The real estate market is collapsing fast. Why? People borrowed more money than they could repay so they could "buy" houses they could otherwise not afford. And the banks that pushed those loans now find themselves the miserable owners of those death support systems for debt. The banks don't want these economic death traps -- so they'll dump them at a fraction of the price at which they were sold. (The Wall Street Journal reports that in June 2008, Credit Suisse sold a 1,230-square-foot home in Corona, CA for $198,000 that went for $450,000 in December 2006).
Bloomberg News reports some stunning statistics about how quickly banks are taking possession of those houses. U.S. foreclosure filings spiked 55% while bank seizures -- when a bank takes ownership of a house also known as real estate-owned (REO) -- skyrocketed 184%. Bloomberg says that "more than 272,000 properties, or one in 464 U.S. households, got a default notice, was warned of a pending auction or were foreclosed on."
This transfer of titles to banks is contributing to a massive loss of wealth. Bloomberg reports that home prices fell "15.8% in May, the most since at least 2001, according to the S&P/Case-Shiller home-price index." And Bloomberg indicates that 33% of home sellers in the second quarter lost money. Moreover, according to SeekingAlpha, 33% of houses bought in the last five years are worth less than the amount of their mortgages.
Is the concept of "free markets" -- which led us into this $8 trillion disaster -- a good idea? That's the notion that markets, rather than government intervention, is the best way to solve economic problems. The source of the current disaster is a special form of free markets -- one that offers government assistance to the banks that sell mortgages but blames consumers for moral turpitude when they can't pay back the mortgages.
Let's look at how the government helps banks. It gives out tax breaks for home purchasing -- such as making mortgage interest tax deductible and exempting up to $500,000 worth of real estate profits from taxes. When banks get into trouble due to poor management, it bails them out. For example, it put $29 billion of taxpayer money on the line to rescue Bear Stearns, which was a huge player in mortgage securities. And it stands ready to spend as much as $800 billion to bail out Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).
Why does government do this? Banks help pay for political campaigns. For example, President Bush got $7.8 million from Ameriquest -- one of the biggest subprime lenders. "Homeowners" don't have enough money to be such significant campaign contributors. And when government goes to bail out the banks, those taxpayers have no say.
So the question is whether we should keep the current special form of free markets -- private profit and public losses -- or instead go for real free markets -- private profit and losses. If we had real free markets, it would not be profitable to make loans that people can't repay to buy houses they can't afford.
And that would free us from real estate bubbles -- like the one whose current collapse is causing so much economic pain in the U.S.. Here are some thoughts on what such as post-bubble economy might look like.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
Reader Comments (Page 1 of 1)
8-14-2008 @ 11:16AM
william lindblad said...
Peter, to prevent bubbles we have regulation and control. The big question is why did this not work?
You have part of it in Ameriquest, but Bush and the White House has never been in charge of the financial sector. How about a look at the campaign contributions to the Congressional finance committees, who DO. I point out that when Cox and SEC decided to go after shorts the market responded. When the oil market faced the scrutiny of regulators, the same happened. What is now a great financial woe is the result of no regulation. Now, as I knew it would, Europe and the U.K. are showing a slowdown and our one bright star in the export market is the next to fall.
The Fed made a grave error - they should have raised a 1/4 point.