A Recent History of the Housing Market

Any history of the inflation and collapse of the housing market will necessarily leave out many important aspects. The housing bubble had been set up in the regulatory agencies in the 1980's and 1990's, but capital had not yet gone into these sectors at such high levels during these decades. In the late 1990's, the dotcom bubble was all the rage, as well as "emerging markets," like Southeast Asia, and Russia and former Soviet Union nations.

Also, partly as a result of the collapse of the Savings & Loan industry, and the resulting wave of foreclosures from the fallout, real estate was a steadily-appreciating, but not inflated, market. Investments were going elsewhere and returns were better in other market sectors than could be had on real estate or mortgages, two seemingly somewhat boring markets.

But then, around 1997, the markets in Southeast Asia and other developing nations became super-inflated, with many of them pegging their currencies to the US dollar. Speculators could then inflate the markets, driving capital into them and inflating stock values, and then create a flight out of the currency, taking their profits. Many of these countries saw their currencies collapse relative to the dollar as capital fled. As a result, they were forced to impoverish themselves and take loans from the International Monetary Fund.

The same currency destruction happened most notably in Russia in 1998, where the government actually defaulted on its debt, which was quite unexpected. The most powerful nation in the USSR that competed with the United States for decades during the Cold War defaulting on its bond payments was a surprise for many investors. A large hedge fund at the time, Long-Term Capital Management, had bet heavily in favor of the Russian bond market, and was in danger of collapse. The Fed and other large banks stepped in to make sure this did not
happen, thereby setting the precedent of bailing out hedge funds.

In 2000-2001, the dotcom bubble burst, as investors realized internet companies could not make money without business plans. Many of them folded, and the market began to sink. It sank even further as a result of the 9/11 attacks on the Pentagon and New York City. As a result, the large energy-trading company Enron faced collapse as a result of its aggressive accounting fraud. But Enron had engaged in the somewhat novel idea of selling off its debt to other investors, a plot the largest banks in the country had helped the company put together.

After the collapse of the dotcoms and the disclosure of Enron's accounting shenanigans, two things happened to work together to create the housing bubble. Without both, the bubble would not have inflated so much, most likely.

First of all, the banks and mortgage companies realized what a great idea Enron had in selling off its debt. The banks could originate mortgages and package them up and sell off the rights to collect the payments. The profits they got from selling mortgages would help them originate new mortgages, and the scam would continue forever, or at least as long as the real estate market was increasing in value. Because they did not have to worry about collecting the payments themselves, these origination companies did not have to worry about borrowers being financially able to pay their debts.

Second, because the Federal Reserve lowered interest rates to below 1%, huge amounts of capital flowed into the US market, and anyone who could successful operate a pen could sign for a mortgage. Interest rates were so low that lending guidelines became nonexistent. If the homeowners defaulted, it did not matter in the least, since the bank could just re-sell the house on the open market and make a profit.

This was the environment until early 2007 or so, when investors started to sober up and realize that maybe giving loans to deadbeats was not such a great idea, because if the market declined, there would be a lot of foreclosures. Banks started tightening up lending guidelines and the Fed was busy raising interest rates to "cool off" the artificially "heated up" housing market.

Then, the inevitable happened: with money becoming more expensive, the real estate bubble burst, taking a few Bear Stearns hedge funds with it. But it was alright for them, since they were bailed out anyway. Homeowners who were actually facing foreclosure, though, were still dealing with higher interest rates and were unable to sell their homes for as much as they paid for them. They either failed to stop foreclosure and lost their properties or the banks had to help them take a loss on the houses through a short sale.

Either way, when the loans went into foreclosure or were paid off for less, the money lost just disappeared. Even worse, no bank wanted to own these bad mortgages anymore, but no bank was quite sure who owned them at all. They were not even absolutely sure they did not own a lot of bad debt themselves, because these loans had been sliced up, packaged, and sold off to dozens of different investors.

So because banks did not want to do business with each other, credit dried up. The Fed started providing loans to banks and dropped interest rates in efforts to stimulate the economy. When that failed to work, the Fed decided to trade bad mortgage debt for US Treasury Securities, which means that the US dollar is now backed by foreclosed loans that no one is quite sure who owns.

Since the rest of the world uses the dollar as its reserve currency, it was none too happy to see that their money was paying less interest and was backed by defaulting mortgage loans. Currencies not backed by foreclosures were assumed to be safer, and nations moved to invest in European Union Euros or Japanese Yen.

Nations still accepted dollars, but wanted more of them for what they were selling. Stuff like gas (refined from oil), food (fertilizer made from natural gas), precious metals, and consumer goods (made in China) went up in price as the value of the dollar went down.

And here we are today, with the US economy facing a recession and politicians providing foreclosure relief which rewards the banks and homebuilding companies with tax breaks. No one is yet sure who owns all of the foreclosed loans, but with the Federal Reserve taking them in return for Treasury Securities, it is becoming clear that all Americans will own these bad debts. The banks will be able to lend money to each other again, while they foreclose on houses, raise interest rate fees, and collapse the economy.

Rob Alley, Realtor of The Avery Group at Roy Wheeler
540-250-3275 (cell)
roballeyrealtor@gmail.com
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