The conventional wisdom that emerged from the crisis of the Great Depression dominated American ideology until almost 1980. Similarly, the reigning ideas that congeal in the next few weeks about the causes of this crash may determine the course of politics for decades to come.
The truth is, we were never as rich as we thought we were. The last decade’s growth was largely driven by huge flows of lending dollars to dubious borrowers. At the bottom of an unknown but frightening number of convoluted new-fangled debt instruments were homebuyers who had no chance in hell of paying the mortgages back when the music stopped and the price of houses in California (and a few similar states) stopped heading toward infinity.
Federal Home Mortgage Disclosure Act data dug up by reader Tino suggests that the recent American Housing Bubble was, more than anything else, a Hispanic Housing bubble, as total mortgage dollars handed out to to Hispanics more than septupled from 1999 to 2006! (Is "septupled" even a word?)
Moreover, in 2006, according to Tino, 51% of subprime and other "higher priced" mortgages (for purchasing homes and for refinancing older mortgages) went to minorities. The higher priced mortgages are, of course, where most of the unexpected defaults have shown up.
UPDATE: Tino has added up all the subprime mortgage dollars for the entire disastrous 2004-2007 period. Among borrowers whose ethnicity is unambiguous, he comes up with $900 billion subprime dollars going to non-Hispanic whites, $887 billion to minorities. So, that's 50% of subprime dollars during the worst years of the Bubble went to minorities.
Someday, we'll get a count of defaulted dollars by race.
At their bubblicious peak, American homes were theoretically worth $24 trillion. The amount of wealth that has evaporated in the popping of the American real estate bubble so far appears to be in the $5 trillion range, to pick a very round number. Dr. Housing Bubble recently estimated the loss to be $4.68 trillion using Case-Shiller data. Another source estimates $6 trillion.
And we haven't necessarily hit bottom yet.
My very rough estimate is that half of the American loss in home values so far has occurred in California, with Florida being next in line.
How big is 5 trillion simoleons? How does it compare to the total wealth in the world?
At the peak, the total "assets under management" (i.e., financial instruments, but not including real estate, private businesses, and marketable luxury goods such as Van Goghs) globally reached $110 trillion, according to the Boston Consulting Group. In North America, "assets under management" were $39 trillion; let's figure $36 trillion in the U.S alone.
If we add $36 trillion in financial paper and $24 trillion in homes we get $60 trillion in wealth in America between them.
Compared to $60 trillion, a fall of $5 or $6 trillion doesn't sound so bad. But the problem is that literally countless trillions of these "assets under management" consisted of a mountain of leverage concocted by high IQ idiots on Wall Street balanced on a pebble of probability that recent mortgages handed out to Californians (and the like) would ever get paid back. The Clinton and Bush administrations were egging the lenders on to increase minority and low-income home ownership.
There were lots of other bubbles going on in the world, such as in Spain, England, and Iceland, but the California-centric American housing bubble was [Mixed Metaphor Alert!] the big enchilada that brought down the whole house of cards. [Actually, now that I think about it, the phrase isn't supposed to be Big Enchilada, it's supposed to be either Big Kahuna or Whole Enchilada. So, never mind ...]
The only way many recent borrowers could hope to get out from under their giant mortgages was if they found even Greater Fools to sell their houses to. In other words, California home prices had to grow to infinity for this movie to have a happy ending. CNN reported in 2006:
“More than 90 percent of homes in [Indianapolis] were affordable to families earning the median income for the area of about $65,100. In Los Angeles, the least affordable big metro area, only 1.9 percent of the homes sold were within the reach of families earning a median income for the city of $56,200.”
By 2007, a 500 square foot one-bedroom house in Compton, CA, the spiritual home of gangsta rap but now majority Latino, went for $340,000.
Thus, a year or two ago, when the interest rate on adjustable subprime mortgages started to reset after the typical two year "teaser" period of low interest rates began ending, housing prices slowed, then started to fall as everybody rushed for the exits.
Granted, trillions were also lost in the popping of the Internet stock bubble in 2000, but the collateral damage was milder because shares in Pets.com were considered "investments." Ever since the New Deal there have been certain limits on how much you could leverage stock investments "on margin" since the presumption is that "investments" go up and down in value.
In contrast, a half million dollar loan for a house in a slummy California neighborhood handed out to a drywaller from Chiapas who obviously must have added an extra zero to his undocumented annual income on his mortgage application is considered an "obligation" and the presumption is that it will be paid back. Defaults on "obligations" are assumed to be the exception rather the rule. After all, as they would say in the City of London when figuring out where to park some Kuwaiti oil money, mortgages for Californians were "safe as houses."
Obviously, in reality, investing in Pets.com and lending a half mil to the drywaller were both equally stupid financial transactions, but, traditionally, they've been considered different breeds of activity.
Therefore, the Wall Street geniuses felt justified in constructing vast Rube Goldberg schemes of leverage on the back of this kind of "obligation." They had data showing that borrowers in 2004 and 2005 weren't defaulting on ridiculous mortgages, but that's because there were still Greater Fools around to hand the hot potato houses to. Ignoring that, the financial wizards attempted to obtain Reward Without Risk.
Well, you can't do that. You just can't.
Of course, they were simply delaying the return of Risk until it all came rushing back in at once this autumn, just like the "portfolio insurance" schemes of the mid-1980s led to the October 1987 one-day crash.
Underneath too many of these market insurance schemes that would take a 300 IQ to understand was the assumption that out in the slums of California, laborers with fifth grade educations would pay back $4000 per month for most of the rest of their lives. Maybe they would quit their day jobs, learn to read English, go to medical school, and become doctors. (We wouldn't want to be guilty of the "soft bigotry of low expectations," now would we?) Either that, or they would find a Greater Fool who would pay even more for the privilege of living in the barrio.
Over the last year, the world's financial institutions started to wake up to the reality that underlying some uncountable but possibly terrifying fraction of all the baroque financial instruments they had been selling each other were pieces of paper "obligating" drywallers to pay each month more than their monthly income for their cruddy California houses.
Today, nobody in the financial world has much of a clue who is solvent and who will crumble tomorrow, so nobody wants to lend to anybody.