Real Estate

Business Ethics

                                                           

                

Real Estate and Consumption

• Increasing real estate prices has made increasing consumption possible

Magnitude

• The Economist, – the total value of residential property

in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion

– an increase equivalent to 100% of those countries' combined GDPs.

Magnitude

larger than – the global stock market bubble

in the late 1990s (an increase over five years of 80% of GDP) or

– America's stock market bubble in the late 1920s (55% of GDP).

– In other words, it looks like the biggest bubble in history.

Causes

• historically low interest rates have encouraged home buyers to borrow more money

• households have lost faith in equities after stock markets plunged

Bubble

• Michael Mandel at Business Week– Residential investment is absorbing a staggering

5.8% of gross domestic product. – That’s the highest level since the late 1940s and

early ‘50s, when an entire generation of returning soldiers was setting up families and expanding into newly built suburbs.

– This time, Americans are building second homes and enlarging current ones at a record pace.

Bubble

• Measured by the increase in its share of GDP, the housing boom so far is 40% larger than tech

Current Situation

• Housing affordability nationwide has dropped to a 13-year low

• The household debt-service ratio has soared to a record high.

• Over one-third of all homeowners devote more than 30% of their incomes to monthly mortgage payments.

• Twelve percent of homeowners devote over half of their incomes.

Current Situation

• Sub-prime borrowers accounted for 28% of all new mortgage lending in the past six months, vs. 5% five years ago.

• In the first half of 2005, two-thirds of homebuyers financed more than 80% of their purchase.

• 17% of homeowners have a loan-to-value ratio (LTV) of 95% or more, versus only 3% one decade ago. (That means that 17% own less than 5% of their home's value free, and clear).

• About 42% of first-time buyers made NO down-payment on their home purchases in 2004.

Current Situation

• Nearly 20% of ALL American home-owners would see their home equity wiped out entirely by a mere 5% decline in home prices.

ARMs

• ARMs are typically initially made at a lower rate and then increase after a fixed period of time, usually one, three, five, seven or 10 years.

• This fall the adjustable-rate mortgages (ARMs) that millions of Americans took out during the recent housing boom will be reset

• Many homeowners will see their monthly mortgage payments shoot up by as much as 20%.

ARMs

• According to the Mortgage Bankers Association, of all mortgages financed in 2005, 36% were ARMs -- the highest ever.

• Between $400 billion and $500 billion in ARMs are due to be reset by the end of 2006.

• Next year more than $1.5 trillion will be reset.• Year-to-date, there has been a 39% increase in

foreclosures over last year.

Current Situation

• The Enrons of the bust phase will be the firms now pedaling – adjustable-rate, – no-interest/nothing-down– assorted other types of “sub-prime”

mortgages.

Current Situation

• At Countrywide Financial, the largest mortgage lender in the U.S., the principal value of negative amortization loans rose almost 100 times, from a value of $33 million at the end of 2004 to $2.9 billion on June 30.

                                                                                                                                                                   

Real Estate Bubbles= More Debt

• Twofold borrowing by household owners is needed: – FIRST, to boost housing prices– SECOND, to withdraw equity

Real Estate Bubbles= More Debt

• they heavily entangle banks and the whole financial system as lenders – property bubbles have historically been the

regular main causes of major financial crises

– Japan’s property deflation has continued for 13 years now

Consequences

• Yale economist Robert Shiller predicts a 25% drop in residential property prices.

• The Economist hints at a worldwide recession when the air goes out of the real estate market.

Consequences

• Yale economist Robert Shiller predicts a 25% drop in residential property prices.

• The Economist hints at a worldwide recession when the air goes out of the real estate market.

Consequences

• Since the end of 2001, housing-related industries have produced a whopping 43% of the nation's total net private sector employment growth.

• Any slackening of real estate activity would slow employment growth in the industry.

• These ferocious excesses of the housing bubble– soaring prices– shriveling home equity– vanishing affordability– idiotic lending practices

Policy-Fairness

• Should the large lenders be bailed out?

• Will the million of homeowners be bailed out?