The Property Time Bomb
By Michael Roberts
The world capitalist economy is being held up like Atlas by just two forces: US household spending and Chinese manufacturing production. If either or both of these should die, then world capitalism will slip into slump.
US household spending growth is probably the most important of these two factors. What is driving this 4-5% annual growth in spending? It’s not rising wage rates. Indeed, for the average American household, income from work is falling. No, what’s been keeping Americans spending has been partly tax cuts, as Bush cuts back on social spending programmes to make handouts, mainly to the rich through cuts in big business taxes, but also to middle-class Americans in personal tax rebates.
But the main reason has been very low interest rates, driven down by the policy decisions of the US Federal Reserve Bank under Alan Greenspan. This has led to historically-low mortgage rates across America. As a result, there has been a property boom that has reached breakneck proportions, particularly in the “hot spots” of California, Las Vegas, Florida and New England.
National house prices are now rising at a 15% annual rate, unheard of in all previous US housing booms. This unprecedented rise in housing wealth has enabled Americans to refinance their debt at low rates and then use the cash they've borrowed to spend, confident in the belief that when they sell their properties they will have risen so much in value that they can pay off the debt comfortably. This is a house of cards.
World capitalist growth now depends on US household spending and US spending depends on house prices in the US rising indefinitely. This is a pyramid scheme that will topple over eventually.
As The Economist pointed out in a June issue: “Never before have real house prices risen so fast for so long in so many countries”. The total value of residential property in the OECD has more than doubled from $30bn to $70bn in the last five years and is now equivalent to over 100% of these countries’ annual output.
Yet this value is not represented by any new production and it is a global phenomenon. House values (if measured against the rents that can be got from property) have never been higher in America, Britain, Australia, New Zealand, France, Spain, Holland and Ireland.
This is purely a speculative bubble – a bubble bigger than the stock market boom of the late 1990s that collapsed in 2000 or the great boom of the 1920s that ended in the Great Depression of 1929-33. The Economist reckons it is the biggest bubble in history!
That’s proven when the US estate agent association revealed that around one in every four properties bought in 2004 were for investment not occupation and another 15% were bought as second homes. In Florida, as many as half the buyers of property resell their purchases immediately! And they are financing this binge from mortgage lenders that offer 100% mortgages or even higher, with reduced interest payments (60% of mortgages in California were like this in 2004).
But the US housing bubble is now set to burst. According to another expert, average US house price rises were about 25% over trend, but in “hot spots” the level of over-valuation was more like 50%. In Los Angeles, the real estate association has calculated that only the top 17% of all wage earners can now afford the price of an average home! It does not matter that mortgage rates are still low. The level of prices in many areas is so high that hardly anybody can buy.
The indicators of a future burst are already there from the collapse of other housing bubbles in Australia and more recently the UK. The price levels reached in the UK and Australia coupled with rising interest rates finally broke the back of the housing market there. In the last 12 months, Australia has seen falling prices and the UK is flat at best.
Now the US Federal Reserve is raising interest rates. Eventually that will seep through to mortgage rates. Then, my own calculations suggest that affordable housing will only be restored in the US if house prices drop at least 15-20% from current levels. That spells bust!
If that turns out to be right, then the US economy will drop like a stone, as many Americans face bankruptcy when they cannot make their mortgage payments, while others will have to pull in their spending horns to make ends meet.
And have no doubt that the US economy depends on this low interest-rate housing boom like no other. The big US banks have made huge profits in the last few years from lending on real estate. Now 45% of all the profits made by the top 500 companies in the US come from the financial sector. If the housing market collapses, that will make a huge hit on the profits of big business.
Even more serious, most US mortgages are sold on by the banks to semi-government agencies, called Fannie Mae and Freddie Mac. Because they are backed by the US government, it is assumed they cannot go bankrupt. And these agencies have been engaged in many financial contracts; using the mortgages they hold as collateral. If these Americans start defaulting on their mortgages in a big way, it could mean that government agencies will be in trouble and require taxpayers to bail them out. That will slow the economy even more. Worse, the trouble could spread through the financial sector like a disease, bringing down a swathe of banks.
Indeed, in Britain, there are already some signs of how the US housing market might pan out. The number of people declaring bankruptcy in the UK reached record levels in the first quarter of 2005, up 28% on a year ago. And there are record numbers of mortgage repossessions already. Personal bankruptcies are one-fifth higher than they were during their peak in the early 1990s, when the UK economy was in recession and almost one million households were in “negative equity” (their mortgages were bigger than the sale of their property could cover). According to John Butler, economist at Britain’s biggest bank, HSBC, “the vulnerability of the household sector is acting like a time-bomb, which will ultimately cast a shadow over the UK economy”.
Of course, the US authorities are not stupid. They are aware of the risk. But for the moment, they seem blithely confident that nothing will go amiss. Federal Reserve chairman and financial guru, Alan Greenspan, recently said he thought there “was some froth” in the housing market and some risky forms of financing, but he was sure that the US housing market was not a bubble that was going to burst.
Perhaps his serenity is due to the fact that for the richest people in the world, a housing bust may have little effect on their wealth. After all, it is the middle class, and even the working class to some extent, in the US, the UK and Europe, who invest any savings or credit they have into their house. For the very rich, property is a much smaller proportion of their overall wealth. Financial wealth – company shares, government bonds and just cash in the bank – is just as big.
Indeed, the world’s wealth is more concentrated than ever. The difference between what the “average” man or woman is worth and what the super-rich are worth has never been so great. A new Merrill Lynch study shows that 8.3 million people around the world now have a million or more dollars in “investable assets” and this does not include their homes. Remember, for the average person, the main asset is the home.
With $30.8 trillion at their command, the “really rich” control one quarter of the world’s financial wealth. This translates into the following: the super-rich, who comprise just 0.13% of the world’s population, own 25% of the world’s wealth!
But very few of the super-rich made their money investing in stocks (Warren Buffett is one great exception). Most made it through inheritance, or building a business, or in investment banking. That means they got rich on the back of other people’s investments. So the super-rich may not be worried by any housing crisis. But it’s an issue for the rest of us.
The US economy is currently motoring on at about a 3.5% real growth rate. Last year, the UK was nearly achieving that on the back of rocketing house prices and big spending by British households as they used up the cash borrowed on their houses. Australia was growing at over 5%.
But this year, the UK and Australian housing markets have slumped. And with that, economic growth has slowed to under 2% a year. Spending in the shops has stopped growing altogether.
The UK and Australian economies are not decisive in driving global capitalism. But the US economy is. If it suffers a similar fate to the UK and Australia in the next year, the world will too. Japan’s recovery is still stuttering, while Europe is growing painfully slowly. If the US stops spending, then China and the rest of Asia will feel the cold draught of slowing export sales too. The world will go into recession.
Does it all depend on the housing frenzy continuing in San Diego, San Francisco and CSI Las Vegas?