Blowing a Real Estate Bubble… and Popping It
How do you get a real estate bubble? A real estate bubble is a type of inflation that is largely limited to real estate. Why would just real estate prices inflate more than other products and equities?
Residential real estate is sensitive to interest rates as very few things are. When most people buy a house the primary factor that determines how much they are willing to pay is not the price of the house but the size of the monthly house payment. If they think they can only afford to pay $1000 a month, that will limit how much the house they buy can cost. Their monthly note will include escrow payments for city and county property taxes as well as their homeowner’s insurance but even those are determined by the value of the house.
In 2000 the mortgage interest rate was about 8%. If you bought a $100,000 house that year, the monthly payment on the loan would have been $733/month. Even with property taxes and insurance your monthly house note would probably have been under $1000. The lender expected that you would be able to pay that $1000 a month and pay it for 30 years. They made the loan based on that expectation. They made it after checking your income, loans and credit score.
After 9/11 the prime interest rate was cut and cut again, 5.6% to 1.75%. This was meant to keep the stock market up, another kind of bubble, and it did. The lower the interest rate, the less investors make on bonds and the more they are forced to go into the stock market to get a higher rate of return. To keep the market up the interest rate was cut so much that it was less than the inflation rate, so that it was effectively zero.
What does this do to house prices? After 9/11 the mortgage rate fell, first to 7% in 2002, then in 2003, to support the economy during Bush’s invasion of Iraq, to 5%. At 5% your house note, including escrow, on a $100,000 house would have been about $750/month, a reduction of about 25% from 2000.
Since you thought you could afford a larger house note, what would you do? Most people would buy a more expensive house. The developers and realtors knew this as well so they began to build and sell more expensive houses or just sell existing houses for a higher price. After all, you wouldn’t be paying any more a month. That is how this bubble grew. The price of houses begins to inflate (up to whatever the market would bear) with the price being limited not by what the house was really worth but by the interest rate the buyer had to pay. The more the fed drove down interest rates, the more the prices of houses inflated. A bubble was produced.
When the fed began to increase the interest rate again, largely because people would no longer buy US debt at such low rates, house notes went up as well, especially on variable rate mortgages that people had been tricked into getting. People found they couldn’t afford to buy because the higher interest rates and inflated house prices produced a house note too high to pay. So the real estate market tanked.
But there was something else going on. Something caused by predatory lenders.
With the passing years most houses increase in value but with the real estate bubble they REALLY increased in value. A house that was purchased for $50,000 30 years ago, might be worth $200,000 or more now. A house in a modest (read poor) neighborhood that was purchased for $30,000 might be worth $100,000-150,000. This provided an opportunity for predatory lenders.
The person who bought that $30,000 house might still have a modest income and not be able to pay the note on $150,000 loan but he/she still was sitting on the equity in that house, equity that the predators thought they could get. Lenders made a push to get people to refinance that equity, to get some of the money without realizing they might lose their house. Say that house they paid $50,000 for, or were still paying $50,000 for for, was technically worth $150,000. Say the owner is paying a $500 a month house note. If he is lured into refinancing that house, and borrowing say, $100,000, that is still less than the $150,000 his house was worth. The owner gets $100,000 cash and thinks he is doing good. But he has to pay various fees to the lender and also has a much larger house note.
Time goes by and the borrower can’t pay that note so the lender gets to take the house and sell it. With each transaction, with the loan, with the default, with selling the house out from under the borrower, with each transaction the lender gets a bunch of fees and, as long as they can sell the house to some new dupe, will not lose a dime. In a few states, such as Connecticut, New Hampshire and Vermont that have “strict foreclosure” the lender gets outright ownership of the house with no obligation to sell it and return any excess to the original owner. So it’s all profit for them.
Then the predatory lenders figured out a new way to make a killing. They bundled their risky loans (called subprime loans) together and sold them in Europe. Then it didn’t matter if people could pay because they already gotten full value and more out of their risky loans.
Also predatory credit card companies, especially out of Delaware (Delaware has made corporate corruption the primary state business. Delaware: The Black Hole of Corporate Reform This is why I don’t trust Biden.), are pushing the holders of their credit cards to borrow cash, to max out the credit cards with cash advances, cash advances that can end up charging as much as 32% (Chase) interest plus a 3% or more initial transaction fee.
One of the credit card solicitations I got in the mail revealed, in tiny print on the back, that if the borrower was late or missed a payment twice in a year that the interest rate on the balance could be increased up to 72%. (No usury laws in Delaware since the people gulled by Delaware businesses are not even citizens of Delware so they can’t exert pressure on Delaware’s elected representatives to change the laws. Delaware is like a judicial “Hole-in-the-wall,” a safe refuge for thieves. Or like a “Black-Hole-of-Corporate-Reform-in-the-Wall. ) These credit card companies try to ensure this happens by varying the due date from month to month. Think you have to have your payment in by the 30th? Then the next moth you don’t look and it turns out it was due on the 25th. ”Many credit card agreements are now written so the company can raise your rate if you are late on any of your bills, not just their credit card.” !!! Such credit cards often result in people ruining their credit or going into bankruptcy. You would almost expect Vinnie to show up with a baseball bat and threaten your knees.
Under the old bankruptcy laws the lender couldn’t take a person’s house. Under the new Republican passed bankruptcy laws, now they can. The credit card companies seem to be deliberately driving people into bankruptcy. On purpose. So they can charge ridiculous interest rates. So they can charge more fees for stealing their homes.
This kind of predatory lending went on for a while. Some people tried to get laws passed to stop it but the Republicans and the wealthy prevented that. People were lured into refinancing their houses, were persuaded to take the equity out of them, and were lent more money than they could ever pay back. Some lenders did not even ask what income the person had, only if they owned their house. They wanted the borrower to default so they could take the house and sell it and take huge fees out of the price. Every time they do anything, they get additional fees. Often ridiculously large fees.
But then the bubble burst. They finally killed the goose that laid the golden egg. Houses had gone up so much that when interests rates began to rise as well fewer people could buy the stolen houses when they were put on the market. This produced the subprime mortgage crisis. Some European banks that had bought the bundled subprime loans went bust. Others declared hundred of millions in losses. God knows how many people have lost or will lose their homes.
Bush and the fed are doing everything they can to protect these predatory lenders, spending our tax money, inflating our money till it is worth less and less, doing everything they can to prop up the stock market but nothing to help people who have lost their homes.
Maybe bankers are as evil as the commies used to claim. Maybe usury should still be a crime.
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To comment email alllie at alllie@newsgarden.org
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© Alllie 2007
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