Economy

That Popping Noise

By Ryan McGreal
Published May 17, 2005

Boom growth is growth in capital accumulation, that is selling things for profit, and investing some of the profit to make more things faster and better.

When the market for actual things is saturated and the boom runs out of steam, it is sometimes possible to replace it with a secondary incentive. Instead of investing in productive activities, the public is persuaded to speculate on the continued appreciation of some investment or other in and of itself.

People become convinced that they can get something for nothing. At this point, the boom becomes a bubble.

Through the end of the 1990s, U.S. Federal Reserve Chairman Alan Greenspan dropped the prime interest rate steadily and repeatedly until it was effectively zero percent. Suddenly, it was very easy and cheap to obtain a mortgage for a house - often easier and cheaper than a rental agreement.

People took advantage of ultra-low mortgage rates in droves, pushing the suburban envelope further and further out to accommodate big, cheap houses. The government and banks helped with federally chartered mortgage investment companies (Freddie Mac and Fannie Mae), no-down-payment mortgages, and handy tax breaks for mortgage payments.

Inevitably, house prices climbed as more people bought into the housing market. New owners saw their home equity increase, and yet more investors were attracted. Speculators started buying houses only to flip them six months later.

New financial mechanisms allowed homeowners to get their hands on some of that newfound home equity and skim value off their houses. Homeowners re-financed their mortgages under low variable rates. This often allowed people to "buy up" to a larger house than they could otherwise afford.

When rates could fall no lower, home equity lines of credit (HOLECs) let homeowners use their appreciating homes like giant ATMs to buy second and third cars, new furniture and appliances, home theatre systems, faster computers, power tools, etc. People grew accustomed quickly to ever-increasing consumption even as median personal incomes stagnated.

The home ownership bubble is a classic positive feedback loop: output (rising home value and more disposable income) feeds and accelerates more input (buyers eager to cash in and get their share). People who wouldn't have dreamed of buying a house for $180,000 five years ago are suddenly eager to snap one up for $300,000.

Positive feedback loops are ultimately unstable, and the housing bubble is no exception. However, the opportunity to make money from nothing seems periodically to affect people like blood in the nostrils of a great white shark.

Those who haven't gotten into the game yet are desperate to do so. That desperation, combined with the tremendous greed of those already invested in the market, has transformed the bubble into a mania. A mania is always the last spasmodic gasp before a crash. The longer the mania runs, the bigger the crash and the more real wealth it drags down with it.

Mr. Greenspan has tweaked the American economy for years, forestalling disaster only temporarily. The last people to buy, like the people who bought Nortel at $120 per share, are the suckers. They'll be hit hardest when the value of their investment collapses back to what it's really worth.

When will the crash happen? It's almost impossible to predict an exact date, but I wouldn't advise buying a house right now. Even setting the manic nature of the current housing market aside, too many factors are about to turn sour:

The next few years are going to be a bad time for the suburbs.

Ryan McGreal, the editor of Raise the Hammer, lives in Hamilton with his family and works as a programmer, writer and consultant. Ryan volunteers with Hamilton Light Rail, a citizen group dedicated to bringing light rail transit to Hamilton. Ryan writes a city affairs column in Hamilton Magazine, and several of his articles have been published in the Hamilton Spectator. He also maintains a personal website and has been known to post passing thoughts on Twitter @RyanMcGreal. Recently, he took the plunge and finally joined Facebook.

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By Trey (registered) | Posted May 18, 2005 at 07:09:30

Kunstler says "The dirty secret of the American economy for the last two decades is that it is all about the creation of suburban sprawl and accessorizing, furnishing and servicing it."

Ssssshh, listen closely you can hear The Meadowlands snap, crackling and _________!

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