Pop goes the economy

I have been talking about the housing bubble for over two years and a year ago I wrote that the so called Bush recovery was mostly smoke and mirrors - a boom built on cheap money and inflated housing prices - and that Booms are always followed by busts! Well today Paul Krugman explains that Housing Gets Ugly - the bubble is about to pop - the bust is here.

Bubble, bubble, Toll’s in trouble. This week, Toll Brothers, the nation’s premier builder of McMansions, announced that sales were way off, profits were down, and the company was walking away from already-purchased options on land for future development.

Toll’s announcement was one of many indications that the long-feared housing bust has arrived. Home sales are down sharply; home prices, which rose 57 percent over the past five years (and much more than that along the coasts), are now falling in much of the country. The inventory of unsold existing homes is at a 13-year high; builders’ confidence is at a 15-year low.

A year ago, Robert Toll, who runs Toll Brothers, was euphoric about the housing boom, declaring: “We’ve got the supply, and the market has got the demand. So it’s a match made in heaven.” In a New York Times profile of his company published last October, he dismissed worries about a possible bust. “Why can’t real estate just have a boom like every other industry?” he asked. “Why do we have to have a bubble and then a pop?”

The current downturn, Mr. Toll now says, is unlike anything he’s seen: sales are slumping despite the absence of any “macroeconomic nasty condition” taking housing down along with the rest of the economy. He suggests that unease about the direction of the country and the war in Iraq is undermining confidence. All I have to say is: pop!

Yes it is a bust in the making!

Now what? Until recently most business economists were predicting a “soft landing” for housing. Even now, the majority opinion seems to be that we’re looking at a cooling market, not a bust. But this complacency looks increasingly like denial, as hard data — which tend, for technical reasons, to lag what’s actually going on in the market — start to confirm anecdotal evidence that it is, indeed, a bust.

So what happened? What many of us predicted over two years ago. The housing boom - and the recovery - was built on a thin, ever expanding bubble.

Why the sudden crackup? When prices were rising rapidly, some people bought houses purely as investments, betting that prices would keep going up. Other people rushed to buy houses, or stretched themselves to buy houses they couldn’t really afford, because they feared that prices would rise out of reach if they waited. And all this speculative demand pushed prices even higher. In other words, there was a market bubble.

But eventually prices reached a level beyond what even optimistic potential buyers were willing to pay, especially after interest rates rose a bit. (They’re still low by historical standards.) As demand fell short of supply, double-digit price increases declined into the low single digits, then went negative everywhere except in the South.

And with prices falling in many areas, the speculative demand for houses has gone into reverse, as people try to get out with a profit while they still can. There’s now a rapidly growing glut of unsold houses. This is a recipe for a major bust, not a soft landing.

My neighbor is a real estate salesman. He sells houses in an over 55 community and has seen many of his recent deals fall through. Why? Most of the people who move to this community must sell their existing houses and now they are not selling. There is a new development on the hill behind my house. When they started building two years ago the homes were sold before they started construction. A year ago they were sold before they were finished. Today homes are sitting vacant for months after completion. Another indication - on every corner the signs "avoid foreclosure - we buy homes" signs are cropping up. It's a bitch when those ARMs come due. Yes booms are followed by busts as sure as the sunrise is followed by sunset.

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