Greed is Good — sometimes.
By Sally Duros
Chicago Sun-Times Real Estate Editor
“Greed is good — most of the time, but not when it comes to residential real estate,” says William Strauss, senior economist and economic advisor for the Federal Reserve Bank of Chicago.
“Early in December, we’ll be celebrating the 20th anniversary of one of my favorite films of the 20th century: Wall Street”, Strauss told the Chicago Economic Outlook Luncheon for 2008. “Gordon Gekko’s comment “Greed is good” is right on in terms of corporate raiders coming in and remaking what was happening in an industry. It’s all to the betterment of that particular company and industry.”
“But [real estate] was a situation where greed was not good because people came in without the kinds of knowledge they should have had.”
For those of you needing a refresher on that over-the-top 1987 celluloid offering from Oliver Stone, Michael Douglas played Gordon Gekko, a ruthless Wall Street merger and acquisitions guy who bought companies, took them apart, and sold off their assets to become obnoxiously rich.
The movie is quite a period piece today with its state-of-the-art, shoe box-sized cell phones, its orange flickering CRT tubes that preceded today’s slick iMacs and, dare I say, quaint value system that saw the workers winning and the corporate raiders going to prison.
In the film, Gekko’s actual quote is: “Greed is good. Greed is right. Greed works. Greed cuts through, clarifies, and captures the essence of the evolutionary spirit.”
It’s true that when the dust clears from the ruckus that is today’s residential housing market, homeownership will have evolved. But it’s not clear, even to Chicago’s very own Federal Reserve bank, what that spirit will have wrought.
“Housing had been doing very well,” Strauss said in an interview. “Housing is reversing itself. That’s what happens in these roller coaster sectors.”
The big question with all the fingerpointing, political posturing and general gnashing and wailing is: Why are we going through this?
“We are all surprised by this extra froth in the housing market,” Strauss said, pointing out that despite housing’s full percentage point drag, the economy is still growing at a 2.5 percent annual clip.
Strauss said that with job creation doing very well, and income rising substantially, the problem is not the economy. “This is not a situation where people are losing their jobs.”
Can we blame interest rates and the Feds?
“As you can see mortgage rates are up to 6 3/4 percent,” Strauss said. “If anyone thinks that is enough to kill off this market, we have to have a long talk.”
The answer is — and if you get it right you win one of those groovy two-pound cell phone product placements from the movie “Wall Street” — ta da!
“The price of homes,Strauss said. “To use a technical term in economics, ˜Prices went nuts!”
For the past 10 years, home prices appreciated at a rate faster than the rate of inflation. So if your income was rising at the rate of inflation, it was taking a larger and larger slice of your income to afford these homes, Strauss said in his presentation.
“You can see where this is going,” Strauss said. “As [homebuyers] put less and less skin in the game, the returns go up astronomically. You know those wealth-creation seminars — a lot of people bought into this Ponzi scheme. It was all based on the fact of home prices going higher,” Strauss said. “As soon as we knew prices weren’t going any higher, that would be the end of the game.”
In his presentation, Strauss pointed out that with 300 million people in this country, raw numbers of foreclosures can be misleading. “This is an issue related to the adjustable rate products,” he said. “Even the risky borrowers who took out fixed-rate mortgages, they are doing fine.”
Strauss said that the dramatic downturn in housing starts is still less than the sharp plunge 40 percent that the nation saw in the early 1990s. “This time they’ve fallen only by about a third,” he said.
“There probably was not enough adjustment, and that’s probably why we are seeing this. “Foreclosures as a share of all loans outstanding right now is at about 1.4 percent,” Strauss said. That’s below the peak of the 2001 recession, but don’t relax yet, he said, it will continue to get worse next year. The downturn is likely to continue for the next two, maybe three quarters. Strauss also maintains that the correct view is to see the main problem being adjustable-rate subprime mortgages.
“With the recession in the early part of this decade where you saw both adjustable- and fixed-rate foreclosures move higher uniformly [due to layoffs].” He said that although we have not yet reached the foreclosure levels of the last recession, we are almost certain to go above them.
Subprime is about 14 percent of all loans that are outstanding. Unfortunately, adjustable-rate loans comprise the lion’s share of subprime loans — about 75 percent of subprime loans. Still it’s less than 10 percent of all loans, Strauss said. “That’s why I don’t think we’re going to have a great macro-economic issue here, because even if we go to a 10 percent foreclosure rate, it’s still less than 1 percent of the entire mortgage market in terms of number of loans. And we know that subprime loans tend to be smaller loans.”
So, why did prices go through the roof over the past decade?
Maybe that’s a question Gordon Gekko can answer.
Many first-time homebuyers and individual real estate speculators succumbed to a kind of bubble psychology. They feared being priced out of the market or missing out on making a killing from rapidly appreciating equity. Some unknowingly” and many knowingly” bought into the now infamous exotic mortgage instruments that are the subject of such debate in Washington.
Yep, some lost their heads when they felt left out, and some were simply greedy.
Let’s not forget Wall Street investment banks Merrill Lynch, Citigroup, Morgan Stanley and Bear Stearns, which have posted $50 billion in write downs this year as a result of their “toxic-waste” mortgage-backed paper. Even with those losses, they are expected to announce $38 billion in bonuses for 2007.
There’s some inspiration for Gordy Gekko.
As David Wessel wrote in his “Capital” column in Tuesday’s Wall Street Journal: “Ditch the cliche that government should be run more like a business. It’s too flattering to business.”
But this time when greed cuts through, clarifies, and captures the essence of the evolutionary spirit it will cut like a laser to the very heart of the American Dream.
View highlights of William Strauss’s Midwest Economic Outlook for 2008 on my blog, The Right Place at SunTimes.com.
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