Wednesday, December 17, 2014


In the early 1600s, as the global economy moved from "production for consumption" into "production for profit", Dutch trading and business had become so efficient that merchants were finding themselves contracting for products that did not yet exist. The Dutch called it "Trading on the wind", a reference to the Dutch trading ships that sailed the Atlantic.
In 1636, increasing demand for newly created varieties of tulips set off a speculative cycle of ever higher prices. Tulip bulbs were bought and sold unseen. Huge fortunes (on paper) were created seemingly overnight.
Then, in 1637, the market crashed. People were ruined. The entire Dutch credit system was almost destroyed and the effects of the crash were felt across Europe.
Since that time, there have been buying sprees of all kinds, including the infamous Bunker Hunt attempt to corner the Silver market, the price of gold, and assorted stock market crashes. "Tulip mania" has become synonymous with reckless speculative behavior that seeks quick profits without regard for long term consequences.
The United States is caught in the middle of its own mania, a housing "boom" which is more and more obviously a bubble. Whereas the Tulip craze was triggered by newly created varieties of tulips, the US housing bubble was triggered by lending institutions worried about a slowdown in borrowing. A simple rule of banking is that money sitting in the vault is worthless, but money out in performing loans is profit. Consumer borrowing had slowed, mostly because the equity on their homes has been cashed out to sustain their lifestyles as high paying jobs fled the nation for tax-friendlier shores. So the banks hit on a plan. They lowered interest rates to almost nothing, which triggered a round of home buying. This was encouraged by realtors, who profit from the commissions, and as the surge in buying started to drive prices upward, suddenly there was newly created equity on which even more could be borrowed.
This started a speculative buying cycle. Prices were moving upwards. This was touted as a good sign of a recovering economy, but was it really? After all, the houses were still the same. A two bedroom 1 bathroom house is still a two bedroom 1 bathroom house whether it sells for $400,000 or $2,000,000. While many Americans took the opportunity to move to a nicer home, a large part of the buying and selling spree was done by individuals who would never live in the properties they bought, but would hold them for a few months in the expectation of selling at a huge profit. Tulips on a grand scale! And even those people who prudently decided to stay with what they safely had are feeling the effects as higher appraised values mean higher property taxes.
But already the mania is cooling. Rising prices have triggered a construction boom, and we are headed to a market which will have more houses than buyers, which cannot help but force prices into a downward trend. And the lending institutions that triggered the mania with low interest rates are now looking forward to reaping huge profits as interest rates start to climb. Even the normally optimistic Allen Greenspan is warning that the housing bubble is about to pop, and the consequences will be as dire as the techno-bubble pop of five years ago.
As interest rates increase and housing values go into decline, homeowners will find themselves in a situation of "negative equity", which means they will owe more money on their homes than the sale of the home can produce. And with the new bankruptcy laws due to go into effect in October, they will be stuck.
While all this is well and good (short term) for the banks and the realtors, there are some long term considerations. People struggling with huge mortgages don;t have money for other things. They don't buy new cars. They don't buy flowers for their wives. They don't take vacations. They defer minor medical care. They wear last year's clothes. They don't buy new furniture. As business slows, they will have to let people go, or even close their doors. Already orders for durable goods are declining as the available cash in our economy is sunk into inflated land values. It will be another crappy Christmas for the retailers this year.
In the long run, the banks will find themselves back in the same situation that started this whole mess. They will have lots of cash in their vaults, and nobody able or wanting to borrow it. They will also have a lot of deeds to foreclosed homes, which they will either have to hold onto or sell at the prevailing market rate. Too many of those foreclosure sales will depress the housing market even further.
History repeats itself. The sad thing is that people who get caught up in buying manias don't seem to learn from the history of people who made that mistake before, or they get into wishful thinking that they are somehow smarter and that what happened to all those others won't happen to them, or they will make sure the disaster falls on someone else's head.
But history is about to repeat itself. And it is time to wake up and smell the tulips.

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