Sunday, November 27, 2011

Housing: After the Bubble Bursts

This article is a sequel to these:
Housing, the most manipulated market in the world 
Bubbles - Extreme Maker and Breaker of Wealth 
Real Estate - Ponzi Scheme?
Housing is a large percentage of the GDP.  Therefore, housing bubbles fuel the economy.  When real estate was booming in the U.S., Spain, Ireland and Japan, their economies were booming.  People in the U.S. were living in big, expensive homes, driving multiple cars and installing new swimming pools and kitchens.  Similarly, the economies in Spain and Ireland were flying high.  People were living the good life and "partying like it's 1999".

However, bubbles are temporary and create temporary fake wealth.

What does a country look like after its housing bubble has peaked or collapsed?  What happens to its people?

Some bubbles are still raging on, as in Canada, Australia and China.  Some have started to correct, such as in the U.K.  We will look at what happened to the U.S., Spain, Ireland and Japan, which have largely but not necessarily fully collapsed.

With their bubble collapsed, the U.S. became much poorer, with high unemployment, anemic economic growth and poverty levels hitting record levels.

Many Canadians believe that when this housing bubble bursts, they will have a soft landing, unlike the American's.  They say that the outcome for Canada will not end in a disaster like it did for the U.S. economy, because Canada did not have AAA rated CDOs (Collateralized Debt Obligations), NINJA loans, etc.

True, Canada did not have these, but neither did Spain, Ireland or Japan.  Nevertheless, Spain and Ireland are now worse off than the U.S.  Here is a comparison:

Drop in Prices
34% as of Dec/11
41% as of April/11
35% as of 2010Q2
Duration of the Great Recession in quarters (source)
Total GDP loss during Great Recession  (source)-4.14%-4.89%-12.2%
Youth Unemployment (source)
Last quarter GDP growth rate
Public Debt as % of GDP (IMF)
Empty Homes

Yes, even a densely populated place like Europe can have lots of empty homes, thanks to the collapse of a bubble.

The collapse of the Irish housing bubble created a banking crisis, prompting their government to bail out the banks.  Due to this, the government became so heavily indebted, they needed a bail out from the Euro Zone countries, exacerbating the European debt crisis.  Ireland's economy is so bad many are emigrating to countries such as Canada.

As you probably know, both Spain and Ireland are part of the PIIGS countries.

Canada's and Australia's bubbles and household debt levels surpassed the peak of the U.S. bubble and household debt levels.  (See household debt to income ratio chart in:  "Bubbles - Extreme Maker and Breaker of Wealth")  According to "The Economist magazine, House of horrors, part 2:
"home prices are overvalued by about 25% or more in Australia, Belgium, Canada, France, New Zealand, Britain, the Netherlands, Spain and Sweden (see table). Indeed, in the first four of those countries housing looks more overvalued than it was in America at the peak of its bubble."
This implies that it is possible that Canadian and Australian economies are more fake than their American counterpart in 2007.  If their bubbles collapse, it is possible that Canada and Australia will become as bad as the U.S. or worse.

Unlike Europe and the U.S., Japan's housing bubble peaked in 1991.  The collapse lasted for more than a decade.  Ever since, the economy has stagnated and their public debt has ballooned.  Now at 220% (IMF), Japan has the highest debt as a % of GDP in the world.  One can argue that Japan would have fallen in a 20 year depression if their government did not balloon their deficits and debt in order to spend and support the economy.

Since the beginning of 1990 until November 25, 2011, the Japanese stock market (Nikkei 225) has declined by approximately 79% (source).  Yes, you read that correctly.  Minus 79%.  "Buying and holding" Japanese stocks for 20 years would have made you very poor.

As explained in "Housing, the most manipulated market in the world", housing bubbles are mostly created by government.  This is true for the U.S., Canada and China.  (Chinese government officials are in cohorts with real estate developers as they take bribes from the developers and are getting rich in the process.  Source.  There are 64 million empty homes in China, many of which are owned by officials.)

Unlike other bubbles, such as the Dot Com stocks of the 1990's, a housing bubble takes many years to peak.  This means that it is mainly the older generation, such as the Baby Boomers, who bought at cheap or reasonable prices and enjoyed the price appreciation.  It is mainly the younger generation who paid the bubble prices.  This creates huge injustices.


There are two possible scenarios after a bubble hits a peak:
  1. Flat line or soft landing:   In this scenario, the younger generation spends the majority of their lives, paying the majority of their income towards their house.  In essence, they will be much poorer than the previous generation.  The older generation, if they sell near the peak of the bubble, will be much wealthier at the expense of the younger generation.  This simply exacerbates the massive stealing from children that is already going on through inter-generational transfer of deficits and debts.  Also, some of this stolen money was directly used to fuel the bubble.  Read "Housing, the most manipulated market in the world".   Note that no major bubble in history has every plateaued after hitting the peak.
  2. Collapse or hard landing:  The older generation may lose their capital gains.  However, the young homeowners will be crushed and will face financial ruin.  Ask the tens of millions of Americans who are underwater with negative net-worth.
Therefore, even if the bubble does not collapse, it creates huge injustices for the younger generation.  If it collapses, it creates an even larger injustice for the younger generation.  Also, a collapse can potentially ruin the country as well.

Every bubble creates win-lose situations.  Read below for an explanation of a win-win-win situation.


Investing in a house is not a pure investment.  It is speculation.  A pure investment is putting money into a business that creates products or services that generate profit by realizing economies of scale during the production of the products or services (read Capitalism for explanation of how economies of scale creates wealth).  A house does not create products or services, therefore it can never realize economies of scale.

A good example of a pure investment is Apple.  Apple creates wealth for every stakeholder:  investors, employees, suppliers and customers.  It creates billions of dollars of wealth for society through economies of scale.  It creates wealth for its customers by providing entertainment value, enabling them to save time and be more productive.  Each year, Apple creates products with more features, more capabilities and better design for the same price.

Each year, homebuilders and speculators sell homes with the same features, same capacity but of poorer quality for a higher price.  (The quality of new homes in Florida are generally poorer than homes built a few decades ago.  Some are so poor there is visible water damage on the outside after a few years.  Some builders cut costs to the bone by installing Chinese drywall, which is now eroding electrical wirings and pipes.)

Apple does not tell its customers, "buy our products because you can make money by flipping it to the next greater fool for a higher price".  Real estate agents do.

Apple can increase the wealth of Americans by selling their products to millions of people around of world.  Homebuilders and speculators cannot do this.

Housing, a speculative fixed asset, cannot create long-term, sustainable wealth for a country.  Only businesses can.  By putting a significant portion of a country's capital and time into housing, you end up with a misallocation of capital.  The capital is wasted because it is not put to work to create long term wealth.  This is why every country that has experienced a housing bubble has gone one step forward and two steps backwards.  A country's capital should be invested in businesses and fostering entrepreneurs.  We need more innovators like Steve Jobs, not more Joe Flippers.


As explained above, we get prosperity when we are able to buy more for less.  Computers have advanced with more capacity every year and prices have stayed the same or dropped.  Cars have more features and functions and the price have stayed the same.  TVs have become bigger every year and prices have dropped.  Smart phones come out with new bells and whistles every year and prices have stayed the same or dropped.  Because of this, your standard of living and wealth have increased.

Now try to imagine if all of the goods that you buy go up in price every year like housing.  You continually get less for more money.  After a few years, you will be very poor.


The main beneficiary of housing bubbles, which lasts many years, is the previous generation.  The younger generation becomes poorer.  It is a massive transfer of wealth from the young to the old.

Some people argue that the older generation will pass their wealth to the younger generation through inheritance anyways.  They may be right about this.  But why make the younger generation go through the stress of having 482% household debt to income ratio and negative equity?  (read more)

Also, not every young couple is going to get much inheritance.  What if they had parents that have the same philosophy as Warren Buffet, who is giving away most of his wealth to charity?  What if the parents splurged the wealth on themselves?  What if the young couple has lots of siblings?  Then there won't be enough inheritance.

Even if the young couple gets the inheritance, they'll likely be waiting a couple of decades before the folks kick the bucket.  During that time, the young couple is much poorer than the parents were, stressed out with high debts and payments, and enduring a lower standard of living.

Some people argue that the older generation are not going to cash in at the peak of the bubble because they still need a place to live.  The ones who can sell at the peak are the speculators who bought multiple homes, and there are lots of those.  The speculators who captured most of the capital gains from the bubble are the older ones who bought many years ago.


Bubbles are extremely dangerous as they create temporary fake wealth.  After they collapse, the country's true wealth surfaces, as can be seen in the U.S. and Europe.  The Great Depression was the result of the collapse of a bubble.  The Great Recession of 2009 was the result of the collapse of housing bubbles in the U.S. and Europe.

Governments should do everything they can to prevent or suppress bubbles. Instead, the U.S., Canadian and Australian governments did everything they can to create and fuel their Housing Bubbles (see Housing, the most manipulated market in the world).  The possible explanations for their actions and policies are:  gross incompetence, corruption, greed or recklessness.  None of these explanations are acceptable.


You should fire every politician who helped create a bubble.  You can start by firing our self-serving politicians (and don't kid yourself, they're buying votes) U.S. Senator Chris Dodd, Senator Charles Schumer, Representative Barney Frank, Canadian MP Mike Flaherty, Canadian Prime Minister Steven Harper and Australian Prime Minister Julia Gillard.

Read more:
Housing, the most manipulated market in the world 
Bubbles - Extreme Maker and Breaker of Wealth 
Real Estate - Ponzi Scheme?
Ban All Mortgages?


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