Real Estate Collapse Caused Recession, Not Other Way Around
Recently, a colleague and I were discussing the recession and people we know of who lost their homes to foreclosure when she posed an intere...
https://www.elkgrovenews.net/2009/07/real-estate-collapse-caused-recession.html
Recently, a colleague and I were discussing the recession and people we know of who lost their homes to foreclosure when she posed an interesting question -- if the recession had not happened, would real estate prices have been sustainable?
On the surface, it seems like a straightforward question. True, if the recession had not happened, home values would not have fallen as far as they have, and many foreclosures would not have occurred.
Taking the question from a different angle, though, it seems to me the real estate collapse was not the result of the recession -- rather it was the cause of the recession. The real question, therefore, ought to be if real estate prices, supported by the fallacious fiscal policies behind them, had not escalated so quickly, would we still be in a recession today?
Let’s take a look at one actual case to answer that question. It is the tale of a middle-class investor with grand dreams.
Going back just a few years, conventional wisdom said that real estate values would continue to grow at a brisk rate and that investing in it was as good as money in the bank. In retrospect, this conventional wisdom, as it usually is, was wrong. Nonetheless, it seems that everyone from Wall Street “masters-of-the-universe” types on down to “Joe six-packs” bought in on the dream.
Our would-be Donald Trump, as we shall call him, started modestly enough with the purchase of a $200,000 home in California about 15 years ago. At the time Trump bought his house, the state was in a real estate slump.
After a few years, though, not only had California recovered from the slump, but prices were quickly escalating. Suddenly, Trump’s $200,000 house was, on paper at least, worth $500,000.
Aspiring for greater wealth, Trump dives in and takes out an equity loan of $400,000 against his home and, with the help of some very creative lending practices, purchases more real estate. The only problem is that the properties Trump buys are just as grossly inflated as his original house has become.
Not to worry, though, the rules of cyclical economics don’t apply anymore. Values would just keep increasing, or so Trump had been told by every commission-hungry real estate agent and mortgage broker, including those masters-of-the-universe on Wall Street.
Trump’s plan is simple -- buy the homes, rent them out for a year or so, and then resell or “flip” them. Never mind that the rent Trump collects on the properties does not cover the mortgage payment. He only needs a year or so before reselling them for a very handsome profit.
Unfortunately, Trump and his lenders fail to acknowledge the folly of his scheme, namely that while real estate prices are rapidly rising, wages are not, and most people are simply priced out of the market. Trump fails to recognize that he could not afford to buy the very property he is trying to sell based on his middle-class household income.
Of course, the inevitable happens as home prices get so high that most people like him are priced right out of the market. At this point, the laws of supply and demand kick in, and prices start to fall.
Unfortunately, that illusionary one-year holding period comes and goes, and Trump continues to pay out more than he collects in rent. Complicating matters is the fact that much of the most recent economic growth was driven by escalating real estate prices, not the other way around, and related consumer spending on everything from furniture to SUVs dries up.
As soon as real estate stalls, so does consumer spending. Since about two-thirds of our economy is driven by consumer spending, economic activity quickly stalls, and housing prices begin to fall even faster. Before long, Trump is upside down on all of his properties.
Soon, our would-be Trump resembles the monocle-wearing guy in Monopoly who just went bust. Reality sets in, and Trump’s empire, as well as all of the various lenders who hold the mortgages, collapses from the crushing weight of the debt it carries.
Although Trump’s is but one story, this has played out repeatedly as the real estate market and our economy have collapsed. The sad conclusion is that Trump eventually lost everything, including his initial real estate purchase which funded the whole would-be empire.
So to answer the question if real estate had not escalated so quickly, would we not be in a recession and perhaps better off? In my opinion, the answer is emphatically yes.
Let’s just hope all the wannabe Trumps, the masters-of-the-universe on Wall Street and our policymakers remember this the next time around.
On the surface, it seems like a straightforward question. True, if the recession had not happened, home values would not have fallen as far as they have, and many foreclosures would not have occurred.
Taking the question from a different angle, though, it seems to me the real estate collapse was not the result of the recession -- rather it was the cause of the recession. The real question, therefore, ought to be if real estate prices, supported by the fallacious fiscal policies behind them, had not escalated so quickly, would we still be in a recession today?
Let’s take a look at one actual case to answer that question. It is the tale of a middle-class investor with grand dreams.
Going back just a few years, conventional wisdom said that real estate values would continue to grow at a brisk rate and that investing in it was as good as money in the bank. In retrospect, this conventional wisdom, as it usually is, was wrong. Nonetheless, it seems that everyone from Wall Street “masters-of-the-universe” types on down to “Joe six-packs” bought in on the dream.
Our would-be Donald Trump, as we shall call him, started modestly enough with the purchase of a $200,000 home in California about 15 years ago. At the time Trump bought his house, the state was in a real estate slump.
After a few years, though, not only had California recovered from the slump, but prices were quickly escalating. Suddenly, Trump’s $200,000 house was, on paper at least, worth $500,000.
Aspiring for greater wealth, Trump dives in and takes out an equity loan of $400,000 against his home and, with the help of some very creative lending practices, purchases more real estate. The only problem is that the properties Trump buys are just as grossly inflated as his original house has become.
Not to worry, though, the rules of cyclical economics don’t apply anymore. Values would just keep increasing, or so Trump had been told by every commission-hungry real estate agent and mortgage broker, including those masters-of-the-universe on Wall Street.
Trump’s plan is simple -- buy the homes, rent them out for a year or so, and then resell or “flip” them. Never mind that the rent Trump collects on the properties does not cover the mortgage payment. He only needs a year or so before reselling them for a very handsome profit.
Unfortunately, Trump and his lenders fail to acknowledge the folly of his scheme, namely that while real estate prices are rapidly rising, wages are not, and most people are simply priced out of the market. Trump fails to recognize that he could not afford to buy the very property he is trying to sell based on his middle-class household income.
Of course, the inevitable happens as home prices get so high that most people like him are priced right out of the market. At this point, the laws of supply and demand kick in, and prices start to fall.
Unfortunately, that illusionary one-year holding period comes and goes, and Trump continues to pay out more than he collects in rent. Complicating matters is the fact that much of the most recent economic growth was driven by escalating real estate prices, not the other way around, and related consumer spending on everything from furniture to SUVs dries up.
As soon as real estate stalls, so does consumer spending. Since about two-thirds of our economy is driven by consumer spending, economic activity quickly stalls, and housing prices begin to fall even faster. Before long, Trump is upside down on all of his properties.
Soon, our would-be Trump resembles the monocle-wearing guy in Monopoly who just went bust. Reality sets in, and Trump’s empire, as well as all of the various lenders who hold the mortgages, collapses from the crushing weight of the debt it carries.
Although Trump’s is but one story, this has played out repeatedly as the real estate market and our economy have collapsed. The sad conclusion is that Trump eventually lost everything, including his initial real estate purchase which funded the whole would-be empire.
So to answer the question if real estate had not escalated so quickly, would we not be in a recession and perhaps better off? In my opinion, the answer is emphatically yes.
Let’s just hope all the wannabe Trumps, the masters-of-the-universe on Wall Street and our policymakers remember this the next time around.
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2 comments
Greed got the best of everyone, and sadly, the whole country pays the price.
I think in economic life, there is an evolutionary process. We work at McDonald's as a teen, maybe move up to a Denny's, go to a junior college and have a better job, all the time, making more $ as we go. We graduate from college and perhaps enter a corporate job, etc, etc. But we slowly build financial building blocks along the way. For some of these folk, they say even after college and a corporate job, I still can't afford the American dream, so they rent. That is fine, not everyone should buy into that. Having said that, some folks who do not have the $, who work at lower paying jobs, WANT that house, the BMW, the pool in the back yard, etc.
These folks want to look rich. They only have an old Corolla budget, but want the Ferrari. They buy a home with no $ down, take equity out of their homes and spend like crazy. These greedy people who want to look rich who made a decision to live beyond their means are doing us all in. Now, they are the same ones who are seeking help.
These greedy people are now walking away from their homes, trashing it along the way, and could care less. It cost them nothing to get into the house, and it cost them nothing to get out. They have no $ invested, so who cares? They are underwater, so it's not worth it.
I wonder if, when these people go to Vegas and roll the dice and lose the $, do they say to the casino, "I didn't win, so I want my money back?" IMHO, they bought the house, and even if it is underwater, they need to continue to pay for it.
Greedy real estate agents, greedy wanna-be home owners, greedy banks, they all drove American into the ground. I am not just talking EG, but al of America. Such a shame how greed has destroyed this country, and on every level.
What ever makes you feel better but we all know the truth.
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