May 11, 2007

The Housing Tipping Point. 3 Factors That Will Burst the Bubble: The Negative Wealth Effect, Negative Press, and Suffocating Debt Payments.

As the Fed does an ostrich impression by sticking its head in the ground and pretending everything is okay, we are facing an economic tipping point ushered in via housing. The Fed has left the key interest rate steady once again. At this point, they are backed to a wall because lowering rates will signal that the economy is weak and needs additional help thus stunting consumer confidence. If they raise rates, they accelerate the bursting bubble because debt service on millions of American’s mortgages will go higher thus taking money away from the national past time of mall shopping. We are quickly approaching a global tipping point. Tipping points are interesting phenomenon because they occur rather instantly even though the build up may take numerous years. There is a certain point where multiple intersecting fields connect to push an idea, product, or opinion into another dimension. 3 of the many factors that will tip the housing market over the edge are the negative wealth effect, negative press, and suffocating debt payments.

Negative Wealth Effect

For the last seven years it is no shocker that all things real estate out performed nearly every investment vehicle. Home is where your heart and wallet is as the old adage goes. The wallet portion was an added amendment that the realtor groups added a few years ago. When people feel wealthy they spend and the economy spins on a kaleidoscope of happiness showing colors that only Teletubbies are familiar with. You beam with joy. Your credit card blisters with ecstasy. This is the American consumerist dream. We spend with no regard for the future. We’ve reached milestones in negative savings only rivaled to those during the Great Depression. The last 17 years have been great for this economy; we jumped from one bubble to another without missing a beat.

Yet the tide has turned. There is a moment in any bubble where people stop, think, and listen and hear their gut (yes your gut is fluent in English) and you realize that maybe you aren’t as wealthy as you once thought you were. See, we’ve been indoctrinated to believe that everyone of us is worthy of being a millionaire. From the office assistant to the CEO, we all deserve to be unbelievably rich. Work? Investing? Those things are for losers who have patience and who can afford patience when my Blackberry is vibrating in my Diesel jeans.

The wealth effect works in two ways. It amplifies a good economic environment because people feel and are wealthier. No one spends exactly as much as their wealth is worth. If you feel rich, you won’t fee so guilty taking that trip down to Cabo especially when you know your job is secure. However when the market reverses and heads south, you begin to tighten your belt and batten down the hatches. It is exponential on both sides. As housing is going down the economy will be vastly affected because this is the number one store of American’s wealth. If they feel the number one investment they hold is losing money each year, they will restrain their spending. And this will happen by force because of the next topic, the suffocation of debt.

Suffocating Debt Payments

If your mortgage jumps from $1,500 a month to $2,000 a month that is $500 less you have from spending in the economy. But you argue that the bank now has this money. Well, in theory they do because they are also paying their debts to the government and skimming anything on margin. In addition most CEOs don't shop at Wal-Mart. This works perfectly when everyone is doing what they are suppose to be doing. But what happens if rates reset and people stop paying? Now that the bank attempts to unload a property and has suddenly become a landlord we now have a negative cash flow problem and negative cash flow is a flu in economics. It will spread. It is contagious. And the person that loses their home? Well as this market implodes on the credit orgy we’ve lived through many will have harder times accessing credit and most will not be able to purchase another home for many years. Thus the number of people in the market buying homes is decreased simply by eliminating those that are currently homeowners via ridiculous credit instruments. Plus market psychology will feed to the frenzy. In essence there is a purging of owners who shouldn’t be owners. Yes, this goes against the American dream of everyone owning their own plot of land but face it, debt is not wealth and no amount of posturing can change that economic reality.

There is an interesting stat showing that credit card debt has increased drastically in the last few months. The logic follows that folks facing resetting mortgages are using their credit cards as a “carry over” to finance their current debt. So things look dandy even though they are heading down the merry road of debtors paradise (not to be confused with Coolio’s Gangsta’s Paradise otherwise known as a Real Home of Genius). So we are running out of time on this credit time bomb and by the end of 2007 we will reach another tipping point; a point where money is worth a lot less and credit becomes more elusive. The outcome is a market where prices depreciate and folks feel poorer because they are paying for today’s expenses with tomorrow’s income.

Negative Press

I’ve talked about the $14,000 a year strawberry picker who was able to purchase a $720,000 home. Or what about the 102 year old man getting a 25 year mortgage? And we also have the story of a 29 year old graduate student who was able to buy a $600,000 home with a $20,000 a year income. Even the Los Angeles Times had a cover story about a sheriff deputy who is evicting people in the Inland Empire this weekend. The press is now anti housing if you haven’t noticed. Once relegated to the blogsphere world and tin hat wearing neg-heads, being anti-housing is now in vogue. Not that it is in fashion, but being financially irresponsible for so many years has repercussions. The press is now finally understanding that a $500,000 500 square foot box may be a tad bit over priced in a neighborhood where people earn $45,000 a year. This obvious logic is now tipping the mainstream public into accelerating the bursting of the bubble.

Yet we have summer. This is the last time before housing agents and brokers will be turning tricks for cash. Last summer I was receiving wonderful glossy invitations from ReMAX, Century 21, Prudential, and other well known franchise brokers to join their team; I am still a card holding agent although from my rhetoric you can tell that I am no longer in the industry. Fast forward to 2007 and those glossy expensive invitations have turned into Xeroxed copies that mirror frat parties in college. Make bank with Joe Schmoe Mortgage” as a model points to you eluding that if you switch over, you’ll get chicks and cash. Stellar marketing. Too bad this was done on pink florescent paper otherwise me and Joe would be selling no-doc suicide loans to the public. Brokers and agents that wouldn’t give me the time of day last year suddenly send me hand written letters of appreciation trying to win my business. Hand written means one thing, more time on your hands.

The thing is, many in the California real estate industry have prospered amazingly from this real estate bubble. Many had high incomes but are not wealthy. See, many in the industry are financially naïve and have invested little of what they earned. They are like Mike Tyson squandering $200,000,000 because when times are good why save? It is a matter of personality I suppose but those folks that grew up in the Depression have habits such as making food last, reusing certain household items, and even SAVING. I heard a lightening bolt strike outside my office because it almost seems like blasphemy this concept of spending within your limits. We are at a tipping point and by 2008 we will be fully engaged in a bursting housing bubble and all the consequences associated with it. 30% of all added jobs in the last seven years have some association to real estate. So what do you suppose this means for our economy?


Anonymous said...

Great blog Doc. It's funny you mention the WWII vets and the men and women who made it through the depression because my dad and I were talking about this just the other night. Your remarks were right on par with what we believe as true too. How they live their lives is drastically different than how many young people live today.

crazed said...

HI Dr. HB,
Thanks again for your great post.

I was wondering why the dollar will buy less if we have deflation?
Wouldn't saver be able to buy things cheaper?

Do you think the FED will flood the market with more cheaper money to keep the economy going?

Ben Franklin said...

Yeah, another well-written article, Dr. HB. I'm not certain of it, but that may be the first bubble article that included mention of teletubbies, Mike Tyson, and Diesel jeans in it. :)

So true about people's attitudes about money having changed vs the great depression, from an era where citizens were extremely distrustful of letting banks hold their money after the bank runs, closures, etc. People used to bury their valuables in the backyard, etc.

My grandfather used to have a fit if one of us grandkids would leave the refrigerator door open for longer than necessary, or not turn lights off when leaving a room. It completely rubbed against his grain to waste. I suspect a new generation of Americans will soon have a deeper appreciation of what it means to avoid squandering, even if it's forced on them via a downturn.

Dr Housing Bubble said...


You know most people go about life by their own experience. They fail to look at history as a lesson for us to gain knowledge from. Most people in their 20s and 30s (even some in their 40s) have no idea what it is to be in a depression. We've had a couple of solid recessions but nothing requiring a reshaping of life. In my view, things will drastically change in the next five years.

We could learn a lot from what your dad has to tell.


It is all relative. Say a house goes down 20% but your dollar is worth 25% less. Doesn't really help unless you peg your currency to something that is negatively correlated. That is, if housing goes down your investment vehicle goes up. In my view, it seems like the Fed is praying for stagflation. That is sluggish economic growth coupled with a high rate of inflation and unemployment. Since we are so reliant on real estate as a source of growth via brokers, agents, construction, housing supply stores, and equity withdrawal that the implications of a housing downturn will easily lead us to a recession and probably more. The Fed is stuck. Whatever they do they are screwed. They are fiddling while Rome burns. The stock market looks healthy because the dollar is getting pummeled and inflation supposedly does not exist according to the CPI. Do you think we are at 2% inflation?

ben franklin,

My article was inspired by my cousin's daughter watching teletubbies and after she switched stations we saw a DiTech ad with similar colors . Notice how the characters seem to live in Silicon Valley? Are they trying to push Northern California real estate on kids?

Your grandfather has the mentality of someone that is resourceful. Can you imagine are society shifting on their own? Something good may come from this credit and housing explosion. Maybe folks will learn to define themselves less by what they own and more by what they do. If we are to look at our society in terms of Adam Smith's examples of capitalism, we are at the peak consumption level; purely driven by credit and buying.

As in any cycle these things can't go on forever and we all know where we are heading. Just take a look at the many examples of houses on this site and others showing the absolute gross level of this bubble. We are in LaLa land and unfortunately the Teletubbies are grounded more in reality than we are.

[hiding in the] bear cave said...

I am ready for some serious demand destruction and deflation--today i finally managed to get a positive net on interest from cash minus interest on loan debt, the first time I can say my investments have become positive since I earned my degree three years ago.

That said, i'm woefully afraid of what might happen. I have long positions in gold and oil but fear that the bull commodities market is only partly a response to the Bubblevision Fox Business News world we live in, and too much an outcome of more all the excess liquidity. My attempts at financial planning are going nuts. Do I go with bear funds? Do I short financiers? Do I buy gold at what seem like speculative, not preservative, prices? Should I try and scam some matching contributions on my 401k in a market more bloated than Christie Allen after a pizza-and-cocaine binge? Do I stock up on toilet paper, ammunition, canned goods and condoms?

It really is enough to drive a sane man nuts. All these grasshoppers singing their grasshopper song before winter comes discovered the magic of Specuvesting, bought a bunch of houses that were appreciating at parabolic rates, gave the banks a metric shit-ton of debt to securitize, and now I am paying for it in my sanity.

Every uptick on the Dow drives me nuts--why the hell am i going to enter a market as an investor when P/E is at something like 15? Is it even sane to sock away 401k money when my employer runs conflict checks and restricts the portfolio to some busted-ass overpriced mutual funds?

bear cave said...

that previous post isn't me trying to weasel advice, it's me freaking out from the crazy pills the bubbleheads keep putting in the water.

Anonymous said...

Nice article, Dr.

But your site is getting a little overgrown with ads and cookies. My browser blocked 120 cookie attempts.

Anonymous said...

I just got a new site through real estate website design they told me it takes time to gain rankings or even be listed on the search engines. Is that true? Please advise.

Dr Housing Bubble said...


Completely new design to site. No more pop ups and quicker loading time. I've adjusted the site to many readers suggestions and comments (thank you all for the solid comments). Look forward to reading new insightful articles and here's to a solid 2007!


Dr. Housing Bubble

Anonymous said...

The builders in Burbank seem oblivious to what is happening. However, the buyers seems just as oblivious.

New TH's next door just went on the market maybe 3 weeks ago for $659K. 4 units all 3bd, 2bth 1,500sq ft range. 1 front unit slightly bigger with balconies for $700k+. $275 per month HOAs for trash and building - no pool, spa, elevators, etc. According to the RE agent 3 of the 5 have sold, including the most expensive front unit.

My block is mostly multi-family units, but until a year ago most of them were duplexes or triplexes. Currently on my block there are 3 new condo/TH units being built, the one that just finished and one that was being surveyed today.

One block down there are another 3 or 4 currently being built. The lots are large enough to turn the remaining single family homes into multi-family units. And apparently it makes sense to even rebuild on the existing multi units lots. And all the new ones are starting at over $550k plus HOAs.

Somehow they are selling. How is this still happening? Aren't condos supposed to be one of the best options for first timers? With lenders supposedly tightening their standards, I'd like to know who these people are that are buying these places. And frankly as someone that has spent the last year watching the place next door being built - you couldn't pay to buy one. The workmanship is that shoddy!

Anonymous said...

Site loads much faster. Far fewer cookies to be blocked. Nice layout and look. Kudos!

(I'm a fanatical cookie blocker; I block even the most harmless ones)

Make Mine A Bubble said...

Hey all,

I have a quick question. The hubby and I found a house (a fixer) in a good neighborhood about 5 miles from the ocean. The asking price was $720k, they've come down to $565k within a few months.

The lot is over 7000 square feet, the house is 1100 square feet.

We were thinking of offering $420k for it - assuming the roof, electrical, plumbing, no mold, etc. is in good order.

Do you think that's smart? I think the house has great potential and we're young and energetic enough to do the repairs, but I don't want to overpay if Armegedon is coming (and then have major buyer's remorse).

We weren't planning to buy until next year, but this seemed like the kind of opportunity we don't want to pass up!

Please advise!


Warcry said...

Without wishing to sound hysterical, I see no-one addressing the potential effect of a major earthquake on the current SoCal real estate market. We know that such an event is inevitable, although of course the timing is uncertain. If we are unfortunate enough to experience one at a time when the market's sentiment and momentum are reversing, as presently appears to be the case, then we may see a degree of wealth destruction beyond the ability of property owners and their insurers to replace that would trigger a major and persistent California economic collapse.

Adam said...
This comment has been removed by the author.
Adam said...

Dr. HB,

Here's one your readers might enjoy, as it pertains to consumer attitudes: this is a local commercial running on T.V. right now (yes, in May 2007). You can call it, "The Lifestyles of the Geniuses who live in Real Homes of Geniuses" commercial:

The message of the commercial is that this couple's consumer debt is "nobody's fault".

Say WHAT? She bought clothes and ate out every night, he bought a car she knew they "couldn't afford", and now the loan officer is letting them off the hook, telling them what they want to hear ("it's nobody's fault")?

Ironic, as mortgage brokers are saying, "hey, it's not OUR fault that consumers are financial idiots. We had NOTHING to do with the problem. What happened to borrowers taking responsibility for THEIR behavior?".

Perhaps consumers acted like idiots, when there was always some idiot (supposed "professional") reassuring them there's an easy fix? This has been the message coming from brokers and real estate agents for years: spend well above your comfort level, and the run-up in equity will bail you out.

If that "it's nobody's fault" statement isn't mind-numbing, in-and-of itself, it is surpassed by the loan officer's claim that "more than 50% of people have debt in collections". HUH? Where did THAT stat come from? It sounds completely outlandish to me.... She's trying to say "everyone is doing it"....

So according to this commercial, the answer is NOT to change one's spending habits, or live within one's means ("everyone else is in debt"), but to re-fi into a fixed loan (what, a 50-year fixed)? I sure hope that couple hasn't extracted to the maximum of their HELOC, or gotten upside-down in the loan with flagging valuations.

Dr Housing Bubble said...


Sounds like a great deal. I know this may sound odd coming from me but that may offend the sellers especially if it is in a prime ocean city. That is, I believe many cities in LA and OC will take major hits in prices. But some cities like Newport Beach or Santa Monica will be more sticky on the downside.

I would run the numbers with your husband. If you are making $120,000+ combined with your husband $500,000 wouldn't be a stretch especially in a prime location. What are rents going for in the area? How much work does it need?

These are the questions you need to ask and run the numbers. If it works, go for it and get yourself a nice place. My view is that winter 2007/2008 will be a better market for buyers.


Glad you like the new site.


The LA Times had an article discussing the lack of Earthquake insurance in California. Most folks have forgotten of the big Earthquakes we've had since they are over a decade ago. But they caused billions in damage. A decent sized Earthquake, which we have every 10 to 20 years, is due unfortunately. Not sounding hysterical just the laws of tectonics and plate movements in California.


Thanks for the link. I like to call this the pass the buck syndrome. Many folks think because they can do something it implies it is okay. As Chris Rock once said, we can drive with our feet but doesn't mean we should.

This type of media hype and lack of consumer knowledge is what got us into this mess in the first place. Yet the game is over and the buck has stopped. The bill is coming due and you can only refi and suck equity out assuming you have equity. Plus, equity needs to be paid back - so much for it being your money. People assume equity translates to cash. Unfortunately you only have cash once escrow closes and you have the cashier's check in your hand.

D.D.Grant said...

Me again.
I added you to my Technorati list but when I tried to read the article the message was "No blog of this name." Seems you haven't "claimed" it on Technorati.

Err.. any chance of a link exchange. I've added you to my list of Bubble Blogs.
Home Foreclosures

Anonymous said...

Sad but so true!!! Each and every American heck World citizen shall pay when the tipping point is finally reached in housing. The Gov continues to spend like there ia no tomorrow. While tomorrow just arrived. People need to participate in civic affairs get their heads out of the sand it is each and everyones fault that we have gotten into this jam. Elect Leaders not followers. We really have a lack of leadership in this country and it has been ongoing for quite some time. Maybe on the rebound citizens will pay closer attention to our elected officials.

pissed off said...

Compared to housing my dollar lent to the housing mortgage lenders has lost 80% of it purchace power in the last 5 years, and due to the change in the inflation rate accounting there will be no breaking even, as the bailouters will now tax me to make the borrowers bailed out, wealth redistrubtions on the backs of peasants, sounds familar???/

Anonymous said...

and cronyism in politics, with kickbacks rakeoffs, skim jobs, and the socialistic communism necessitated as the repair of, for affordable housing will be another taxation scheme or depression era make work program, if it was not already so, due to the 2000-2003 wall streat crash

Anonymous said...

The dumb are not punished often enough... that's about to change.

Anonymous said...

Hi everyone not in lovely OC but feel your pain from a distance. I agree with all three reasons here but want to add a few more.

I feel rising taxes are on the horizon somebody has to pay for Social Security and Medicare. less money after taxes=less money to buy a house.

The baby busters are moving into their peak buying years and baby boomers are moving out.

Interest rates are likely to rise if we want attract foreign investors to prop up the dollar.

People just flat don't make enough money to support these prices. In the real world it takes about 100000 a year with 20% down to afford a 400 to 450000 dollar home. This is dependent on homeowners insurance, interest rates, and other debt obigations of course.

Any of these problems alone could sink housing a combination or all of them are possible.

Anonymous said...

Sigh... unfortunately the DC press only wants to highlight positive RE stories.

I always knew news could fail to travel outside the beltway, but I guess I didn't notice how much the reverse is also true.