Omnipotent Property Depression: History's Ominous Precedent

By Guest Author Michael White

The Treasury, the Federal Reserve Bank, and the new administration are making two fundamental mistakes. They are failing to concentrate their minds on the value of our homes. And they are dumbly underestimating the size of the correct response. The first error leads to the second. How could you know what weapon to use when you don’t know what war you are fighting?

After reviewing a history of the relationship between banking crises and property losses (see graph), one reasonably concludes that we are now drowning in a worst case scenario. A nationwide loss in property values of 40% to 50% from the high is now a reasonable guess.

A loss of this magnitude cannot be less than devastating.

Banks in Crisis: Graphic History. The graphic below suggests we are going to incur an enormous and unprecedented loss in property values. We have already far surpassed the great depression in property value loss (measured as a percentage of the peak value). The first red box is total property value loss in the depression. The second red box is our present total loss. Practical steps based upon this projection follow later in the letter. The graph depicts property value losses in 21 different banking crises. Property loss is on the left. Duration of the fall is on the right. We appear to be at an early stage.

In a typical bank crisis, property values fall for six years. We are now 2.5 years into this crisis. Let history be the guide and assume we are half way through the depression. And take great and determined notice of the frightening velocity of our property-value losses. Case-Shiller reports an 18% loss nationwide in 12 months based on comparing sale prices from September 2007 and September 2008 (released Nov 25, 2008).

Obviously the future is unknowable, but there can be reason in history, and the patterns suggest an answer. Better to follow the logic of the pattern than the prejudice and ignorance which guide almost all of us most of the time and in most matters.

The meaning of the pattern is simple.

Painting with a broad brush, assume a 40% loss in property values throughout the entire United States in a period ending in 2010 or 2011. This means eight trillion dollars of equity disappears. That’s a boatload of money to take away from somebody, but turns to catastrophe when you recognize borrowed money purchased this loss.

Assume mortgages of half of the eight trillion disappear. So four trillion dollars of mortgages burn and go away and are never paid and are a complete loss and write off.

This means the banks and other mortgage owners are bankrupt to the tune of $4 trillion dollars. So the owners of the mortgages need $4 trillion dollars of new capital to get back to square one.

The Treasury has thus far given away about $250 billion to commercial banks. I don’t know how much private-source new capital banks have raised during 2008. If it is a trillion dollars I would be shocked.

In any case, we are so far away from having raised $4 trillion of new capital for the banking industry that you must run your finances based upon the assumption that zombies are running the economy. Because if zombies are running the economy then zombies are running the economy. Putting $250 billion into a $4 trillion problem is not taking half measures, it is using a squirt gun on a burning home.

Take these practical steps to protect yourself.

Don’t buy real estate: Avoid buying real estate unless you drive an exceptional bargain and have a minimum ownership period of five years.

Sell real estate: If you are waiting for prices to improve, you may have to wait five or ten years. Assume the price of your home will fall 25% from its value today. Then make the decision of whether or not you should sell today: Do you want to own your home in two years when it is worth 25% less than it is worth today?

Sell stocks: Take all money out of equities unless you treat your stock investments like your budget for gambling and don’t care about losing it. Put your cash in dumb dull places like savings accounts and money markets. Avoid treasuries - the smartest investment by far last year, but far too popular to be stable.

Work hard. Pray for good things for your family and your country and the world. Pray that zombies may be enlightened. We do have a way out. It’s expensive, but smart. You will know the zombies are enlightened when they enact Plan Orange.

Read the details of Plan Orange here.

Comments

[Lee Smith1:]

If banks are bankrupt, why would you put money in a savings account?

Jan 20 07:44 AM

[investor88:]

Brace for tough times for the next 2 years at least. Agree stay in cash or raise cash for survival in this turmoil.

Jan 20 07:47 AM

[prairiedog555:]

Cash is not the place to be with the specter of hyper inflation brought on by hyper paper printing.
I don't know where the best or safest place to be is but cash on a long term, 2-5 years is a way to lose value.

Jan 20 07:57 AM

[Jan Rogozinski:]

This reminds me of Abelson in Barrons, who has been predicting a depression every week for many years. This year he was right. A stopped clock, as they say, is right twice a day in the US and once a day in Europe.

What I don't get is this. (a) The great rise in housing prices was a Ponzi scheme and a bubble. Real Estate prices now are returning to a price set by normal supply and demand. Why is that bad for the economy?
(2) The problem is that real estate agents have convinced Americans to believe stupidly that their home is an investment. Graham-Dodd type analysis shows that the place one lives in never is an invest men; it always is 100% an expense. 95% of folk have mortgages they can afford to pay. Those that are sane will ignore totally that the notional value of their home has declined; they simply will live in the house and keep warm in the winter and be happy.
(3) In almost all cases those that sell stocks now will sell at a loss and probably at the bottom.
(4) If the Depressions gets so bad that every company goes bankrupt, including companies such as Exxon and Johnson and Johnson, and stocks are worthless, then all money in cash or banks will be useless. Gold also would be useless. Since no one would be making anything to purchase. So if one believes this crazy crap, then one ought to commit suicide now.

Jan 20 08:21 AM

[2houndz:]

Your number of $4T in bankrupt numbers is at least reasonably close to Nouriel Roubini's updated number of $3.6T. If things get that bad, a .4T error will not even be noticed - We'll be living in caves and hurling rocks at each other.
Unfortunately you are probably more right than any of us want to admit, especially jan814. Now excuse me while I go out and gather more rocks.

Jan 20 08:33 AM

[Did U Think...:]

No amount of bail out can save it so please don't spend my tax money bailing you out of your dumb home purchase, OK? Did you share the gains of your last home sale with me? No? Then don't try to share the loses this time.

"That’s a boatload of money to take away from somebody"
TAKE AWAY? I'm soooooo sorry, but nobody is taking anything away from people here. In fact, it is the homeowners who are trying to "take away" exactly that same amount of money from people who refuse to take on ridiculous debt in order to have granite and marble.

Jan 20 09:27 AM

[kelm:]

Housing represents the tangible loss of wealth that is most apparent to the average person. Spending government money to re-inflate the housing market is not the correct solution though. Doing so does not increase economic activity. At best, it will reignite housing construction but in the process it will debase the dollar even more and lead to inflation - which will then makes homes harder to purchase.

Taxpayer money spent on stimulus needs to spent in a manner that gives us something useful and physical at the end of the day. Repaired infrastructure, new technology, new industries, a competitive edge, goods to export - something. Using the money to plug gaps in wealth destruction (much of which was simply an artifact of leverage) is the wrong approach.

Jan 20 10:13 AM

[OldLimey:]

jan814: "The great rise in housing prices was a Ponzi scheme and a bubble. Real Estate prices now are returning to a price set by normal supply and demand. Why is that bad for the economy?"

If I answer this question in a UK context, there might be some degree of relevance to the US as well. In the UK, the central pillars of the economy have been retail expenditure and financial services. By 'financial services' I mean the City generally rather than housing finance in particular, although the latter has clearly been important. The least said today today about the City, the better. Retail expenditure has relied heavily on cheap and freely available credit, an important aspect of which has been home equity withdrawal. This rug has been pulled. The Bank of England has in fact had mixed feelings about the importance of house price inflation to spending, although intuitively it is difficult to believe that people who feel 10-20% richer each year aren't going to be more inclined to spend on discretionary purchases than people who feel 10-20% poorer. Be that as it may, the decline in housing market activity has had a direct effect throughout the retail sector (e.g., home improvements and consumer durables) as well as affecting construction companies and realtors. To summarise, the model has been to use cheap and freely available credit to fuel a housing bubble to fuel retail expenditure to fuel GDP growth. There is no Plan B, which is why in his spare time when he's not 'saving the world' Gordon Brown is desperately trying to reinflate housing - albeit with no success.

There is a parallel in both Australia and New Zealand, where housing bubbles greater than those in either the UK and the US have been inflated but have yet to burst. In Australia, the twin pillars have been housing and commodities. The Rudd government has been giving cash grants to first-time buyers, and there has been immense political pressure on the banks to lower home loan rates at a time when they are still charging very high spreads to corporate borrowers. Again, there is no Plan B.

Rational property prices are a threat to the politico-economic status quo throughout much of the English-speaking world. I suspect that the incoming US administration is, for that reason, shortly going to be spending a great deal of your money directly addressing this threat.

Jan 20 11:44 AM

[notsosmart:]

jan814 is so on the mark. your house is not an investment. its the roof over your head & a liability.so many dumb-dumbs learning the hard way of this fact.paid mine off in 20 yrs.no heloc ever.dont have a granite counter or hummer but sleep good at night.heard from australia on this site.bursting has begun there.

Jan 20 02:16 PM

[carey_jim:]

Something I haven't heard in this discussion is that sometimes owning a home is a bad investment and it is better to rent.

Renting puts the responsibility of repairs, taxes and upkeep on the owner and gives the renter the sweet possibility of mobility.

How many friends do you have who own a yacht that is permanently moored at the local yacht club and which they never use?

Not to speak of the really high rollers who own wineries and villas they never visit, and which suck money from their large bank accounts.

One thing deflations bring is a healthy dislike of owning things that will depreciate in value while bringing the burdensome responsibilities of ownership.

Deflation makes renting and leasing much more attractive, especially if you've got any savings.

Savings? What's them?

Jan 20 08:09 PM