Pop goes the bubble

A couple of years ago, as I was rapidly getting priced out of the Southern California housing market, I was thinking, "How can this go on? I make above-average money, and yet I can't afford your average house." How is it possible for housing to go up 30 percent in one year? Did people start making 30 percent more? Did the area become 30 percent more desireable? Are interest rates 30 percent more affordable? None of the above. Just good old-fashioned bubble-market psychology.

That was before I did any serious reading on the subject. Just a couple of weeks ago, I googled "Housing Bubble" and what came back at me was scary. Very scary. Not to scare you, but the only ones that had anything positive to say about it were, predictably, those whose living depends on real estate.

Without getting into all the technical details, what's basically happening in the most overheated markets (San Diego, SF Bay area, NYC, Miami, et al.) is a big pyramid scam: If you buy low and sell high, the next guy that comes along thinks he can do the same, and so on. Until the market runs into a little thing called REALITY. Reality being that your average person cannot afford houses in these places. Reality being that a lot of people are 1 or 2 missed paychecks away from foreclosure. Reality being that if interest rates go up much more (which they almost certainly will), those cute little negative amortization loans won't look so pretty anymore. When the market stares at reality in the mirror, I predict a meltdown in certain markets.

Why? Because the same basic factors that drove the market up (greed and fear) will drive it down. Here's what I mean: in a booming market, buyers want to get in while they can for fear of being priced out of the market. Hence the people camping outside of a new construction phase, or making blind offers above asking price. On the other hand, sellers have no incentive to sell in a booming market. The longer they wait to sell, the more they make. But what about when the market goes down? Just the opposite happens: when the psychological see-saw is tilted the other way, the sellers want to unload as soon as they can, and the buyers now figure they will wait it out a little longer.

So when all the fundamentals of the market start to dampen sales (as they already appear to be doing in certain areas), watch for a compound effect as the market psychology changes. And then watch for the fallout throughout the economy: a soaring default rate, personal bankruptcies, possible insolvency of certain banks, hedge funds; not to mention what may happen to Fannie Mae and Freddie Mac. The only thing that propped up the U.S. economy after the dot-com bust was housing. God only knows what the economy will look like after the rug is pulled out from under this housing market. I don't think it's going to be very good.