Letter Re: Housing Market: An Analysis and Prediction

Jim:

Dr. Kurt Richebächer’s “A Tightening Farce” featured in Wednesday’s September 13th, 2006 edition of The Daily Reckoning makes three salient observations about the way asset inflation in the housing market leads to economic dislocation.

Item: “Housing price busts have larger wealth effects on consumption than the
equity price busts [do]…”

Item: “All major banking crises in industrial countries during the postwar period coincided with housing price busts.”

Item: “The disinflation increased the real burden of debt, which exposed inflation-related overinvestment and associated financial frailty."

A stock market crash primarily affects discretionary spending; a housing market crash will leave many homeowners insolvent and create repercussions in the economy as a whole. Homeowner insolvency will cause banks to accrue large foreclosure positions and force them to restate assets and earnings to a new, lower level. This will leave less money for new loans [i.e., “disinflation“ or credit contraction]. This will cause interest rates to spike upward as businesses rush to borrow funds for the completion of projects that looked profitable when the housing boom was in full flower. This frenzy will push out other borrowers, particularly small business owners who may have secured start-up capital by acquiring a second mortgage on their home. Whoops! One more homeowner is now in bankruptcy court…

Is that the sound of “cross-cascading defaults” I hear in the distance? Regards, – Christian W.