|Jonas Max Ferris|
The main culprit for our current economic recovery is a real estate boom. So what happens if real estate does a dot com and goes belly-up?
While it certainly doesn’t have to happen, a real estate bust could be exponentially more destructive to our economy.
Tune in to "The Cost of Freedom" business block, Saturday at 10am ET and Sunday at 3am ET, when the "Forbes on FOX" experts debate if a housing bust would be worse than the dot com crash.
While the dot com bubble was spectacular, it was not that big a part of the near ten trillion dollar U.S. economy. While it seemed like everyone was going to work for a dot com, only a fraction of the workforce ever did. General Motors had more employees in 2000 than every pure play dot com combined.
While the collective value of dot com stocks may have peaked at a few hundred billion, “only” tens of billions were actually invested in dot com businesses by venture capitalist and ordinary investors (the rest was just paper gains). Besides, the total market value of all stocks at the time was around fifteen trillion, a few hundred billion was a rounding error.
Last month alone “investors” bought $50 billion worth of new homes (to say nothing of sales of existing homes) — possibly more than was invested in dot coms in total. Today eBay, Yahoo, and Google alone have a combined market value in excess of all the net money invested in bad dot com ideas. This is not to say investors didn’t lose money, but some have made money as well.
To make the relationship between home bubbles and stock bubbles more comparable, consider all technology and new economy bubble era investing — not just dot coms like DrKoop.com or Pets.com.
Factor in all the hundreds of billions frittered away in telecom companies, half backed mergers, new economy business models like Enron, and now you’re talking trillions of wealth destroyed — the sort of dollars that would vanish if real estate prices slip significantly in major markets.
A housing decline would still be more disastrous to the economy.
For one, people buy their homes with leverage. Few bought Enron or Worldcom stock with no money down. Even a total loss was just that, a total loss, it was hard to lose more than was invested.
Investors also borrow against their paper gains in homes. The wealth effect of having a home grow in value is stronger because people take out home equity loans against the rising home values and pay down consumer debt, or just buy more stuff or renovate their homes. Few did so with stock market gains.
Home wealth is more skewed towards the typical American — unlike stock wealth which is more commonly distributed to wealthier Americans. The typical financial portfolio for an American is $125,000. A one room apartment in New York City is around a half million bucks.
The average consumer is more likely to spend money — and juice the economy — when their home climbs in value.
While homes will never fall as fast or hard as tech stocks (you have to go back the Florida land bubble of the early 1920s to find widespread 50%+ drops in price), the leverage makes relatively small declines significant.
If homes fell 50% in value nationwide, all home wealth would be destroyed, or total mortgage debt would match home values. Yikes. This is one reason the recent run up in home prices is disturbing — we’re leveraging the paper gains with more borrowing.
Doomsday scenarios aside, our economy could easily sustain a moderate to severe correction in home prices, so long as another part of the economy picks up the slack created by housing-related-spending declining (in much the way the housing boom picked up where the tech wreck left off).
Maybe this is what keeps Fed Chairman Alan Greenspan up at night — he’s not sure what part of the economy will inflate next and save the day. And Mr. Greenspan (and the government through fiscal spending and tax cuts) is running out of magic levers.
This weekend our Business Block has more on comparing the dot com crash to a possible housing bust. Tune in Saturday 10am — noon ET.