An alternative to popular faith
        Why did we endure a real estate collapse? (Some call it a bubble.) There is a difference between a boom and a bubble. A bubble is a boom that gets pricked. So first, why did we have the boom?
        The price of any commodity, including real estate, is based on supply and demand. The question is, why did demand for real estate rise faster than the supply for more than 60 years, then suddenly fall?
        Fed haters will tell you the reasons for the collapse were low interest rates and lack of federal credit supervision. I suggest this is somewhere between overly simplistic and just plain wrong. There were many reasons for the boom, and several for the collapse:
        As for the boom, one reason may be that too many people believed unaffordable housing was affordable. The ongoing idea was: Buy a house you really can’t support today, but rely on your future income growth to make it affordable tomorrow. The notion that tomorrow’s income increase will cover today’s unaffordable expenses might sound familiar. It’s a first cousin to a Ponzi scheme, and it’s what many young couples subscribed to.
        Add to that the “safe,” insured profits lenders made, and there was strong encouragement on the credit side.
        Add to that the ridiculous tax law that gave advantages to owners, but not to renters. This was part of the governments historical efforts to help everyone own a home and live the American dream.
        Add to that the history of home value growth since WWII. Experience said, owning real estate was a “sure” way to make money. Think tulip bulbs.
        Add to that the notion that poor minorities should not be prevented from buying houses (Remember Jesse Jackson’s criticisms of the banks for redlining certain neighborhoods). A bank that refused a loan could be accused of racism. This created an influx of “entitled” home owners who not only could not afford their houses today, but never would be able to afford those houses.
        Add to that population growth that in itself increased demand.
        Add to that foreign investors, who saw the U.S. real estate boom as a great place to invest money.
        Add to that the introduction of condominiums, which made renting financially less prudent than owning.
        So there were plenty of reasons for the 60+ years boom. But then, what turned this boom into a pricked bubble? The tipping point may have been the reduced federal deficit growth rate which exacerbated all of the above factors. Because the real estate boom was a long-running Ponzi scheme, it depended on continuing increases in money flow. Ask Bernie Madoff’s investors.
        Yes, low interest rates may have had some recent effect by making property seem more affordable, but this real estate boom had continued for 60+ years, through low rates and high rates.
        Yes, lax supervision of lenders and insurers made everyone feel “bullet proof” when it came to risk. But trying to point at interest rates and supervision as the only factors making for the housing bubble, seems to miss the point.
        If you’re looking for a one-word description of what could have burst the bubble after all these years, that word may be “leverage.” Real estate was purchased with mortgage leverage. These mortgages then were leveraged by being bundled with many mortgages, that leverage being a version of the law of large numbers. (The failure of a small and predictable number of mortgages is distributed harmlessly over a large number of mortgages.)
        The next layer of leverage came from the belief that such organizations as Fannie Mae and Freddie Mac really were government sponsored, and so were absolutely safe.
        An additional layer of leverage was insurance, which fundamentally is a leveraged product (A small number of failures is distributed harmlessly over a large number of insureds.)
        Still one more layer of leverage was added when massive futures trading of insurance was adding to the mix.
        Ultimately, the leverage became so great, that a few billion dollars of real estate supported many trillions of investment. Every change in real estate supply and demand became magnified exponentially.
        In 2004, Federal Debt held by private investors increased 14% from the previous year. Subsequent annual increases declined to about 4% in 2007. The government pumped money into the economy too slowly to support a real estate demand that depended on faster growth.
        Those whose investments relied on greater growth in real estate values, began to feel a pinch, and the massively leveraged house of cards swayed more and more until it tumbled down.
        Previous reductions in federal debt growth almost always had led to recessions, but now the leverage was too great for just a small recession. After a series of smaller economic earthquakes, each caused by reduced deficit growth, this was (as they say in California) the big one.
        In short, the real estate bubble didn’t grow and burst because of something that happened recently. It grew and burst because of many policies that, beginning with the end of WWII, built leverage higher and higher, until a cause that previously had warned us with a series of small recessions, now collapsed into a big recession.
        This leaves us with the question, what has the government now done to reduce the fundamental cause of the bubble burst, leverage? The government has added money. Adding money does provide a temporary solution, but to prevent future bubble bursts, the government also must reduce the various sources of leverage.
        Requiring larger down payments, eliminating the sale of bundled mortgages, eliminating underfunded insurance and eliminating futures trading of mortgages, might be worthwhile for discussion.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com