Tuesday, July 19, 2005

We Can't All Get Rich Trading Hats On An Island

I liked this column about our current financial situation. Food for thought.


According to The Economist, homebuyers in Los Angeles are relying on their homes to increase in value “by a whopping 22% a year over the next decade”. This would push the median price per house up 800% to well over $3 million, while at the current rate of increase the median family income would only rise to around $54k.

Consumers are now relying on their homes to make up for static or falling incomes, and to provide them with a comfortable pension in their twilight years. These same consumers may soon be rudely awakened from their dream of ever increasing property prices and financial instruments. They may soon awake to a stark reality indeed. If so, how might they react?

Firstly, they will realise the need to stop spending and start saving (as former generations once did). For example, in tough times young people may choose to move back home to save rent (if their parents will have them back) rather than choke on a large mortgage.

Secondly, they will begin to par back or eliminate spending on non-essential services they can do themselves or do without, such as mowing their own lawn, doing their own housework and laundry, passing up on pampering facials, massages, manicures and so on.

Thirdly, loans will be paid back (or in many cases repudiated) as people strive to get out of debt. If house prices stop rising, or (Heaven forbid!) actually begin to drop, there will be Hell to pay… not to mention the possibility of rising unemployment, rising interest rates, rising oil prices, rising cost of living, etc, etc.

Fourthly, a severe slump in financial instruments will mean fewer paper shufflers will be required leading to an increase in lay-offs. Meanwhile, a downturn in the residential building industry will ultimately see builders and their trades-people chasing work with further lay-offs to follow. The past several years have been a bonanza for mortgage brokers, bankers, builders and retailers of household hard goods… but the fact remains that historically low interest rates have brought forward future production resulting in massive overbuilding which may take a decade to work off. The party was great, but the hangover is going to be a doozy with the prospect of many lean years to come!

As Eric Fry warns in Rude Awakening (www.dailyreckoning.com) …”housing-related industries have produced a whopping 43% of the nation’s total net sector employment growth… any slackening of real estate activity would slow employment growth in the industry. Indeed, this massive job-creator could become a job-destroyer.” Some analysts even credit the housing asset bubble with adding as much as 2% to overall GDP. Clearly then, a collapse in house prices would severely impact upon economic growth.

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