To those misguided souls who blame our economic woes on Obama, Reid and Pelosi (how idiotic is that?). To those, like Robert Rubin, who say, "Nobody was prepared for this." To those like Larry Kudlow, Don Luskin, Jerry Bowyer, Brian Wesbury, and all the others who never saw this coming, I offer you all this piece of research, dated August 6, 2004, which lays out in painstaking detail (on pages 5 through 14) exactly what was going on at the time and why it simply could not last. Granted, this bit of wisdom was just a bit early, most likely because the amount of credit and/or leverage in the system was underestimated, but it was deadly accurate. Herewith some of the commentary. Please take the time to read pages 5-14 -- and closely examine the charts and tables -- at your leisure:
Housing: If Not a Bubble Then an Oversized SudThe entirety of pages 5-14 is a must read for anyone who really wants to understand how we got here, and how preventable this crisis was. I cannot do the report justice here, as it really must be seen to be believed. I encourage everyone in the strongest possible terms to go and read it. Examine the charts and accompanying text, as they are a detailed roadmap to our current crisis. Had the ominous warnings in this piece been heeded instead of ignored, we would almost certainly have avoided the dire straits in which we currently find ourselves. But it was simply too politically expedient to allow the bubble to continue inflating than to take the appropriate measures, a decision that will impact our lives (and likely our children's) for many years to come.
Classic traits of a bubble:
(i) Extended valuation
(iii) Excessive leverage
(iv) Supply surge
In this report, we assess the likelihood that the housing market has entered into a "bubble" phase. There are numerous shades of gray, but when we examine the classic characteristics of a "bubble" (extended valuation, over-ownership, excessive leverage, a surge in supply, complacency (denial?), and speculative behavior, it seems to fit the bill. At the very least, housing is overextended, and even the Fed has acknowledged as much.
"Reports from some contacts suggested that speculative forces might be boosting housing demand in some parts of the country, with concomitant effect on prices, suggesting the possibility that house prices might be moving into the high end of the range that could be consistent with fundamentals." (FOMC Minutes — March 16, 2004.)
"To be sure, indexes of house prices based on repeat sales of existing homes have outstripped increases in rents, suggesting at least the possibility of price misalignment in some housing markets. A softening in housing markets would likely be one of many adjustments that would occur in the wake of an increase in interest rates." (Fed Chairman Alan Greenspan — May 6, 2004.)
"The key features of a bubble are that the level of prices has been bid up beyond what is consistent with underlying fundamentals and that buyers of the asset do so with the expectation of future price increases." (NY Fed, July 2004.)
Democratization and/or overownership is a classic characteristic of a bubble. Housing certainly fits the bill given that the homeownership ratio has hit a record high of almost 70%. Remember in the late 1990s that investor participation in the equity market surged to levels that were last posted in the roaring 1920s. "Herd effect" and "caveat emptor" tend to go hand-in-hand.
Another way of seeing just how levered the consumer has gotten is to look at the aggregate loan-to-value ratio for real estate. This ratio is hovering near an all-time high of 45% on the household balance sheet. The flip side to that argument is that households, in the aggregate, own only 55% of their home, hovering near an all-time low. This, in part, reflects aggressive lending behavior this cycle as well as the record pace of mortgage cash-outs. Existing homeowners have effectively borrowed against the rising notional price of their house. Much like the tech stock boom of the late 1990s, the housing market boom has also attracted an increasing number of marginal buyers. For example, subprime mortgage lending has risen at an estimated 25% average annual rate over the last decade.