Houses of cards: can they be sustained?

Citation

Boese, K.C. (2005), "Houses of cards: can they be sustained?", The Bottom Line, Vol. 18 No. 4. https://doi.org/10.1108/bl.2005.17018daf.001

Houses of cards: can they be sustained?

Many factors impact the economy, and each and every one of them can play a roll in how effective fund-raising efforts might be. Successful investors can often become valued donors, but an economic downturn can just as easily turn an expected boon into a bust. Identifying and nurturing prospective donors is hard work and time consuming, and the return on that investment is higher in a healthy economy.

What worries me most is the state of the economy, or the current economy that is referred to as healthy. While it is true that there is nothing that is immediately alarming about it, there are indicators that suggest all is not what is seems. Frenzied behavior by real estate speculators and home buyers in the US market have caused what some analysts have labeled a “bubble” in several housing markets.

I have come to understand that bubbles in any market are never a good thing, but perhaps they are unavoidable, cyclical, and natural. But every bubble represents a market that has developed beyond its means to maintain its growth. We saw such a bubble in action in the late 1990s, when the stock market seemed invincible with almost weekly record breaking highs.

When the stock market bubble popped, ripples were felt far and wide, even if only slightly. Personally, I saw my projected retirement dwindle over night. I saw others lose significant amounts of money from what they wrongly thought of as safe investments with high returns. On a larger scale, I even witnessed a substantial donor become slow to uphold their philanthropic commitment. While the details are not known to me, it is likely that the original gift was to be from the revenue generated by investments in the market that were no longer producing. I am sure this was not an isolated case as many saw their worth on paper recalculated downward after the market readjusted.

In many ways, I think the real estate market is in a similar situation today. Even Alan Greenspan, though loath to call it a bubble, admits that what is going on in the housing market right now can be described as “froth”. But a housing boom is not historically unprecedented, nor necessarily a bad thing. We have seen them before, and they do not last forever. The last one in the Washington, DC, area in the late 1980s did not end in a bust, but rather was followed by a long period of housing price stagnation. (Milbank, 2005).

What concerns me most about the current housing boom are two things. First, the number of investors that are purchasing a property or properties other than a primary residence. Second, the manner by which buyers are coming by the money to make these purchases. These two factors taken together have generated a situation that has fueled the flames of an ever-increasing frenzy to purchase property now before it becomes unaffordable. Well guess what, it is unaffordable, and much of it I fear is over valued.

This has all led to impressive numbers and statistics as home sales in Washington have set a record in June, 2005, with home sales increasing at their fastest pace in 25 years, June gaining on May sales by 2.7 percent, and the median price of a home rising 14.7 percent from a year ago. For such numbers to exist, the economy must be in sound shape, right? (Crutsinger, 2005).

Well, along with these benchmarks are another set of numbers. Subprime mortgages have surged by 20 percent over the last year, with the majority of these loans going to purchasers with poor credit. Nearly half of all home buyers resorted to lower-rate adjustable mortgages (ARMs) to pay for increasingly unaffordable homes. Additionally, there was a surge in mortgages taken out last year by investors buying second homes – a phenomenon that many economists say is evidence of a housing bubble. Depending on where in the Nation you reside, investors accounted for between 9 to 19 percent (in booming areas) of mortgage originations. All this indicates a speculative presence in the market (Hill, 2005).

Because of the degree of speculation in the market, any downturn in the market could be felt widely and broadly. In the past, downturns have been weathered by the economy relatively well. But the degree of speculation, coupled with the unprecedented level of no-money-down mortgages, interest-only loans, and “liar’s loans” – that require no proof of a borrower’s income – have set the stage or a more painful readjustment should one come (Andrews, 2005).

What is worse is that the Federal Reserve is handling this current housing market much the same way it dealt with the stock market in the 1990s. It has expressed concern and discomfort about the explosive rise in risky mortgage loans, but does not think it is its job to get involved or to push housing prices back down.

Real estate has always been seen as a safe investment, but not a place to become rich quick. I think that has changed. In markets that have seen house prices soar in the last few years, the number of homes that are being purchased for the sole purpose of being flipped has increase. This has become a popular enough idea that The Learning Channel (TLC) has even developed a show around the premise, Property Ladder, in which novice real estate developers attempt to renovate properties considered “diamonds in the rough” and re-sell them for a lucrative profit (http://tlc.discovery.com/fansites/propertyladder/about.html).

Where the real problem comes is if the market starts to slow or stagnate, which will happen when it enters a phase of correction … and such a phase may be around the corner. While it is too early to tell, $700,000+ homes that were selling in a week a few months ago in the Washington market are now selling slowly, or not at all. This could be a hiccup, or it could be a start of the end of the bubble. Either is possible, and for either only time will tell. But, what is certain, is that when such a correction occurs, many investors, and even home buyers, risk financial loss. Consumers have taken on more risk than in the past. The “risky” types of loans mentioned above account for nearly 60 percent of the mortgages last year, and these mortgages will work for their borrowers only as long as interest rates remain low and the market remains strong. Should either of those cease to happen, we might see an increase in foreclosures, which might be the true indicator of how healthy the market is.

Because such a large portion on loans in the past few years are riskier that we have historically seen, any adjustment of the real estate market could cause ripples in the broader economy, and that could affect our success rate when knocking on doors and nurturing prospective funding sources. The best defense has always been to be prepared, and keeping an eye on the housing market is just one more piece of information that will help us to do just that.

Kent C. BoeseCataloging Services Department, Smithsonian Institution Libraries, Washington, DC, USA