Thursday, April 07, 2005

Greenspan and the real estate bubble

By William F. Hague

There has been widespread denial that there could be anything like a real estate "bubble," even given recent activity. Yet, anyone with a pulse can see wild speculation taking place all around them.
If we reflect back on the stock market bubble of 2000 ­ and, yes, it was in fact a bubble ­ we can see many similarities. Without a doubt, the level and severity of speculation we're experiencing currently, particularly with single family residential homes, resembles the type of fanatic behavior we experienced towards stocks just before the end of the last stock market cycle.

What makes things worse, is that with such speculation often comes an unhealthy level of leverage, meaning buyers buying more than they can actually afford.

Consider this: When it all ends, whenever that may be, the financial institutions will be left with record levels of bad assets, which can cripple the economy.


Easy money

Today's housing bubble is a consequence of policies designed to soften the effects of the then bursting stock market bubble. The use of "easy money" by Mr. Greenspan and the Federal Reserve Board can easily be correlated to the current real estate bubble.

The ability to borrow $1 million for a speculative home purchase with a monthly payment of approximately $3,500 versus, say, a cost of almost triple that five years ago paints a clear picture of how this whole thing started in the first place. How many real estate investors today would or could afford $9,000 per month for the same $1 million? I think the answer to that question is easy.

Well then, following that logic, with rates on the rise, who's going to continue to purchase and prop up this current real estate bubble? With the increase in consumer demand, comes the rise of prices. This is fundamental Economics 101.

"Cheap money" has driven the prices up, and as a result we have an inevitable inflationary scenario right smack dab in front of us. If there weren't, then the Fed wouldn't have raised rates as they have in recent months and certainly will in the coming months.

Mr. Greenspan and the Fed have gone to great lengths to avoid using the term bubble because, clearly their policy has been the catalyst behind it.


"Mr. Bubbles"

The truth of the matter is that the Fed chairman gives all-new meaning to the children's toy "Mr. Bubbles." He did it in the late 1990s with stocks, and certainly they have successfully done it again with residential real estate.

Approaching our sixth year of flat earnings and a relatively flat economy and considering that real estate purchased with easy money has been the only thing propping up this economy, this Fed chairman may have clearly overstayed his welcome.

Remember, we must be careful what we wish for, everything comes with a consequence, and this time it is no different. Record low rates may end up spurring an economic correction of such magnitude that we have never imagined, similar to the magnitude of the run-up in property values here on Marco Island, which we may have never imagined.

Chairman Greenspan claimed that the Federal Reserve Board never clearly identified the stock market bubble of 2000. So, now after the biggest stock market bubble in history, they decide to bail us out with a housing bubble that investors say can't exist because real estate can't experience a bubble. Here I reference the Focus on Finance column a few weeks ago referencing a lot on Marco Island that was bought in 1988 for $110,000 and sold in 1993 for $75,000. If you don't think it can happen, let your fingers take a stroll through the Collier County tax rolls and see for yourself.

The New 1031

Finally, because the Fed works diligently at being evasive and non-committal, clearly new concerns about inflation and speculation that the Fed is prepared to take an even more aggressive approach in raising rates have put investors on edge.

If you are a real estate investor lucky enough to sell your investment at the tail end of this maniacal real estate trend, then consider a fresh approach to your 1031 exchange. Consider the institutional strength of high-end commercial real estate available with the New 1031. Avoid interest rate and economic sensitivity that comes with a professionally managed commercial real estate portfolio.

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