When Will America’s Housing Bubble Burst?by
Eric Englund
Throughout 2005, my clients – contractors of all trades, fabricators, and suppliers – have watched housing continue on its tear. Housing demand seems insatiable. Residential, commercial, and public works contractors are busy all across the U.S. When housing subdivisions and condominium complexes are built out, commercial and public works projects often follow. Strip malls, supermarkets, restaurants, and department stores are constructed to serve these new population centers – much to the delight of the commercial construction trades. With these new population centers comes the "need" for new public schools and other public infrastructure. Public works contractors get a piece of the action as well. Most of my clients are quite busy and turning nice profits. However, during a recent business trip, a common theme emerged in meeting after meeting. My customers are seeing severe shortages in building materials and quality labor. Many are outright stating that the heady pace of construction is simply unsustainable. In turn, some of the more seasoned contractors are predicting a bust – but they just don’t know when; yet I will hazard a guess. In my meeting notes, I found that contractors were running into shortages of the following (pre and post-Hurricane Katrina):
Of these shortages, the one causing the most frustration pertains to a dearth of quality labor. Contractors, frequently, have little choice but to load their construction budgets with ample overtime pay in order to keep quality (and often shorthanded) crews together for the duration of a project. One client quipped: "This constant battle for labor and materials can’t go on forever. Things have to cool down sooner or later. But when?" As to precisely when the bust will occur, this is not knowable. As to why boom turns into bust, only the Austrian Theory of the Trade Cycle provides the intellectual framework allowing one to understand the boom-bust cycle. What we will find, as explained by Roger Garrison, is that central banking is at the epicenter of the business cycle. Dr. Garrison provides the following explanation in the Mises Institute’s fabulous book The Austrian Theory of the Trade Cycle:
Undoubtedly, the current American housing boom has not been built upon a foundation of savings – keeping in mind that, presently, America has a negative savings rate. This boom has been fueled by the Federal Reserve’s aggressive creation of money and credit. Correspondingly, the federal funds rate hit a low of 1% in June of 2003 – about the same time the housing boom began to accelerate. Since money and credit can be created out of thin air, yet building materials and other resources cannot, does it not stand to reason that relentless credit creation would lead to resource shortages? Of course, the answer is "yes" – and Austrian economists know this. Accordingly, Roger Garrison covers this issue in his excellent book Time and Money: The Macroeconomics of Capital Structure:
It is not often one finds an economic theory that describes reality – and Austrian theory does so magnificently. In fact, from the labor and materials shortages my clients have described, it would seem the bust phase of the business cycle is nearly upon us. Tom Barrack, widely considered to be among the world’s greatest real estate investors, wittingly or not, has an Austrian perspective as to why the United States’ real estate/housing boom will soon come to an end. He stated the following, about real estate, in a recent Fortune article: "There’s too much money chasing too few good deals, with too much debt and too few brains…. That’s why I’m getting out." Tom Barrack certainly understands the dangers of high-octane credit expansion. Yet, what about the inevitable resource scarcities caused by the Federal Reserve’s accommodative credit policy and how will this affect the housing bubble? In the following excerpt, from this article, Mr. Barrack hits the ball out of the park:
To be sure, the severe construction labor and materials shortages, seen throughout the U.S., signify the housing boom is nearing its end. Not surprisingly, Austrian economic theory predicted such shortages would emerge before boom turns to bust. For good measure, let’s throw in the following housing affordability and financial-stress factors into the fray – which also point to the impending demise of the housing bubble:
But what about my promise to hazard a guess as to the timing of the bust? After all, Tom Barrack indicated that he sees enough busted deals materializing, over the next year or two, to bring about a downturn in the real estate market. In order to make a reasonable prediction, I am going to bring into the mix a September 2005 Federal Reserve discussion paper titled House Prices and Monetary Policy: A Cross-Country Study. Per this discussion paper’s abstract: "This paper examines periods of pronounced rises and falls of real house prices since 1970 in eighteen major industrial countries, with particular focus on the lessons for monetary policy." Here is what I found to be most interesting: "House price booms are typically preceded by a period of easing monetary policy, with policy rates bottoming out about the same time that house prices take off, about three years before house prices peak." Considering the fed funds rate did not bottom out, at 1%, until June of 2003 (and remained at 1%, until June of 2004, before being ratcheted upwards) one could reasonably surmise house prices will peak somewhere between June of 2006 and June of 2007 – and then, of course, will break downwards (for the reasons mentioned above).
November 4, 2005 Eric Englund [send him mail], who has an MBA from Boise State University, lives in the state of Oregon. He is the publisher of The Hyperinflation Survival Guide by Dr. Gerald Swanson. You are invited to visit his website. Copyright © 2005 Eric Englund |
