Monday, November 28, 2005

The housing bubble created by a credit bubble and poor banking standards

I hope everybody had a good Thanksgiving holiday.

I came across this article by Gary North on I suggest you click the link and read the whole thing, but I want to focus on certain parts of it below.

Bubbles always continue for months or even years after old timers say they will pop. Old timers have trouble estimating the fear of the buyers at being left out and the fear of lenders at being left out. The two sides debtors and lenders keep the dance of doom going much longer than old timers can imagine possible. But eventually the dance ends.

I spoke at Lew Rockwell's conference. One of the speakers is a banker. He lives in Las Vegas. He was taught by Austrian School economist Murray Rothbard. He earned a masters degree in economics. Then he went into banking.

As an Austrian School economist, he understands the business cycle. He understands that the Federal Reserve system has pumped money into the economy, creating a housing bubble since 1996. He knows this boom will bust.

He has no illusions about this housing market. Compared to him, I have been Pollyanna. He spoke of the mental outlook of the builders in Las Vegas. They all know it can't go on, but they are determined to party until it does. "Then they will declare bankruptcy and start over," he said. This is their exit strategy.

A one-acre lot sells for $200,000. Then the developer must build a home on it to sell. But rising building costs since Katrina are creating disasters for their plans. They are coming to him for extension loans. He doesn't plan to make them. But there is no doubt that other banks will.

He was a participant in a panel that closed the conference. I was also a member. There, he tossed a grenade. He said that in his region, the banks' loans are 80% in real estate.

I sat there stunned, trying to take this in. He was not speaking of the savings and loan industry. He was talking about banks.

Diversification? There is none.

I still could not quite believe it. I approached him privately after the conference. I asked him if I had understood him correctly. "You are saying that bank loans are 80% in real estate in Las Vegas." "No," he replied, "I said in the 80s. In fact, it's the high 80s."

I asked if Las Vegas is unique. He said that he has heard similar figures about Phoenix and the southeast, presumably meaning Florida.

He explained that loans are first made to builders. Then they are made to companies that depend on builders. In other words, what may appear on the books to be a diversified portfolio is in fact tied almost exclusively to real estate.

The implications of what he said are staggering. The post-2001 boom in real estate is the heart of the American economy today. The housing market did not fall during the 2001 recession. The FED pumped in fiat money in 2001 to drive down the federal funds rate from 6.5% to 1.25%. That unprecedented fall in the fed funds rate provided the incentive for borrowers to buy a new home. The economy responded accordingly.

Now the FED is steadily raising short-term rates. Those institutional speculators who borrowed short and lent long the carry trade are now facing a squeeze. Short rates are rising. The spread between the cost of short-term money and the return on long-term money is shrinking fast. You can see this here.

We are not yet at the inverted yield curve, where 90-day T-bills have rates higher than 20-year T-bonds. This is a crucially important indicator. I explain why this is so important here.


There is a life cycle to personal investing. There is a life cycle in the capital structure. People grow old and die. They must be replaced. Businesses and churches must plan for the retirement of today's leaders.

How will tomorrow's leaders be able to move through the cycle if they are locked out of the housing market?

I asked the audience this question: "With the median price of a home this high, how will all those kids at the check-in desk ever become home owners?" I gave the answer in one word: "Later." The price of houses will fall.

There is another answer: "They will move."

In either case, today's home owner in San Andreas fault country will see the bubble burst. I think the mortgage market will do the job. But if I am wrong, then greener pastures will. California has lost 100,000 residents over the past year.

The American economy as never before rests on the housing boom. Yet this boom cannot be sustained much longer in the bubble regions. A recession looms. Even without a recession, the boom will falter because of ARMs: adjustable rate mortgages. These time bombs are about to blow, contract by contract.

If nothing changes if short-term rates do not rise monthly mortgage payments are going to rise by 60% when the readjustment kicks in. Yet buyers are marginal, people who could not qualify for a 30-year mortgage. This will force "For Sale" signs to flower like dandelions in spring.

The FED's present policy of announcing a .25 percentage point hike every few weeks is going to force the late-comers to sell. It is going to bash the plans of home builders, whose industry moves from feast to famine.

If you remember the S&L crisis of the mid-1980s, you have some indication of what is coming. The S&L crisis in Texas put a squeeze on the economy in Texas. Banks got nasty. They stopped making new loans. Yet the S&Ls were legally not banks. They were a second capital market. Today, the banks have become S&Ls. They have tied their loan portfolios to the housing market.


I think a squeeze is coming that will affect the entire banking system. The madness of bankers has become unprecedented. They have forgotten about loan diversification. They have been caught up in Greenspan's counter-cyclical policy of lowering the federal funds rate. Now this policy is being reversed. Rates are climbing. This will contract the loan market. Banks will wind up sitting on top of bad loans of all kinds because the American economy is now housing-sale driven.

You may think that you are shielded. But your banker is not shielded. You may not deal with bankers. But your employer does.

Your employer had better have a signed line of credit to keep the doors open. Without this, there may not be money to borrow when the housing bubble pops.

There will be great opportunities to buy houses at discounts during the down phase of the cycle. Be patient.

November 25, 2005


Blogger AZgolfer said...


Hope you had a great Thanksgiving! Keep up the great work on your blog.

11/28/2005 5:35 PM  
Blogger SoCalMtgGuy said...

Thanks Azgolfer!

I'll keep it up!

Keep checking back and letting others know.


11/28/2005 8:23 PM  
Blogger Sam said...

Wow - your post was such an eye-opener. For the longest time I've been thinking to myself that this is not just an abnormal run in housing prices, and that the adjustment process in the end will involve both real estate prices and mortgage lending standards. The thought of banks having little diversification on their balance sheets, however, really never occured to me.

I always read blogs with a healthy dose of skepticism - now I'm curious to see if I can get my hands on some corporate balance sheets to verify the "80-plus %" hypothesis.

I'm a half-believer in the recession scenario. Some days I think that GDP growth will just slow, some days I get slightly more pessimistic. But if everything in your post holds true on a wider scale, it's probably one of the most convincing arguments I've come across to date...

Thanks. Sam

11/28/2005 8:44 PM  
Blogger SoCalMtgGuy said...


Let me know what you find. Again, I did not go on that "fact finding mission" yet.

From what I see and know in the industry, it would not surprise me...and certainly not in a place like Vegas, or the other hot areas listed.


11/28/2005 8:53 PM  
Blogger Metroplexual said...

If it goes badly how does that bode for your job? I know I am in a field somewhat affected by the ups and downs but your in the crosshairs. I feel bad for what is coming.

11/29/2005 8:31 AM  
Blogger SoCalMtgGuy said...


I knew going in that I was "late to the party".

Yes, it does worry me a little bit...but I have plenty of other options that I am looking at. I will keep going as long as I can keep making decent money.

Honestly, if the thing died tomorrow, I wouldn't lose too much sleep over it. I have kept my expenses low and saved the money that I have made. I missed the big boom and the huge paychecks...but I do OK for me. I know that I'm not near as stressed about it like some of the brokers I visit that have big months expenses.

Best of luck to you!

11/29/2005 9:01 AM  
Blogger faliero said...

Socalmtgguy, I would take anything that Gary North said with a HUGE grain of salt. He was one of the leading advocates of the Y2K apocalypse... you know, sell everything, buy a farm in the country, buy lots of gold (preferably from Gary North), mass starvation is coming, etc etc....Great work on the rest of the site, enjoyed reading your posts on some of the inner workings of the mortgage industry...

11/30/2005 4:28 AM  
Blogger SoCalMtgGuy said...


I hear you on that. I know there is a lot of "doom and gloom" out there, but from what I see in the mortgage/banking industry, it does NOT surprise me that some banks might be getting a little carried away with their portfolio balancing. That is the only real point I was trying to make.

Again, I don't see all the inner workings of the banks numbers...but I talk to enough people in the industry to know that more than enough "executives" believe this thing will keep on going.

11/30/2005 10:50 AM  

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