Housing Doom

Reader Mike Folkerth, the King of Simple and Humorous Economist extraordinaire, just launched the following article over the wall here at Doom Castle. Stand by to be enlightened about what has been happening to us all during the housing bubble. The story is straightforward, scary, surprising, and — all too often — uproariously funny.

UPDATE: Author profile at bottom of post

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Economic Cycles — Surely We Must Be Nuts!
Mike Folkerth [1]

While predicting the exact time that nearly any modern economy will experience ups and downs is difficult, yet defining the reason for these fluctuations can be reduced to simple terms. In a country that practices free enterprise, such as the U.S., production is not closely linked to demand. In other words, no one is keeping score.

In our private lives we purchase goods according to demand and anticipated consumption. For instance, we buy only enough bread to consume over the period that the bread will remain fresh. The bread company on the other hand is not nearly as conservative. The bread delivery person who placed the bread on the super-market shelf comes in each day and removes the now day or two old bread and replaces it with fresh. Much of the bread being removed is then discarded. The same arrangement applies to nearly all perishable consumables.

As individuals, we also purchase clothing, furniture, appliances, transportation, tools, spare parts, and so on, to meet the needs of our immediate and near-future requirements.

Industry doesn’t keep score nearly as well as the individual consumer. Competition and the absolute necessity for business growth push the envelope of production beyond natural and fluid consumption rates. This has never been truer than in our current “instant society.”

Inventory levels must constantly remain sufficient for instant order filling. Combine the need for growth and the expectation of “on the shelf availability,” and it equals over-production and waste. Recovery for the cost factor of this designed-waste is then necessarily counteracted by higher prices on all goods and services.

Products that will never be consumed, and that eventually will be discarded, are produced in huge quantities to meet the new rules of supply and competition. In short, supply, competition, the necessity of growth, and the expectation of instant fulfillment, have trumped the fundamental rule of supply and demand.

If this practice were confined to bread and grapefruits, the economic consequences, while still undesirable, would have little bearing on the broad economic scene. But it isn’t confined to perishables. Durable goods are also produced and marketed under the same changing rules.

Housing may be the most vivid example that I can produce for the purpose of demonstrating a full circle economic cycle in durable goods. As a side-bar, all depressions have been led by a collapse in the market for durable goods. While much has been written on the subject of economic cycles, the reasoning for such fluctuation is normally quoted by the masses as, “That’s just what it does.” Since no action can take place without being preceded by thought (economic cycles are the result of actions), “that’s just what it does” is not an acceptable explanation.

The cyclical nature of housing begins with the ill conceived belief that regardless of how many homes are built, someone will purchase the ever growing inventory. The fact is that only so many qualified home buyers exist at any given time. This is not true when it comes to potential home builders. You will note that I left off “qualified” in the home builders’ category.

As demand for homes rise due to population growth, shifting population base, or more aptly in past years, moronic financing, home builders and developers pop up like dandelions in spring. This is a problem, as streets, sewer, power, water, and bureaucratic oversight, don’t “pop-up” at all. The latter activities resemble the speed of the three toed slough and take years to materialize.

So, first-to-market are the contractors and developers who survived the last housing bust and actually have developed lots ready for construction. Demand for housing at this sector of the cycle is absolutely bursting at the seams and profits for the early-to-market developers appear to be a dream-come-true. Also remember that these available lots were developed with money from an earlier time, which significantly increases the initial profits. America lives, breaths, and eats by means of artificial inflation. That is, until we reach the deflation point in the economic cycle.

This display of perceived instant wealth does not go unnoticed and is followed by every red blooded American that ever swung a hammer or built a tree house adding “contractor” behind their name. The scramble to provide housing for Americas’ masses begins to resemble an Oklahoma land rush.

Land for thousands of subdivisions, shopping centers and the associated peripherals are platted simultaneously across the country. So what if it does take two years until ground can be broke, the rush is on and if you don’t engage, how are going to get the gold?

We must not forget about the material suppliers at this point. Suppliers have also been idled during the slow growth recessionary period that preceded this newest boom, and are wiped out of available inventory nearly immediately. In order to try and become the supplier of choice, the second and third shift are put back to work, based on the word of the building contractor, who assures the supplier / manufacturer that price is no object — but time is.

The manufacturers now convince their raw material suppliers to gear up, and so goes the process. The dog is now in full pursuit of his tail.

About this same juncture, the real estate agents who also survived the last big bust begin making better than average wages as home buyers start to outnumber agents. This is not a problem, it’s why we have real estate schools. Mortgage lenders, appraisers, escrow agents, loan closers, surveyors, and engineers all find more work than hours in the day. Nor is this a problem, we have schools for all of these professionals too. Sure, it may take from one to four years to complete the schooling, but housing is permanent and so is this boom. Of course it is.

In the mean time the demand continues to swell, due to the delay in getting the machine up and running. So what happens when we have limited supply and increased demand? Capitalism at its finest answers the bell and a little price gouging seems appropriate if not mandatory. The result is then inflation with a capital “I.” In America or any other capitalist country on earth, inflated prices and profits are similar to putting honey out for flies. You lead, follow, or get the hell out of the way. Never mind where we are going.

Fast forward two years. The subdivisions are coming on line, the real estate agents and buyers are standing in line, and the show is on the road. It should not surprise you that sub-division applications did not diminish over this two year period, nor did enrolment in real estate school. This keen attention to detail will ensure an unending supply of home sites and agents — ready, willing, and able to serve buyers for the foreseeable future. Unfortunately for all of these new entries, foreseeable meant the end of next week.

Now this is where I ask for your indulgence into my more graphic depiction of the final outcome of all this diligent preparation. Imagine a dam; a big damn dam. Behind the dam, in place of water, are home buyers. Below the dam, in place of irrigated farm land, are subdivisions, developers, contractors, real estate agents, suppliers, tax collectors…you get the picture. During the initial two years that the dam was being built (infrastructure), the buyers were filling up the reservoir while the sellers were working feverishly downstream preparing to extract a little cash from whole process. The big day comes and the flood gates are opened. Praise the lord and pass the tax notices.

‘We have now entered developer paradise. Buyers are coming in droves and their money is flowing like green water. How could it get any better? It won’t. But, for now the process seems to be going along nicely and will remain so for eternity and beyond. Home Depot puts up another store and Lowe’s builds across the street.

It is a new mathematical discovery, that initially begins to rain on the parade (maybe snow), which brings some concern to the participants on the lower side of the dam. Some fool economist armed with basic math skills concludes that the buyers flowing into the reservoir behind the dam are somewhat fewer in number than those flowing out of the flood gates. This is the point that another great scientific fact is discovered. When the supply reaches greater numbers than the demand, gouging is no longer possible. To a point in fact, that eating regularly comes into question for the folks below the dam. This point of the equation is often referred to as a “Buyer’s Market.”

Reversing a buyer’s market is difficult. Okay, impossible. The continual applications for subdivisions, from the two years prior, bring developed lots to market like the Johnstown flood. The real estate schools are cranking out agents in record numbers and …everyone is dressed up with no where to go. With the exception that they could go broke.

The economy at this point shows signs of weakening, which can be detected by noticing that it is lying in the prone position. There is only one measure to correct this most terrible situation — cheat. Lower interest rates, lower qualifying standards, lower down payment requirements, lengthen loan terms, develop government subsidized building and loan programs, and lower prices … a lot.

Once all of these last resort fixes run their predictable course, we reach the final segment of our full circle journey which is termed, “total market saturation,” and comprises of foreclosure, bankruptcy, and deflation. After which we wait a few years and repeat the process with the promise that there have been government employees and banking rules put into place that won’t allow a repeat of the last performance. I also have a perfectly good quitclaim deed for the Brooklyn Bridge.

There we have it, a complete cycle in the scientific development of housing in America. No one is keeping score.

UPDATE: added around 4PM PDT

Mike Folkerth is not your run-of-the-mill author of economics. Nor does he write in boring lecture style. Not even close. The former real estate broker, developer, private real estate fund manager, auctioneer, Alaskan bush pilot, restaurateur, U.S. Navy veteran, heavy equipment operator, taxi cab driver, fishing guide, horse packer…(I won’t go on, it’s embarrassing) writes from experience and plain common sense. He does not use borrowed text book examples provided by a PhD in economics who has remained inside a building for the majority of their adult lives due to the inability of finding gainful employment. This type of lifestyle tends to shelter one from reality.

His new book “The Biggest Lie Ever Believed” is all about reality. If Middle America continues to follow the path of convention, it will lead to a place that you really don’t want to go. Mike’s passion is to provide the awareness necessary for Middle America to take the fork in the road that still leads to the American Dream.

“If you find you’re on the wrong train, get off at the next stop, it’s a much shorter trip back home.” – Mike Folkerth

Mike’s new website www.mikefolkerth.com will be up and running in a few days, after which you’ll be able reach him using the e-mail address mike@mikefolkerth.

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Notes and References

[1]: © 2006, used by permission of the author.