It sounds like such a noble undertaking. Who
could possibly object?
Freddie Mac, the giant mortgage
recycler, announced a partnership last month with BB&T bank
and an affordable housing coalition in Alexandria
to help poor people become first-time home owners.
The faith-based initiative, “Catch the Vision,
Develop the Dream” will provide homebuyer
counseling and low down-payment mortgages to help
low-income families purchase their own houses.
dream of homeownership is now one step closer to
becoming a reality for more than 1,500
families," said U.S. Rep. Tom Davis, R-VA, at a
roll-out of the initiative.
"I applaud Freddie Mac and each of their
partners for their continued efforts to expand
homeownership in Northern Virginia."
a curmudgeon would fail to succumb to
over the thought of helping Virginia's poorest
citizens get a piece of the American dream.
you happen to be John
Rubino. The author of How to Profit from the
Coming Real Estate Bust, Rubino is as
compassionate as the next guy, but he has no
patience for the lofty platitudes and feel-good rhetoric that
substitute for thought, especially among members of
the political class.
“We’re creating a class
of very fragile homeowners,” says Rubino.
“People figure if they’re paying the same for
their mortgage as they used to pay for rent,
they’ll be OK.” But maintaining a house adds costs
they may not have reckoned on – and poor people
have little margin for error. “All it takes is one
illness, one [auto] transmission going out, and
they’re a step away from default. People are
covering that stuff with credit cards. But they
can’t keep it up forever.”
Rubino worries about the ability of poor people to
pay their mortgages and maintain their houses, what really
concerns him is what initiatives like “Catch the
Vision” portend for the broader housing market.
Giving poor people a sliver of equity and hobbling
them with debt is classic peak-of-the-
behavior. Rubino regards a real estate crash as all
but inevitable. And when it comes, nearly all
Americans – not just over-leveraged homeowners –
face a day of reckoning.
known Rubino for years: We worked together on the
editorial team of Virginia Business magazine. He’s
naturally cheerful, an optimist in his personal
up-beat guy with a ready smile -- not the dour-faced
scold you’d expect from someone who's predicting
imminent disaster. Now, I don’t
know if his prophecies will pan out or not. But the
risks he highlights are real, and intelligent people
will take his warnings into account, whether planning
their personal finances or plotting taxes, spending
and other public priorities in Virginia.
point, the easy credit will dry up and the bubble
will be impossible to sustain. Then confidence
will collapse and investor psychology will kick into
reverse. Judging by previous real estate recessions
in Boston and California, prices could tumble
nationally by 20
percent or more. The bear market will vary from
region to region, depending on where the worst
excesses occurred, but Americans everywhere will
suffer from the sudden crisis of business confidence
and loss of buying power.
let Rubino riff a bit: "We’ve
been borrowing insane amounts of money to buy wildly
overpriced homes," he says. "As a society,
we are like a family that over the last few years
has maxed out our credit cards. We have an SUV in
the driveway and a big-screen TV in the family room.
To the neighbors we look like we’re in good shape,
but we’re not.
reality, we're about to lose our shirts. Since
our homes are the things we’ve been borrowing
against most aggressively, that’s where the worst
pain will be felt. More and more people will have
trouble making their monthly mortgage payments, home
prices will fall, home builders and mortgage lenders
will start laying people off, and the stocks of
everything related to housing and consumer finance
words. Now for the hard, cold facts.
prices are the highest in U.S. history: The price of
U.S. home has increased 181 percent since 1980, far
outstripping the CPI index; over the
past five years, it's up by 38 percent. The total
value of U.S. housing has inflated by $5 trillion
in the past five years. (Rubino is citing 2002
rates, which have reached a 37-year low, have almost
nowhere to go but up. For the past two decades,
declining mortgages have made housing more
affordable. When rates reverse course, they will
push monthly payments higher and crush the buying
power that has sustained prices to this point.
than let their equity build as home values rise,
Americans are refinancing their debt and draining their equity
to sustain lavish lifestyles. Equity as a percentage
of home value hit a post World War II low around
2000, declining to 55 percent, down from 70 percent
as recently as the mid-1980s. When prices do
decline, as they inevitably will, homeowners will
have less equity than at any point in history to
a related phenomenon, Rubino notes, consumers are
gorged on debt. Homeowners have been piling on
new mortgage debt at an unprecedented rate -- $820
billion in 2002 alone. That wouldn't be so bad if
they'd used that debt to restructure their household
balance sheets, but they haven't. Credit card
liabilities are soaring too. Total consumer debt as a percentage of disposal
income reached 14 percent in 2002, higher than at
any time but a brief spike around 1988.
debt happens to coincide with record U.S. debt of
all kinds, including business and government. The
federal government is running up half-trillion dollar
annual deficits again. Add it all up, says Rubino,
and debt amounts to an astronomical $34 trillion --
that's trillion with a t, folks -- or about
$450,000 for a family of four.
of this debt has been financed from overseas, but we
can't count on the world's generosity forever,
Rubino warns. Currently, the U.S. is running a
balance of payments deficit of roughly $500 billion
a year. The world is sloshing with dollars. And it
looks like the tide is turning: The dollar has been
falling against major currencies for the past year,
and he expects it to fall a lot more.
the last couple of years, foreign investors have
begun to lose interest in buying our bonds and
stocks. What they’re doing instead is converting
into yen and the Euro. They’re selling dollars,
pushing down the value of the dollar. It’s been an
orderly decline so far. But orderly declines don’t
stay orderly. Peoples’ perceptions change. People
losing money, and they all bail out at once."
the picture is the existence of something that no
central bank really understands or controls:
derivatives. There are some $170 trillion -- again,
that's t like trillion -- of these financial
instruments, interest rate and currency swaps
mostly, laced through world financial markets. The
people engaging in this financial hedging and
speculation think they know what they're doing.
Indeed they may, as long as financial markets follow
familiar patterns. But if the dollar undergoes a
prolonged plunge, asks Rubino, who knows how
these complex, interlocking obligations may be
affected? Conceivably, one big failure could trigger
a series of cascading defaults.
thinks a currency cataclysm is inevitable -- indeed,
he's researching that very subject in his current
book project -- and he believes that such a crisis
will trigger the real estate collapse.
the crisis occurs, hundreds of billions, maybe
trillions of dollars of foreign capital will pull
out of the U.S. Supply and demand of credit will
shift drastically. Interest rates -- and that
includes mortgage rates -- will soar. Higher
mortgage rates, combined with a change in investor
psychology caused by the collapse of the dollar,
will kick the props out from housing prices.
Households with adjustable-rate mortgages will face
escalating payments even while the value of their
properties decline. Millions of Americans will find
their mortgage obligations exceeding the value of
immediate impact of the real estate bust will be
felt most intensely in regions, like Boston and
California, where prices have seen the greatest
run-ups. The Washington metro area should be hit as
well, says Rubino, though not as badly. Prices
haven't outpaced incomes by as wide a margin as they
have in the super-heated markets. Other metro areas
in Virginia may get off relatively mildly.
the concussion, like shock waves from an asteroid
strike, will spread beyond the point of impact. A
huge chunk of the economy revolves around real
estate: land developers, home builders, construction
workers, real estate agents, mortgage financiers,
real estate insurers, and the like. Issuers of other
forms of consumer debt will be close behind as homeowners,
faced with the devil's dilemma of falling behind in
their mortgage or credit card payments, start
defaulting on their credit card debt.
the Washington region, Freddie Mac and Fannie Mae,
private companies who repackage mortgages for sale
to secondary markets, could be major casualties.
Capital One, a major employer in Northern Virginia
and Richmond, could run into big trouble, depending
on how well it's managed its credit card risk.
Rubino regards it as all but certain that big home
building companies will tank and the construction industry
the blast radius expands, the damage spreads. The
value of all homes in the U.S. runs around $13
trillion to $14 trillion, Rubino notes. A 20 percent
decline in property values across the board could
vaporize some $3 trillion in equity. The impact will
be far more pervasive than the Internet crash not
only because the destruction of wealth will be
greater but because far greater percentage of
the typical household's net worth is tied to housing
equity than was ever invested in dot.com stocks.
Homeowners will curtail spending, perhaps on a scale
not seen since the Great Depression. Thus, in a
tertiary impact, businesses from furniture
manufacturers to restaurants, from appliance
manufacturers to vacation resorts, will suffer
drastic fall-offs in business. As these enterprises
lay off workers, unemployment rises and purchasing
power declines even more, spreading even more
a massive asteroid hits the earth, it blankets the
atmosphere with debris and dust, cutting off the sun
and spreading its destruction to all corners of the
earth. Similarly, in the modern, globalized economy,
havoc in one nation's economy is rapidly transmitted
to others, as we witnessed during the so-called
Asian Contagion of the 1980s and, later, the Russian
debt default. Havoc in the United States could
spread globally. Rubino doesn't discuss these
quaternary effects in his book, but he was willing
to explore some ideas during a recent chat.
precipitous decline in U.S. purchasing power would
have devastating effects on the economies, especially in Japan, China and other East Asian
countries whose economies depend upon exports to
the U.S. The financial systems of both China and
Japan are incredibly fragile, with banks tottering
under hundreds of billions of dollars of bad debt. A
collapse in export markets could trigger financial
crises in those countries. In China, economic
hardship could easily translate into social unrest,
political instability, riots, lawlessness and
general mayhem. (See my column, "The
Five Instabilities," April 28, 2003.)
Disorder in China could disrupt global supply chains
with incalculable consequences.
foresees the possibility of the United States,
wracked by economic hardship, losing the political
will to pursue the war against terror in the Middle
East. If we pull out of Iraq and the bad guys
consolidate power over the Gulf oilfields, convert
oil wealth into nukes and long-range missiles, then
the entire global balance of power turns topsy turvy.
"The political side of this is too terrifying
to think about," says Rubino. "If you take
out of the mix, you have global chaos."
tag-line for Rubino's book is "Money-Making
Strategies for the End of the Housing Bubble."
His first piece of advice is eminently sensible: Cut
your spending now, reduce your debt load and, if
possible, start saving. He offers a variety of more
aggressive options such as selling short the stocks
of home builders and credit card companies,
investing in cash-rich companies like Microsoft and buying gold.
Rubino himself has paid off the mortgage of his
house just outside Moscow, Idaho, and is heavily
invested in gold. (Major nations will deal with the
spreading chaos by injecting massive liquidity into
the financial system, which will be highly
inflationary and spur people to buy gold, a
traditional store of value, he argues.)
can buy Rubino's book for advice on how to protect
their personal wealth. Unfortunately, there's no
handbook for elected officials entrusted with
Virginia's government spending and tax structure. At
the very least, they should avoid the temptation to
avoid optimistic budgetary assumptions which, if
they prove unjustified, create painful budget crises
like the one just past.
economic chaos spreads across the globe, all regions
will suffer. But will suffer more than others. Let's
just say that I wouldn't want to be Arnold
Schwarzenegger right now: California could slip
from "really bad" to "total
meltdown." By contrast, a handful of polities
-- hopefully, Virginia will be one of them -- will
display fiscal caution and spending discipline.
They'll be able to survive the turmoil with minimal
tax increases and modest disruption to essential
services. Owners of capital will seek the security
of these geographic havens. All other things being
equal, the economic performance of these islands of fiscal rectitude will
be less dismal that that of their spendthrift
now, as Gov. Mark Warner and the leaders of the
General Assembly gird for combat over tax reform and
spending issues, Virginia appears to be entering the
virtuous up-side of a business cycle. Secretary of
Finance John Bennett has just announced numbers
suggesting that tax revenues this year are
unexpectedly robust. Past
experience suggests that Virginia can expect to
enjoy several years of strong revenue growth. Given
the backlog of perceived needs in transportation and
education, our lawmakers would have to be
super-human to resist the temptation to ratchet up
state spending commitments.
the odds of another economic downturn, however, our
leaders need to prepare for the worst. "Think
of this as a sucker rally," Rubino cautions.
"Don't be fooled into thinking that the 1990s
are back. Build rainy day funds. ... Government gets
into trouble when it thinks that surpluses will last
as far as the eye can see. Virginia needs to manage
itself with the expectation that revenues could
Rubino is right, we could save ourselves a lot of
grief by following his advice. If he's wrong, it
won't matter -- we'll be too relieved to care.
November 17, 2003