not suffer the agony of Argentina. Brazil is close, and for that matter, a lot of other nations are close to an economic crash. America is so far in debt, and so weak economically, that we have already crashed, but no one knows it. As long as the PPT, manipulators, and presses can do their thing, we may be relatively safe for a bit longer. Just hope these Gold Eagle columns don't get read by too many, or it will exacerbate the situation. If millions suddenly decided to buy gold and silver, rather than the tens of thousands that now do; prices would escalate far faster than anyone wants them to, because they would pyramid also. If a few thousand sell their over-priced houses, and move into reasonably priced ones, rather than millions suddenly dumping, or trying to do so, it can stay fairly sane.
When things begin to pyramid, buying or selling in any sector can get really ugly. With hundreds of thousands laid off, housing greatly over-priced in many locations, the stock market wiping out millions of retirement nest-eggs and pension plans, it could happen. Don't speculate in housing.
We can hope for the best, but must protect ourselves in case of the worst.
July 29, 2002
Don Stott has been a precious metals broker since 1977, has written five books, hundreds of columns, and his web site is www.coloradogold.com
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