A Drunk Driving a Hummer a Mile Wide


Like spectators gawking at a speeding drunk, we have been watching the housing bubble closely…we’re wondering what he’ll run into.

In this, we are different from most viewers. Most people seem to think he’ll run every red light in town and then just coast to a stop out by the dump. Then, he’ll have a chance to sober up without hurting anyone.

Maybe so. But we doubt it.

This drunk is driving a Hummer a mile wide.

Here’s the hot news:

For the first time in 11 years, no longer is the rate of growth in housing prices merely flattening…now house prices are actually going down!

Here’s the Reuters’ report:

“The pace of existing home sales in the United States fell for a fifth straight month in August and prices dropped from year-ago levels for the first time in more than 10 years, a realtors group said on Monday.

“While the report offered a fresh sign of cooling in the U.S. housing market, the sales drop was not as steep as expected on Wall Street, where economists had looked for the pace to slow to 6.18 million units.

“The report, however, did show prices have begun to drop when compared to the lofty levels of last year. The median price dropped to $225,000, off 1.7 percent from August 2005 and the first annual fall since April 1995.

“In addition, the stock of unsold homes on the market rose 1.5 percent to 3.92 million units. At August’s sales pace that represented a 7.5 months’ supply, the highest since April 1993.”

Tech stocks could go down without doing much damage to the broader economy. You win some; you lose some; that’s just the way it goes. But housing is too important to lose. Too many people count their blessings in housing. Too many people depend on it. Too many people have too much of their wealth tied up in the roofs over their heads. And too much of the nation’s GDP is linked to the bubbly housing market.

While a rising housing market pumped money into the economy…a falling housing market will suck it out. In the last two years, about $1.3 trillion was “taken out” of housing by way of refinancings and equity withdrawals, and shoved into the U.S. economy. But now there is no more equity to take out. And even in a flat market, the Institutional Strategist estimates that the owners of 8 million houses will have their mortgage payments increased by as much as 50% over the next 16 months.

Imagine what happens with prices falling. Suddenly, the equity disappears. Sellers — if they can get a bid — have to put the money back into housing. That is, one way or another, they have to make up the difference between what they borrowed against and what the house is really worth. In many cases, that will mean owners will walk away from their houses — putting more and more properties on the market at distressed prices.

“The home-equity line has supported American consumer spending,” wrote Lon Witter in Barron’s last month, “but at a steep price: Families that tapped into their home equity with creative loans are now in the same trap as those who bought homes they couldn’t afford at the top of the market.”

Buyers have been strapped for cash from the get-go — even in the midst of the biggest bulge of liquidity the world has ever seen. As many as 70% of the people who took out ARMs (adjustable rate mortgages) ended up making the lowest permissible payment.

As the bubble grew, mortgage lenders became more reckless…as if Avis or Hertz were to give young drivers a bottle of whiskey along with the car keys. Loans made with "reduced documentation" — wherein the borrower was allowed to state his own level of compensation, no questions asked — rose to 40% of the entire mortgage pool. Eventually, the Mortgage Asset Research Institute wondered how much lying borrowers were doing. They did a survey and found that 90% of borrowers inflated their income by at least 5%…and nearly 60% of them falsified the figure by more than 50%.

What are credits of that kind worth? Borrowers pretended to earn more than they actually did, so they could buy houses they couldn’t afford…and lenders pretended the credits were good so they could sell them on to hedge funds, which pretended to know what they were doing. Now that prices are going down, we’re about to find out what all that pretense will cost. We don’t know the answer, but we guess it will be more than most people expect.

u2022 Although the gas price has been steadily declining in recent weeks, people are still looking for a fuel-efficient, environmentally friendly option for transportation.

The big automakers are falling over themselves to develop what has been coined “the car of the future”…we’ve got the Toyota Prius…GM is claiming to have “reinvented the automobile” with their Chevy Sequel, a fuel cell powered car…and now Honda reports yesterday that they have developed a new and simple diesel powertrain that is as clean as gasoline-fueled cars.

“Its new diesel drivetrain features a unique method that generates and stores ammonia within a two-layer catalytic converter to turn nitrogen oxide into harmless nitrogen,” reported the Japanese manufacturer.

Although some fine-tuning and technical hurdles remain, Honda hopes to roll out this diesel engine within three years.

“Just as we paved the way for cleaner gasoline engines, we will take leadership in the progress of diesel engines,” Honda Chief Executive Takeo Fukui told a news conference at the automakers R&D center north of Tokyo.

u2022 Here is something interesting: for the first time in 90 years, the United States is paying more to foreign creditors than it receives from its overseas investors. The Wall Street Journal says this development may presage a drop in U.S. living standards.

u2022 We are grateful to the hedge funds. While the lumpen watch reality TV for laughs, we have the comic unreality of hedge fund industry.

Says the Economist:

“Finance has been convulsed by a computer-enhanced frenzy of creativity. In today’s caffeine-fuelled dealing rooms, a barely regulated private equity group could very well borrow money from syndicates of private lenders, including hedge funds, to spend on taking public companies private. At each step, risks can be converted into securities [like mortgage-backed securities], sliced up…re-packaged, sold on and sliced up again. The endless opportunities to write contracts on underlying debt instruments explains why the outstanding value of credit-derivatives contracts has rocked to $265 trillion — $9 trillion more than six months ago, and seven times as much as in 2003.”

More and more, risk is divorced from consequences. A mortgage company lends money to a guy who misstates his income. When the crunch comes, the guy cannot pay. The house goes into foreclosure. But who loses money? The lender sold the mortgage contract on…where it was sliced and diced in many different ways. Who takes the hit?

It is as if one man got drunk…and another had the hangover.

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.