Thursday, September 25, 2008 9/25/08-Real Estate

In today's excerpt--prominent investor George Soros commenting on the real estate crisis well before the meltdown of the past few weeks:

"The [real estate] crisis was slow in coming, but it could have been anticipated several years in advance. It had its origins in the bursting of the internet bubble in late 2000. The Fed responded by cutting the federal funds rate from 6.5 percent to 3.5 percent within the space of just a few months. Then came the terrorist attack of September 11, 2001. To counteract the disruption of the economy, the Fed continued to lower rates--all the way down to 1 percent by July 2003, the lowest rate in half a century, where it stayed for a full year. For thirty-one consecutive months the base inflation-adjusted short-term interest rate was negative.

"[This] cheap money engendered a housing bubble, an explosion of leveraged buyouts, and other excesses. When money is free, the rational lender will keep on lending until there is no one else to lend to. Mortgage lenders relaxed their standards and invented new ways to stimulate business and generate fees. Investment banks on Wall Street developed a variety of techniques to hive credit risk off to other investors. ...

"Double-digit price increases in house prices engendered speculation. When the value of property is expected to rise more than the cost of borrowing, it makes sense to own more property than one wants to occupy. By 2005, 40 percent of all homes purchased were not meant to serve as permanent residences but as investments or second homes. ... Credit standards collapsed, and mortgages were made widely available to people with low credit ratings (called subprime mortgages), many of whom were well-to-do. 'Alt-A' (or liar loans), with low or no documentation, were common, including, at the extreme, 'ninja' loans (no job, no income, no assets), frequently with the active connivance of mortgage brokers and mortgage lenders. ...

"It was bound to end badly. ... Former Federal Reserve governor Edward M. Gramlich privately warned Federal Reserve Chairman Alan Greenspan about abusive behavior in the subprime mortgage markets in 2000, but the warning was swept aside. Gramlich went public with his worries in 2007 and published a book on the subprime bubble just before the first crisis broke. ... Martin Feldstein, Paul Volcker (former chairman of the Federal Reserve), and Bill Rhodes (a senior official of Citibank) all made bearish warnings. ... As the Wall Street Journal recently noted, there were many hedge funds taking a bearish stance on housing, but 'they suffered such painful losses waiting for a collapse' that most eventually gave up their positions."

George Soros, The New Paradigm for Financial Markets, Public Affairs, Copyright 2008 by George Soros, pp. xiv-xx.


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