THE REAL ESTATE DEPRESSION OF 2007

The Real Estate Depression of 2007

By Alex S. Gabor

In economics, recessions are sometimes defined as periods of economic contraction marked by an extended decline in general business activity, typically two consecutive quarters of falling real gross national product.

During a recession the state of the national economy falters causing a widespread decline in the gross domestic product and employment and trade lasting from six months to a year according to some economists.

It can safely be said that at the beginning of 2006 America entered into a real estate recession and despite all rhetorical pumping and dumping of real estate inventory by mortgage bankers, brokers, Realtors, agents, builders and developers, the statistics show that we are now at the beginning of a long and protracted real estate depression.

Anyone capable of doing math and adding two plus two could see that a real estate recession was coming back at the tail end of 2005 when numerous savvy writers began to publish statistics stating their concerns about the oft repeated concept of a “real estate bubble”. Unfortunately if your job, your income, your net worth, your assets and your life are totally dependent upon the real estate market two things may happen to you.

First you can go into a severe state of denial if someone tells you anything contrary to what you believe to be an endless run up in asset prices thus ensuring your future profits from leveraged real estate, and second, by the time reality sinks in and overrides your false belief system it is already too late. Depression sets it. And yes there is a double meaning to that word in the context of this article.

In a typical national economic recession, if gross domestic product, asset prices, stock prices, or other assets and growth decline in value or quantity anywhere between five to ten per cent, over a six month period, it can be safely argued that a recession has occurred.

When real estate prices begin to drop at rates between twenty five and fifty percent, and inventories of used homes listed for sale double in one year and then double again in the second year, we can be very certain that a real estate depression is well under way as it is now.

But does a real estate depression mean that a national or global economic depression will necessarily follow? This author doesn’t see that happening.
In the process of battling inflationary pressures, the Fed will be forced to raise interest rates again in 2007 as the volume of leveraged buyouts by private equity firms doubles the 2006 record $4 trillion in transactions.

If any investor or researcher is interested in following this developing national interest story one simply needs to look at the statistics of where money that was flowing into the residential real estate boom has shifted to understand why a real estate depression does not portend a national or international general economic depression.

A depression is generally defined in economics as a period of drastic decline in a national or international economy, characterized by decreasing business activity, falling prices, and unemployment. Any student of the current real estate market does not need to look far or wide to find those characteristics to define the current real estate depression.

In the past two months alone over 50,000 jobs have been lost in the mortgage, real estate, housing construction and other industry related businesses, however the official unemployment rate (usually skewed by the fact that people on commissions or self employed do not qualify for unemployment) remains at 4.5% and 167,000 new jobs were added in December of 2006.

Professors of economic theory would argue that a period during which business, employment, and stock-market values decline severely or remain at a very low level of activity marks a depression. Because the global real estate market has grown to a level that has reached $70 trillion in dollar terms, it can be severely impacted while other business sectors continue to boom.

Thus we can watch a rising stock market in general, even though Real Estate Investment Trusts, mortgage bankers and brokers, and other industry related stocks plummet in value, while the real value of real estate assets also tubes to more practical levels after the bubble has finally let out all of its’ hot air.

Typically those who believe in devils advocacy economics will tell you that because real estate prices went up by almost 500% between 1990 and 2005 that a correction of 25 to 50% still leaves smart investors ahead by 250%.

Such hucksters usually fail to mention that almost 80% of all real estate purchased in the past decade has been leveraged with mortgages which have been sold off as securitized assets to a global market that was developed by Wall Street to keep their money machines pumping bonuses and cash into their own coffers – damn the general public.
If you put 20% down on a million dollar property and values drop by 25% you are upside down on your mortgage. You should be so lucky during a real estate depression if you bought within the past five years.

Almost 60% of all new home purchases in the past decade were made using more than 80% financing and at least 40% of the ten trillion in outstanding mortgage debt involved stated income-stated asset loans or 100% financing using option ARM loans – loans that don’t amortize but carry negative amortization clauses in the note.

Default rates doubled in 2005 from 2004 and again in 2006 from 2005. This trend will continue well into 2008 as foreclosures double and triple during the same period. A foreclosure in any neighborhood hurts the entire neighborhood and further depresses prices.

During the run up to the real estate bubble pop in 2006 there were very few foreclosures for two reasons: borrowers could lie on their loan applications and pull equity out before they ran into serious trouble, many who lost jobs and still had homes would borrow hundreds of thousands, get any old tax accountant to sign off on their self employed status, and refinance two or three times all while really not producing any valuable product that contributed to real gross domestic product growth.

Second, anyone who still had property equity during the run up, no matter how poor their credit, could either refinance or sell and still pull money off the closing table.

So why are we having a real estate depression in 2007? Here are just some of the factors that have contributed and will continue to contribute to just that state of economic affairs, factors which the individual homeowner has no control over.

Money that was being invested in mortgage backed securities is drying up – European, Asian and Middle Eastern investors are shifting their reserves and liquid cash into the Euro and Euro denominated bonds, while globalized hedge funds are taking advantage of a falling dollar and the rapid decline in real estate asset values.

Securities that are backed by mortgages are suffering from fraudulent loan packages within their portfolios and it will take another two years to sort out the good from the bad and ugly.




The Securities and Exchange Commission, although previously lax in its enforcement of securities laws in the mortgage backed securities market, is stepping up its investigations of companies who have sold mortgage backed securities which contain portfolios of false and misleading loan applications, particularly those containing option ARMs, stated income-stated asset loans, and interest only provisions in their loan documentation.

Congress has forced Fannie Mae and Freddie Mac, through the Office of Federal Housing Enterprise Oversight to limit their assets and to slow down the raising of loan limits for conventional loans thus bringing a temporary halt to the monopolization of house pricing by fixing the maximum loan amounts for conventional borrowers.

Both of these federally guaranteed institutions have annually raised loan limits to ensure that their monopoly on conventional loan purchases was maintained over the past three decades, something which the Anti-Trust Division of the Justice Department is yet to crack down on.

The FBI has stepped up and is increasing its’ national investigation of mortgage loan fraud which could bring the U.S Justice Department to prosecute as many as 2000 new criminal white collar fraud cases in 2007 where as much as $5 billion in losses will not be recovered by investors and hedge funds.

Private equity funds which now manage over a trillion dollars in liquid investable cash are staying away from riskier investments in the mortgage industry and focusing on buy outs of publicly traded companies such as Harrah’s Entertainment, Equity Office Properties Trust, VaxGen, MGM Mirage, Kinder Morgan, Alliance Atlantis Communications, and thousands of other announced deals.

These funds are the best customers of the ten largest banks in the nation which have over $5 trillion in assets and are also shying away from investing in mortgage related business lending and investments.

Private Equity Funds will borrow more than $8 trillion in 2007 for mergers, acquisitions, leveraged buyouts, and consolidations while mortgage originations will fall below $1 trillion for the first time in five years. Clearly this shift of money flows out of residential real estate will add to the dwindling price spirals currently being experienced in many markets, the worst of which include San Diego, Boston, Sacramento, Denver, Las Vegas and Phoenix.

Several bank failures or major mergers to prevent public disclosure of bank insolvency such as those rumored for the past few years between Countrywide Funding and Washington Mutual and a few others.

The largest Hedge Funds are avoiding investments in residential real estate related mortgages and their industry related stocks but are shorting them where timing is good, and putting more money into prospective merger special situations where the returns on average are greater than longer term investing strategies such as NDAQ/LSE, NWACQ/MAIR, Thales/Alcatel/Lucent, NYSE/ARCA/Euronext and others.

Global Central Bankers and multi-national corporate financial controllers are investing more money into the bonds of the 27 member European Union and buying Euros while selling or shorting the US dollar.

This is forcing US Treasury yields up and their prices down, making it more costly to run the $8 trillion national debt refunding operations of the United States Treasury Department, which for all intents and purposes has become a global ponzi scheme exempt from the national securities laws which govern almost every public corporation traded on Wall Street.

If the Government Accounting Office were forced to publish an audited financial statement of the United States Government and the Federal Reserve Banking System, the dollar, the treasury market, and the stock markets would all collapse from true revelations, triggering a global depression – and no politician wants that to happen on their watch.

Foreign investors are all too wise to this and are shifting their risk based investments out of dollar denominated assets. Many can only hope they get out enough of their money in time to prevent their own economies from collapsing if ever there really is another global depression like the one that began in 1929 and lasted over six years.

Congress is less than a year away from forcing up the national debt ceiling, adding further inflation concerns to the Feds policy making open market committee, which will add more pressure to raise rates to prevent inflation from getting out of hand. The Fed can no longer control the value of the dollar just by raising rates alone as long as confidence in the mortgage markets remains unstable.

There are many regional factors that will create pockets of greater price deflation in certain sectors of the real estate market in the United States and abroad, but in general, the overall decline in residential real estate asset prices will continue well into 2008.

A recent article attributing the bust in the real estate bubble to greedy consumers falsely skews the reality. Saying that economists are blaming the buyers is a complete farce. 90% of what economists say and write is wrong anyway. They are paid by vested interests to argue points in favor of their clients, who usually profit from their “expert opinion”.

If lenders weren't set up to be corrupted in the first place, the programs getting the buyers into the deals would not exist. One loan officer who gets paid $25,000 a month for her overages - none of which are disclosed to the borrowers gets a bonus for ripping people off. She works for a federally chartered institution which encourages all 300 of their loan officers to get as much as they can for their bottom line.

While she makes the 25K each month the institution makes $75K a month from her originations. Blaming consumers for the housing bubble is like kicking the cat for having stubbed your own toe. It’s the wrong source and wrong target.

If you offer consumers 100% financing with bad credit to buy over inflated homes, and they are not educated about the risks, your going to have a new sucker every time. Buying a home in today’s market is more akin to buying a car. The minute you drive it off the lot it is worth 40% less than what you agreed to pay for it. Only the savvy don’t get burned again.

Economists blame the consumers, lenders blame the regulators and the politicians blame the economic experts. In the end everyone loses everything because no one can take responsibility to fix a broken system of finance. The Band-Aid will no longer stop the bleeding.


Alex S. Gabor is the author of "Bonanza – Profiting During a Real Estate Depression – How to Make a Killing During a Real Estate Bust", an electronic book being readied for release in 2007. He is a freelance writer living in Hollywood. He spent 25 years investigating and working in the mortgage banking industry and is an inventor of zero interest mortgages. He is a major proponent of changing the current tax laws to eliminate mortgage interest deductions and replace them with principal reduction credits to encourage debt free home ownership and affordable housing.

Copyright © 2007 by Alex S. Gabor. All World Rights Reserved.