Tuesday, May 8, 2007

Margin of Errors

Having argued in a recent post that the position of homeowners faced with foreclosure on being unable to meet rising mortgage payments coupled with stagnation or housing price decline, ( see Speculation and The Housing Bubble - "The position is no different in essence to that of someone stricken with margin madness in a stock market bubble."), I was gratified to read this take presented in detail in a comment by jm on a thread at Economist's View . The whole comment is reproduced here:

The real problem in the housing market is
that people are being allowed to speculate with nearly infinite leverage.

In what other market are people as
unsophisticated as the average home buyer allowed to make multi-hundred-thousand
asset purchases with so little cash up front, and without being adjudged capable
of understanding the implications of a margin call -- and more to the point, of
having the financial resources to withstand one?

As interest rates fell through the
last decade, homes began trading like bonds, except that no one would ever let
anyone, let alone the average home buyer, buy bonds with margin loans like the
mortgages being made today.

For decades the home ownership rate
in the US held within a very narrow band around 64%, but over the last ten years
has risen to 69%. That's 0.5 percentage points a year against the number of
households, meaning that the pace of new home buying has been at least 400,000
units a year above the rate of household formation, and that there are now 4
million more home-owning households than we'd have at the historical average
level. Is anyone out there going to claim that this is because the economy is
booming for people in the economic situations of those households?

I predict that, since wages
have risen very little since the late 90s, and home prices were already elevated
then due to the rising ownereship rate, prices are going to fall back to
late-90s levels or below. A lot of people are going to get very cruel lessons on
the risks of highly leveraged speculation in illiquid assets.

The awful evil of this is that it
could have been prevented just by enforcing in the mortgage lending markets the
same kind of standards that are applied to margin buying in the bond market. It
wouldn't have taken any explicit targeting of asset prices or judgments about
what did or did not constitute a bubble.

Posted at Economist's View by: jm Mar 31, 2006 8:24:05 PM

I am left wondering what is the mystery behind the inaction in the face of what could have been prevented so easily. One answer put forward so far is that fueling the housing bubble was a sure fire way of maintaining momentum in the economy in the face of looming recession and in the aftermath of the bubble. Another sees the Fed's cheap money policy as being more a result of being caught between a rock and a hard place than a policy of choice.

Meanwhile we are confronted with what to some are mixed signals everywhere. Reports of the Housing Bubble being a global phenomenon multiply. Yet the securities market appears to roar on oblivious. The common wisdom on bubbles, which I share for now, is that things can't go on forever. Yet there does seem to be a certain resiliency in the Global Economy. Could it be that there is something different about the new conditions of globalization that we are not seeing?