Monday, June 21, 2010

The Government Bubble

Our government has pushed our nation of foolish investors solidly into our third bubble in the series. I was able to clearly document the Tech Bubble and the Housing Bubble while they were happening. My charts showed once in a hundred year manias that our nation’s economists demanded was a normal occurrence. But this bubble seems more opaque. I predicted this opacity a year ago as I stated that none of the economic indicators would point to a recession in 2011. This is because of the monumental market manipulation by our government in our investment markets and our economy. Even the most sophisticated market investors could be blindsided by this downturn.

When I say sophisticated investors I mean stock investors. The Government has managed to wipe out all of the sophisticated investors from the housing market. The housing market will be dead for the next ten years.

I’m not saying that there aren’t some reasonable values in lower end markets. For the first time in ten years rental real estate investors can get positive cash flow on an investment home purchase. This is good. But most of the investors that are coming into the low end market have very unrealistic expectations of the future. They see their investment as a way to make a quick buck and not a back loaded stream of income for the next 30 years. Even though these investors are buying in at fair value most have a good chance to lose money as the economy slows and interest rates rise. Only long term low end real estate investors will make money.

Most of the Bay Area’s high end real estate markets are the antithesis of the lower end markets. The Federal Reserve can feel proud that they are pushing many affluent young families into economic debt servitude for the next 30 years with no chance escape. Many families are paying bubble prices for homes that will be underwater in 5 years. I can not imagine how anyone can justify paying 30% to 50% above rental value in a contracting economy at historically low interest rates. When interest rates begin to increase these families will be locked into a runaway train. High end home prices will absolutely be forced toward fair value and quite possibly below fair value by rising interest rates, economic contraction, skyrocketing taxes for the rich and a higher national savings rate. There are no short term gains or long term gains anywhere in high end real estate.

I would absolutely love to own a home in Lafayette but unfortunately I am a value investor. I sold my home in 2007 with the hope that the housing bubble would subside in high end markets by 2010. It appears that I could be renting for another three years.

I have tried to think of a combination of economic events that could either keep home prices above fair value in Lafayette for an extended period or how the government could manipulate our economy to make rents and income increase at a faster rate than GDP. I am looking for some event that could force Lafayette home prices to fair value without a decline in prices.

Mathematically there is no combination of events that could push up income and rents without raising interest rates.

But there are two possible events that might create a demand shift in the higher end real estate markets. First would be if we let rich Chinese nationals become citizens if they buy our high end homes. The only other shift would be if our government makes an immediate overnight cut in the value of the dollar by 50%.

Both of these options will be suggested by lobbyists during the recession of 2011.

There is a very good chance that the financially unsophisticated families that are buying into overpriced high end housing will show outrage at their loss in value and demand a solution from the government.

As our nation of incompetent debt fueled speculators continues to make terrible decisions and then expect a bailout, I think anything is possible.

Who knows, in a couple years I might have to learn Chinese so I can communicate with my next door neighbors.

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