Where’s the Money Coming From?
Yesterday afternoon, a realtor friend of mine called to ask if I’d be interested in seeing a property she recently listed. Always the curious, I tagged along to see what you’d get for the money. In my opinion, for $1.5 million, you weren’t getting much.
In conversation, I asked the realtor, “Randi, did you see the guy trying to sell those eleven homes off the main road for $1.4 million a pop… who’s going to spend that money on such small lots?” Randi’s response, to my astonishment, “Seven have been sold in the past two weeks.”
Later that afternoon, my friend Doug from California called to say he was flipping through a local real estate magazine and it dawned on him that there was not one listing in the magazine for less than $700,000.
I ended the day by having coffee with my favorite accountant (“favorite” for the simple reason that he does not look or think like an accountant). All fresh from filing last year’s tax returns, I asked, “Of your 1,000 or so clients, who were the biggest income earners last year?” You might have guessed his answer… realtors. It was common for good-to-great realtors to post incomes of $1 million plus last year.
Where’s the money coming from to push real estate prices so high? In talking to my network of business owners, it is obviously evident that business is not booming.
Retail (unless you’re Wal-Mart) is not making money. Manufacturing costs have become too high for factories to make the money they made in the 1970s. In fact, many manufacturers are now having their products produced in foreign countries. One factory I know of, which employed about sixty people and makes plastic tarps, laid everyone off because it’s cheaper to have the tarps made in Taiwan and shipped back here. And then there’s the service sector, which isn’t exactly booming either.
It is common knowledge that income levels have not risen proportionately with housing prices. But something else has risen… and it’s the size of people’s mortgages. My network of accountant and lawyer friends tells me that while, only five years ago, it was common for white-collar median-income families to have a $200,000 or $250,000 mortgage, $500,000 mortgages are more the “norm” today.
By lowering interest rates to their lowest level in 46 years, Greenspan has enticed consumers to borrow like they have never borrowed before.
What made Greenspan do this?
Simple. We experienced an unprecedented stock market bubble, which began to burst in the spring of 2000. Greenspan is not a stupid man. He knows all great stock bull markets are followed by great bear markets.
My assumption is that Greenspan saw that the stock market had become a huge source of wealth for Americans and that a collapse in stock prices would bring the country to its knees. So he made the decision to fight the bear tooth and nail. Greenspan brought interest rates down to their lowest level in 46 years and expanded the money supply by flooding the gates with easy money. The rest is history.
So what we have now is a debt and property bubble. Now please… don’t get me wrong. Real estate prices are not about to collapse. In fact, they are far from collapsing. As I discussed yesterday, a one percentage point rise in interest rates will not kill the market. Home builders don’t build on spec any more like they used to, so there is no big overhang of supply of new houses (the condo market could be a different story).
My question is, Where do we go from here? If interest rates were zero, we would see the prices of homes bid even higher because mortgages of $700,000 would cost the same as mortgages of $500,000. But the bond market is telling us rates are moving higher, not lower. The stock market doesn’t like higher interest rates. So maybe, just maybe, the natural forces of the stock market will kick in and the bear will complete the unfinished business it started in 2000.
If that’s the case, and stocks start moving lower, and the retirement funds of millions of Americans come into jeopardy, we will wish Greenspan never brought rates down so low, enticing so many consumers to have such big mortgages. It might not happen this year or even next year. But, eventually, whatever goes up must come down. And the faster the rise, the faster the fall. That’s economics 101.