How the Crash May Occur

Because our nation’s consumers are deeply in debt, losing jobs to outsourcing will cause many to go bankrupt. This, in turn, will cause housing prices to drop because foreclosures will become more frequent. Increased bankruptcies and falling housing prices has negative effect on stocks, which will also be sold by retiring Baby Boomers. Basically, a vicious circle will occur as the economy snowballs into a long bear market.

Based on the evidence, we’ve seen that the economy is on very shaky ground. If even just one of these aforementioned scenarios comes true, the stock market will drop considerably. Most likely, these unfortunate events will trigger each other and topple our house of cards economy.

Outsourcing: Will it hurt our supremacy?

The outsourcing of jobs is a thought that sends chills through spines of many white collar professionals. Outsourcing is when a company hires workers in a foreign area to replace domestic workers. Currently, the tech industry is swapping workers who earn about $100k+ per year for workers in India for $20k per year. The companies that outsource cut their costs dramatically and the educated Indian workers become wealthy. In India, earning $20k gives you very high standard of living.

Obviously it is the American professional that loses out. So far 40% of the Fortune 500 firms have outsourced by the end of 2003. According to Cynthia Kroll, senior economist at UC Berkeley’s Haas School of Business, “14 million jobs are vulnerable in some way to offshoring”.

Unfortunately, having the best credentials offers no protection against offshoring. This is what happens when you can hire a PH.D in India for a fifth of the salary of an American with a “mere” Masters. In order to keep jobs, many workers will have to take a tremendous cut in pay. The employment market is based on supply and demand-and there is an abundant supply of highly educated professionals who would do anything to work for $20,000 per year!

Stocks will Fall as Baby Boomers Cash Out

More than 76.1 million Americans were born between 1946 and 1964. Sociologists have defined those born during that period as “Baby Boomers.” Boomers are now between 40 and 58 years old. The vast numbers of Baby Boomers flooded the job market in the 1970’s. Throughout the 80’s and 90’s, Boomers have had an insatiable appetite for investments and the stock market benefited from massive capital inflows.

In the next few years, scores of Baby Boomers will be retiring, which means retirement portfolios and 401ks will be liquidated. This generation certainly can’t rely on Social Security, so stocks will be sold for cash and invested in bonds.

The danger lies in the fact that Baby Boomers are the largest and wealthiest population group. Stocks will fall for many years as the Boomers cash in their chips. Think about it: They provided the fuel for the long bull market and by pulling their capital out, the market will fall.

Won’t the next generation buy the stocks Baby Boomers are selling?

Unfortunately, Generation X is a much smaller generation than the Boomers. Plus, Generation X’s buying power is no match for the large portfolios that will be sold off in droves. This is expected because older people simply have more money. To top it off, X’ers have less money for investing because of the increasing cost of living. Just being able to afford a house and paying large college debts leaves very little money to invest.

We're in a Housing Bubble

Housing prices have escalated at a breakneck pace in the last several years. The bull market in housing is fueled by mortgage rates that are hovering around 35 year lows. What is problematic is how interest rates are destined to rise to their normal levels. Rising interest rates are notoriously bearish for housing prices because monthly mortgage payments will rise.

The housing market needs a steady stream of hungry home buyers in order to maintain its lofty prices. When mortgage rates rise, prospective home buyers will be discouraged and housing prices will implode on their own weight. Additionally, housing prices have become unaffordable to many prospective house hunters, as housing prices have been rising at a vastly higher rate than incomes.

How will this affect the stock market?

Approximately 25 percent of the US economy has its roots in the housing sector. This is put into perspective by the fact that a house is the biggest investment that most individuals will ever make. Housing prices are absolutely critical to the success of companies such as Loews, Home Depot and Sears. The success of most banks is also closely tied to the health of the housing market.

As further evidence, several studies have shown that housing prices exercise twice the effect on consumer spending as comparable declines in stock prices. So, if housing crashes a modest 20 percent the economic onslaught will be as if the stock market crashed 40 percent! Based on today’s overvalued housing prices, a 20 percent crash is certainly in the cards.

We are in a Credit Bubble

As housing prices have soared to nosebleed heights, homeowners have flocked to home equity credit lines. Basically, this allows you to use your house as an ATM machine. Consumers have been maxing out on credit and spending it on things like large SUV’s, vacations and big screen TVs. Living above your means has never been easier, or as widespread! Of course this money is borrowed, and must be paid back.

To make matters worse, consumers aren’t the only ones in debt up to their eyeballs. The Federal debt is valued at $7.2 trillion and growing by $1.71 billion per day! Much of this is fueled by deficit spending, which is in vogue in Washington.

The total national debt (combined government, business and household borrowing) has grown by $13 trillion, from 1990 to 2001, to $32 trillion! This type of massive debt growth is extremely risky and most government officials have no idea how to pay it off.

How will this affect the stock market?

As interest rates move higher and higher, debtors will find it increasingly harder to pay interest. Many debtors will simply default or become bankrupt. The entire economy will be hit hard as many are unable to pay their debts. This in turn affects the stock market in a multitude of ways. Consumers and businesses will diminish their spending and banks will become insolvent from bad loans. The credit bubble can pop in any number of ways, but each one will set up a chain reaction that will reverberate throughout the stock AND bond markets.

After the Housing Bubble Pops

After the housing bubble pops, prices will likely plummet for at least a decade, unfortunately. Too pessimistic? Consider this: After the 1989 Japanese housing bubble, housing prices tanked for 13 straight years! The Japanese housing bubble was a similar situation to what we are currently experiencing.

Even if the housing crash isn’t nearly as drastic, it could still take at least 9 years to recover. This is precisely what occurred after 1988 as the United States housing boom ended. National housing prices finally reached previous 1988 levels in 1997!

From what we have seen, it is inevitable that we are in a housing bubble that will end in an economic crisis. The economy always finds a way to punish excess.

The Borrowing Binge

As interest rates have dropped, and housing prices soared, homeowners have found gold in home equity credit lines. These credit lines are a way for homeowners to borrow large sums of money backed by their home’s equity. Sort of like a credit card, but in the form of a house. Basically, these credit lines increase the amount of mortgage the homeowner owes.

To make matters worse, 51 percent of this borrowed money is being spent on home improvements and consumer items. Now you can see why $70,000+ luxury car market is booming!

Home equity has diminished significantly as we are consuming our free cash rather than paying off our mortgages. Simply stated, frivolous consumers are maxed out on credit. Since 1995 national mortgage debt has risen from $4 trillion to $7 trillion! In just 2002, $820 billion was borrowed! If this isn’t a sign of a housing bubble, than I don’t know what is.

The United States, as a whole, is in debt by $32 trillion, of which the majority was added in the borrowing binge of the 1990’s. The economy is so debt-ridden that we are now similar to a house of cards. It won’t take much to topple this ever inflating housing bubble.

The housing bubble will start to deflate when interest rates rise. Furthermore, even a slight downturn in our already feeble economy will cause an increase in mortgage delinquencies as consumers buckle from their debts. Of course when this happens, credit card defaults will also rise as will personal bankruptcies.

New warning for buyers: Get a CLUE

Home buyers who have never made a claim on their own policies are finding themselves being rejected for insurance coverage on the house they've just bought, because the house itself has a poor CLUE record.

If you can't get insurance coverage, you can't get a mortgage. Worse, if you pay cash for a house and then get turned down for coverage, you can find yourself between a rock and a hard place -- either paying excessive premiums to get your property protected or "going bare" with no insurance protection against a variety of perils.

...Under CLUE guidelines, any homeowners' insurance claim is logged and kept on the database for five years. More than 600 insurers, or nine of every 10 in the industry, provide and share the data.

They report on claims for about 30 kinds of losses, from wind damage to dog bites. A cyber visit to Choicetrust.com, a division of the credit reporting giant Equifax, will get you a report on every claim against the property filed in the past five years for $12.95.

Insurers obtain a CLUE report before issuing a policy. This usually doesn't happen until near the end of an escrow, which can produce serious problems for a buyer if a prior claim is found. The insurer might not be willing to issue coverage. Or, the premium might go up - dramatically.

What is Fueling the Housing Bubble?

This answer is the simplest: Mortgage rates are at a 40-year low. In 1982 mortgage rates were at a lofty 16 percent and have been dropping steadily to about 5 percent! When mortgage rates drop, monthly mortgage payments decrease as well. This decrease makes housing more affordable, which in turn triggers a bull market in housing prices.

Mortgage rates won’t stay low forever as this low rate environment can’t be maintained for much longer. When rates do rise, housing prices will fall as prospective home buyers will be discouraged by higher monthly mortgage payments.

A major sign that we are in a housing bubble is the fact that fewer people can afford homes. Housing prices have been rising at a vastly higher rate than incomes. Now more people are unable to afford the average home in their town. A housing bubble needs a steady stream of thirsty home buyers. If housing is significantly less affordable, then who is left to keep buying to prop up home values? No one! Overheated real estate prices are going to collapse plain and simple. This is just a real life example of supply and demand.

Residential Real Estate Speculation

A.K.A. "The Housing Bubble"

01] Interest rates being raised at a “measured pace” by the fed.

02] Unemployment figures could go up.

03] New employment figures continue to miss economists projections.

04] Inflation rising.

05] Supply/demand in residential real estate is to be questioned. “Authentic” supply vs. demand (i.e., s/d which exists outside of speculation) seems artificial.

06] CPI (Consumer Price Index) rising.

07] Large speculative sentiment (flipping) vs. small ownership sentiment. In 2004, 23% of home purchases were made by such investors. (Rising interest rates, among other things, could cause these people to pull out money abruptly).

08] Baby boomer retirement approaching. 80 million North Americans will be turning 65 between years 2010 – 2014 while a large majority of them have lost money in the stock market crash of 2000 (the biggest crash in world history) which wiped out nearly $7 - $9 trillion in investments… The rich got richer.

09] Social security – US government program that provides retirement income, health care for the aged, and disability coverage for eligible workers and their dependents – is under fire and will likely not suffice so many retirees (baby boomers) when the need arises.

10] Warren Buffett and Alan Greenspan warned of caution in the residential real estate market. The stock market crashed in 2000, 2 to 3 years after the two authorities warned of an overpriced market.

"...irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?" - Alan Greenspan, December 5, 1996

11] Wide gap continues to develop between the residential rental and residential ownership real estate markets (Residential Affordability Index – RAI – decreasing).

12] Gap between median income and median home price widening.

13] Unforeseen events as terrorist attacks on North American soil, or corporate blunders the likes of another Enron, could damage the market (real estate) severely.

14] Oil prices at all time highs.

15] US dollar fallen causing foreign investors to withdraw investments from US bonds.

16] Outsourcing (layoffs) to countries like India poses a significant threat to North American employment.

17] Federal budget and payment deficits sitting around $10 trillion.

18] Mortgage loans sitting around $8 trillion.

19] Average time on market for a residential property was 4 weeks (30 days) in 2004. In 2001 the average time on market was between 180 days – 210 days. As the time on market drops lower the issue of mass speculation in the residential real estate market becomes more evident.

20] Housing industry hasn’t grown in the past 50 years. 2 million new housing units per year were built in the 1950’s – 60’s, 1.8 million in the 70’s, dropped slightly in the 80’s – 90’s, and now back to 1.8 million/year.

21] 300,000 – 400,000 of these homes each year are “second homes”.

22] Corporate accounting problems at Fannie Mae and Freddie Mac (a GSE - Government-Sponsored Enterprise) being brought to light.

23] Low income housing shortage (1.6 million units were short last year) even after potential $400 million - $1 billion in financing from the government.

24] The financing’s main purpose is to provide new, more stringent regulation for the two GSE’s – not to make life easier for low income earners.

25] The funding could result in anywhere between 4,000 and 14,000 new units each year (significantly less than low income demands).

DON'T SIDE WITH THE DUMB MONEY! BE PATIENT AND BUY AFTER EVERYONE SELLS! "BUY LOW, SELL HIGH!"