Saturday, June 11, 2011

"The Tulip Bubble"

Strange as it may seem, in the 17th Century the Netherlands financial markets participated in one of the most bizarre exhibits of financial madness known to man.  It seems that a half a century or so prior, a Dutchman had imported a few dozen tulip bulbs from what is now Turkey.  Over the next few decades the Tulip became wildly popular.  Conditions were in effect which limited supply and, following traditional supply and demand principles, tulips began to be a prized possession.  Accordingly, some sharp financial mind of the day set up a "tulip exchange" in the financial markets.  As the popularity of this exciting new commodity spread the price of tulips soared to absolutely insane price levels.  At the height of the bubble the price of a single tulip bulb was the equivalent of a year's salary for a middle class Dutchman.  (Google Tulip Bubble; it's true!)  Eventually the market collapsed and thousands of tulip investors were very sad indeed.

Five years ago the U.S. housing bubble was not much different.  Spurred by government mandated low income home loans instituted during the Clinton administration, the financial institutions began playing fast and loose with the home mortgage market.  Early signs of trouble were evident and some of our conservative lawmakers warned of severe abuses of the system.  They were largely ignored by the Democrats who, in typical fashion, expanded Fannie Mae and Freddie Mac mortgage loans to a larger, and far less qualified group of mortgage applicants.

Financial institutions saw how the game was to be played and jumped in with glee.  Zero down, low adjustable rate loans and no documentation of income transactions were the play of the day.  Loan applicants, seeing how easy the game rules were, began lying about their income and taking the keys to their new homes.  The mortgage lenders, packaged these questionable loans into a trading block and created a new medium of exchange, Credit Default Swaps which were flipped to markets all over the world.

Of course this easy money created an insatiable demand for housing.  Home prices exploded.  The home buyer, seeing his home increasing in value by the thousands each month, took out home equity loans for swimming pools, new furniture, or, what the hell, a European vacation!  Whee!  Amateur investors began taking out loans for five or ten houses, then flipping them for profits a few months later. 

Of course, like those tulips, the crazy conditions that created the housing bubble had to burst eventually, and it surely did; quickly and painfully.  There are tens of millions of very sad housing stories these days.  Sadly, recovery will come slowly; the very government that established laws that created the abuse has now, rather than let the market settle under traditional economic patterns, intervened to try and ease the pain of those oh so coveted voters.   The Democrats have yet to learn what all of us already know; you can't make housing payments, no matter how favorable, if you don't have a job.   This government intervention assures us that recovery will continue to be slow and painful.  Housing experts are predicting two million more home foreclosures this year.

My modest home was, at the height of the bubble, worth twice what I paid for it.  Alas, it is now assessed at a lower value too, as the tanking of the housing market has driven down real estate prices.  Fortunately, unlike millions of Americans, I owe less than the house is worth and my mortgage is affordable.  Not so for the millions of Americans who have lost, or have walked away from their homes. 

I think Warren Buffett, one of our wealthiest and wisest American billionaires, has it right.  A few decades ago he said of his modest home in Omaha, Nebraska, "I don't check how much my home is worth on a daily or weekly or monthly or yearly basis".  "That would be silly", he said.  Perhaps, a few million Americans have now learned that lesson too.  Sadly, the lesson was accompanied by great pain.

1 comment:

Anonymous said...

Well done piece. You should also consider the effect of fed government efforts to lower loan qualifications in order to prevent "discrimination." The banks fought this at first and then realized that if loans were sold off, the risk didn't matter and they could make more money.