Housing Faw Down, Go Boom

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"Strapped homeowners feel the pain," observes a Wall Street Journal headline.

The pain these homeowners feel is, of course, the pain they richly deserve. They took out mortgages with low teaser rates…and now their rates are being adjusted upwards. And they are being squeezed.

The article tells of one couple whose mortgage jumped from a 2.35% rate to 8.75%, two years later. They had something called an "Option ARM," which gave them a selection of alternatives. But now they find they have no alternative at all — they cannot afford their own home and must sell the thing. They and every one else, apparently. The market is flooded with inventory. Sellers are getting soaked. The homeowners mentioned in the article put their house on the market for $400,000. With no bids coming, they’ve cut the price down to $270,000. They have no choice; they can’t afford to keep the house.

And there are plenty more facing the same dilemma. Delinquency rates are rising, led by delinquencies on ARMs that are three times the rate of regular, fixed-rate mortgages.

Our heart is not breaking. But we are nevertheless appalled by the shabby way the poor chumps are treated. They are regarded not only as fools who blundered and deserve to be separated from their money (they didn’t have any anyway), but now they are also losing their homes.

When we left you yesterday to go gallivanting around France — on business, alas — we were expostulating on the idiocy of the professors of "Behavioral Finance." They think they are being investment "descriptivists," who merely tell us what people actually do. But they can’t seem to resist being "prescriptivists" — telling people what they should be doing if they want to maximize their investment returns.

And, when the investor doesn’t do as they say he should, he is accused of making "mistakes." Yes, of course, the average investor does things that seem stupid to the analyst. But the deeper mistake is the one made by the analysts themselves. They misjudge their subject. He is not a rational profit maximizer at all; he is merely a man.

If he chooses a stock because he likes the sound of the name or because his neighbor told him it will go up…so what? It might go up. And so what if it goes down? He might have taken the money and bought something — but what? Why is buying a new car, a big-screen TV, or even a few dozen pills better than buying a stock? They are all consumer junk, one way or other. All of them break down, go down, wear down and eventually disappear as completely as any dotcom.

On the other hand, buying a tech stock, for example, the lump at least has the pleasure of momentarily strutting around like a cross between Livermore and Lynch. Who knows, the darn thing may go even further up…and make him feel like the one of the gods themselves. And if it goes down, at least he has learned something valuable. Something that is worth more than staring at a TV screen or smogging up the ozone in a fancy car, we think.

The big error made by the Behavioral Finance professors, economists, investors, and consumers themselves — is that they overrate the value of money. They think money is everything.

But just a few days ago, we had a taste of its limitations.

"I was shocked," Elizabeth announced upon returning from a trip to visit friends. "They spent all that money and the place is just not very attractive. The stables are well built, but they are just badly designed. And the house is nothing to get excited about. They are too close to the highway, and they have a view of the power lines. I know they invested millions in the place. And I know why they bought that place rather than something else. They thought it was a better buy; it was cheaper. Now I know why. It’s not very nice. And it’s not very nice for reasons that they can’t do anything about."

Money is not everything. In their hearts and souls, people know it…and they devise financial strategies that take it into account, often "wasting" money or failing to maximize revenue. And, they probably make as many blunders by focusing too much on money as they do by ignoring it.

And yet, economists build their theories around a man who only cares about money. Thank god, he does not exist.

The poor sap who does makes plenty of "mistakes," of course, buys houses tangled in power lines, and takes out an ARM to save money. But the Adjustable Rate Mortgage is more than a "mistake." And the poor man who got one — without fully understanding what he was getting himself into — is more than just a fool.

Now, everyone knows that the housing market is coming down. And everyone knows that all those chumps with ARMs are paying through the nose and getting it in the neck. Investors have convinced themselves that the great property boom is floating down to a soft landing. They look at England and Australia, for example, and say, "Look, both had residential real estate booms bigger than in the United States. Both have seen prices come down. But neither has had any real problems as a result."

But in England, the day of reckoning for property prices is yet to arrive, for prices have been propped up by huge waves of foreign money pouring into London. And in Australia, the economy was only saved by the boom in commodities. What will save the U.S. economy? What will save all the marginal investors, homeowners, and consumers who have chained themselves to the ship of rising property prices?

We have a guess: America will not be so lucky. Our property market will come down in the biggest, hardest landing ever. Homeowners and consumers have so much debt, that when the ship goes down, they will drown in it.

But whom should we blame? Are the luckless home owners willing victims of their own "mistakes?" Or of what?

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis.

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