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The
housing bubble is going to burst: take your profits
while you can
by
John Rubino
For Virginia Business
February 2004
A
lot of Virginians are feeling very smart these days.
You know who you are. You were farsighted enough to
buy a home in Alexandria or Charlottesville or Richmond’s
West End, and since then you’ve happily watched
your net worth grow by five or ten or fifteen thousand
dollars each year. Many of you are up $100,000 on your
homes in the past decade, and some of you have made
much, much, more. You are, in short, highly successful
real estate investors, with every right to a little
self-congratulation.
But now you face an interesting problem: How do you
hold onto those big, juicy capital gains when home prices
go back down? Because they are going back down, further
and faster than might seem possible in the warm glow
of today’s recovering economy. Why? It’s
simple: home prices are too high and we owe way too
much money.
So let’s begin with the common sense notion that
when you borrow too much, your lifestyle changes in
disturbing ways. This is as true for a country as it
is for a family and, by any reasonable measure, Americans
have clearly borrowed too much. For the past decade,
we’ve taken on about $5 of debt for every $1 of
new wealth we’ve created (as measured by gross
domestic product or GDP), and instead of pulling back,
in 2003 we stepped up the pace, borrowing more in a
single year than any other society ever. Add up all
our outstanding debts — mortgages, credit cards,
business loans, government bonds, etc. — and the
total comes to about $34 trillion, or $450,000 per family
of four.
Meanwhile, home prices (as a result of our nonstop borrowing)
have soared to record levels just about everywhere.
In hot markets like California and Boston, the average
home now costs about $400,000, which is about twice
what the average family can afford. In Virginia, the
average sales price was $192,537 in November, a 9 percent
increase over the previous year. Nationwide, the ratio
of home prices to our take-home pay is the highest it
has ever been. Housing, in short, is a classic financial
bubble, propelled by excessive borrowing to unsustainable
price levels and destined, like all bubbles, to burst.
Now, I’ll grant you that in theory the housing
bubble could have some life left in it, since most bubbles
last far longer than their early critics expect. But
this bubble won’t, and the reason it won’t
is, in two words, the dollar. For the past decade, Americans
have been buying a lot more stuff from abroad than we’ve
been selling to our trading partners. We make up the
difference (known as the trade deficit) by giving them
dollars, and right now we’re flooding the world
with about half a trillion dollars each year. This was
fine as long as our trading partners were willing to,
in effect, loan those dollars back to us by buying U.S.
bonds and other financial assets. But lately they’ve
lost interest in lending us money and, instead of buying
our bonds, they’re converting their dollars to
yen, euros and gold. The dollar, with more sellers than
buyers, is becoming less valuable day by day and soon,
perhaps very soon, its orderly decline will turn into
a rout.
At that point, a panicked Federal Reserve will be forced
to raise interest rates to make U.S. bonds more attractive
to foreign investors. Mortgage rates will jump to 8
percent to 10 percent, effectively pricing most buyers
out of overheated housing markets. Hard times in Boston,
California, New York and Florida will quickly spread
to the rest of the country, including Virginia. And
those capital gains that were going to make your retirement
so cushy will evaporate like fog on an August morning.
So what should you do? The obvious answer is to take
your profit now. Sell that expensive place and rent
for a few years. If that’s not an option, shift
your capital into investments that will benefit from
a collapsing dollar and bursting housing bubble. Gold
is one clear winner, since, as the only form of money
that governments can’t simply create at will,
it tends to do well when the dollar is falling. Global
bond funds, since euro and yen-denominated bonds pay
interest in currencies that are rising against the dollar,
will also benefit. And if you can tolerate a little
risk, consider betting against the housing bubble by
“shorting” the stocks of the companies which
now benefit from it. As a major financial center, Virginia
is a target-rich environment for short sellers. Do some
of these things, and a few years hence you’ll
have a whole new set of reasons to feel smart.
John
Rubino is a former Virginia Business contributing editor.
He is the author of “How to Profit From the Coming
Real Estate Bust” (Rodale Press) and is now at
work on a book about the dollar’s coming collapse.
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