Housing Bubble Burst: American Style

The real estate market had been going through ups and downs in various parts of the world for a while however it probably wasn’t very noticeable until things started to spiral downward in America around the year 2005. Many had guessed correctly even during the dot com upheaval that there was a bubble forming in the real estate market. Things were being written and discussed in small scale, but nobody seemed to pay much attention. I guess when time is good why would anybody listen to such warnings? It is only then when the goliath comes crushing down people takes notice. If you are one of them who cannot make sense of the circumstances that caused the once glorious real estate market to crash down practically to dust in some parts of the country almost overnight you are not alone. Even today I doubt the so called experts can clearly explain the phenomena. Yes, it is possible to identify several primary reasons but narrowing them down can become a matter of individual perspective.

I am not an economist, my relationship with economics has been only on printed papers as I  read various columns often contributed by reputed economists to get some in depth analysis. Unfortunately time has changed, my confidence in them have waned away. As a result I have started to do my own analysis to see if I can come up with a layman proof solution to explain the mystery of the housing market fallout. One thing that had always baffled me is the situation where a house sells more than the seller asking for! Of course such anomaly happens when several buyers bid for the property – a very common observation during the peak time of real estate in America. I was living in the Boston area during that time working on a visa and thankfully stayed away from the temptation of being a home owner primarily because I did not yet have residency. However, that did not prove to be enough deterrent for some of my acquantances who had bought houses and later found them at the wrong end of the economy after losing their jobs. Many ended up forced out of the country leaving behind everything they had – house, car, furniture etc.

Anyway, lets get back to the curious point of a house selling more than the market price. It is not very dificult to figure out that the buyers were convinced that the ultimate value of the property they were about to purchase would eventually grow to such a height that their investment would return with a hefty profit. It didn’t happen, in most part of America, as we know now. Let alone profit, many homeowners either lost their homes to foreclosure or saw their equity evaporate with some even having to start their life all over again.

Now, lets try to identify the primary reasons that led up to one of the biggest man made economic disasters in American history despite being overcrowded with all kind of financial experts. 

Here are the events in chronologial order:

• Due to the prosperity of dot com there were too much wealth floating in the market. Even though the wealth did not get equally distributed but still it trickled down to all level, more or less. As a result the overall standard of life increased, people had more buying power, there was a sense of life in the economy – one might wish for such good times to stay forever.
• As the buying power of the general population increases so does the price of the essentials and especially the land which evidently brings up the house prices. 
• On and after 1997 when dot com burst had started some prosperous areas took a huge beatings as a result many jobs were lost. Many had to declare bankruptcy. Many others lost a fortune in the share market. As a whole the prosperous market suddenly turned into a dead field, the so called wealth had turned into dirt.
• In this kind of situation government is required to take some measures to help recovery of the economy. As a result they are always prone to reduce the prime lending rate as this rate can pump in new life into the economy by encouraging people to take advantage of the low rates. With the rates low the borrowers are required to pay less as monthly repayment installations and are left with some extra money in hand which they can spend on other items in the market, increasing consumer spending. Starting from the year 2000 American government continued to reduce the lending rate from 9% and went down to 4% by the end of 2003.  
• At this point two things happened
• People who had borrowed for higher rate refinanced their properties and received substantial amount back. As a result they now had quite a bit of disposable income which streamed into the market.
• Another group of people who had reasonably safer jobs or wealth from other sources used their equity to buy even bigger houses. As a result demand for houses increased considerably pulling the price up as expected.
• At this point started a new chapter in the epic story which many believe caused the actual havoc in the end.
• As the interest rate went down many people became interested in purchasing houses, many of them neither had a good credit history nor the necessary money to deposit as a down payment. However, after the dot com burst as the market was down the businesses especially banks and investment companies were eager to pick up just about anything to bring back life into the market and rip off some profit. They eventually started to lend money to these high risk clients for zero down payments often allowing their representatives to resort to questionable means to show this potential clientele as eligible borrowers.
• Many people who only had a modest earning took this advantage and became owner of large houses and expensive cars. As a result they started to spend practically all their earnings as living cost, about 80% of which went to the mortgage payment and other house related costs like taxes, utilities, maintenance etc. Some even went on to expensive vacations into the cherished destinations. They were basically living on the edge of a sword.
• What happened next is not very difficult to understand. To describe in plain words
• Anything that goes up must come down – accounting for gravity. Same happened in real estate. When the prices started to reach ridiculously high level the land pricing became target of revaluation immediately causing house price adjustments and resulted into drastic devaluation of many high priced properties.
• At the same time to reduce inflation government had to increase the lending interest rate which went up to 7% around the end of 2007. This created another issue. As the interest rate increased the monthly mortgage payment went up too, in many cases this amount became too much for the homeowners to pay who already lived on the edge. As a result they simply walked out from their houses knowing that they risked very little to lose as they had practically no money invested in the house. Banks and investment companies now got stuck with many foreclosed houses with market filled with mostly sellers and few buyers. It eventually became so devastating that many companies could not even continue to operate while others required substantial government assistance to exist. Example – Fannie Mae, Freddie Mac.
• From there on things continued to go down. The executives powering the banks and mortgage companies might have thought they had created a good herd of cash cows who would continue to pay interests on their long term mortgages keeping the cash flow in the market going forever but in reality their lack of sincerity, appropriate understanding of the market and possibly sheer greed had thrown the whole balance into a complete chaos causing the market to crash.  

To summarize, one might simply state that if it wasn’t for the greedy banking and investment sectors things might have not turn so bleak in such short time. Clearly the executives of the failed companies appeared to conspire against the general population showing total disregard for appropriate financial practice. As a result house market in America still going through a slow and painful recovery process with no guarantee on its eventual success.  

The Dot Com Bubble Burst

I doubt if there are too many people out there who doesn’t already know quite a bit about the Occupy Wall Street movement that took place around the end of last year. It was labeled as America’s own movement compared to that of Tahirir square in Egypt that saw the end of Hosni Mubarak’s long hold, for good or for bad that’s yet to be determined.  The question is – why? What might have caused this sudden change of events in the great land of opportunity – the sole superpower?  The answer to this question is not a simple one. Whether an individual decided to participate in the Occupy movement or not, there’s little doubt that there is a general concession among ordinary people that the disparity among classes – primarily focusing on wealth – is getting bigger and bigger, with rich getting richer and poor getting poorer. 

The answer to that question is neither simple nor straight forward. However, it is not difficult to figure out that in the corporate world a relatively small group of people controls majority of the cash flow and manages most of the tangible wealth while the rest have little choice but to become the cards of their hands – being played as they wish.  When things look good they take credit for the success and are rewarded with hefty bonuses, when things look bad they get to truncate workforce in their quest to make things look profitable to the investors and again receive hefty bonuses for making it look good. Talk about a fair deal!

Anyway, before discussing the occupy wall street it is important to look a little back to cover two major events in the recent history in the economy of America.  In this article I’ll briefly visit the circumstances of the two market falls – the dot com burst starting around 1998 and the real state bubble burst starting around 2007.

In the year 2000 when dot com bubble burst was going on in full swing I was right in the middle of it all, scared, affected, driven, suffered and finally jabbed right into the face, eventually made my way out of the burst into my new country Canada. At that time I wasn’t fully sure what had hit us but later as things settled down and everybody had time to think the truth started to become very apparent. Too many companies had mushroomed with similar ideas and started their journey with the money borrowed from venture capitalists and failed to bring any reasonably good product in the market before the funding wasted away.  Even the ones that did release some working products they faced stiff competition with other similar products. In such a situation only the best survives and most others perish, with all its ship load of contributors, investors and workers. With that coupled with high compensation for the high ups, offering public shares even before any tangible product was created, and irrational expectation of earnings – everything chipped into the downfall. At the end thousands were out of work, many companies closed.

At this point I must elaborate on the two occasions where I had lost my jobs. The first company was working on to create a new kind of search engine, the novelty of which I was unable to figure out even after working for six months. Everything looked about the same as other ones already in the market with majority quickly disappearing in the oblivion.  I wondered if an insignificant IT professional like me could see it then why couldn’t all the talented venture capitalists.  I guessed they had taken a chance, just in case some miracle had happened.  None did. Eventually the investors figured out they weren’t about to experience any miracle and quickly backed off and I was out looking for work – along with everybody else, must have been a few hundred. That made it even difficult, because too many people were looking for work in an already terrified market.

I ended up getting another position with yet another dot com running with venture capitalist money. This one looked more prospective.  I even heard they were about to get a buyer – a really good thing, sure sign of success. Not sure how things would have gone if not for the terrorist’s attack on the world trade center on September 11 2001 but after that already shaky market turned shakier and worst of all, our potential buyer backed off. So much for success! The company went belly up as they could not find anybody else to finance. The good – I bought a laptop for fraction of the price it was selling in the market from the now defunct company.  The bad – I was out looking for a job again and so were hundreds of others from my previous company. This time things became really personal. Anyway, had I not been working as a foreign worker and getting squeezed by the parent company that sponsored me and only provide a mere percent of the gain for my services I probably wouldn’t be too sour. The loot was all gone and I got barely any share of that. Some did get rich, bilking the cash cows to the max.

 Me and my misfortune!

I’ll continue this article to talk about the real state bubble.