Week one, the Housing Bubble

So, where to start on the housing bubble. Not knowing where most of you are coming from on this topic I'll start simple and work my way up.

How does one make a housing bubble? First you have two general groups of people, some are "Home Owners" and others are "Home Wanters". Easy enough. There are sub-groups of each of those groups. Of those that want homes, some can afford to pay in cash (we'll call them "Cashers"), some will have to borrow and will have the means to pay back the loan (We'll call them "Good Loans"), and still others will have to borrow but will not be able to pay the loan back (and we'll call them "Bad Loans"). Subdivisions of the Home Owners group are: those who decide to refinance their homes for extra disposable income (They will be "Refinancers"), and those who own their homes outright (we'll call them .... well... "Happy"). We'll also add another group that is created by all this activity, "The Home Builder". We'll examine these sub groups to see how this bubble pop ripples across the economy.

The bubble first begins to rise when loans are made to everyone with out proper credit checks, or at a lower interest rate than the risk of the loan dictates. This is exactly why Fannie Mae and Freddie Mac were the first to implode, the government in an effort to make housing more available to the lower middle class, dictated to Fannie and Freddie that they lend at sub prime rates. If the risk of the loan is not compensated for by higher interest rates on other loans of that type, the entire system falls apart.

So, how does that reach out to touch everyone in the economy? First we'll start with the Home Builder. The Home Builder sees all of the activity in the market. Homes are suddenly going for twice what they used to be worth (largely due to people being granted loans they can't really afford, the Bad Loan Home Wanters) So the Home Build goes about building tons of houses and making a great living at the same time. The trouble is.. that in the midst of building his latest development, those Bad Loans begin to catch up with the lenders, and they begin to either go out of business or change the way they lend. So suddenly it becomes more difficult for the Home Wanters to buy a new home, and at the same time the housing market is saturated with homes that sit vacant. So effectively the housing bubble has been pricked, but not yet completely popped. The Home Builder sees that he has all these homes sitting vacant, he needs to continue making the money back that he has invested in the homes. So he decides to lower the prices on them to entice Home Wanters into buying one.

Now we reach across to the Home Owners, now with all housing values falling because of the new relative low cost of buying a new home from the Home Builder, the estimated worth of the Home Owners house has fallen. Now for those who were counting on refinancing there homes, to send their children to college, or to buy a new car, or to improve their home further. This is how the housing situation prominently burst into other markets. Our economy has become so dependent upon lending, such as second mortgages and home equity lines of credit. So now that the Refinancers have no value to borrow against in their homes, they cannot afford that new car, lavish Christmas presents, or a trip to visit their distant families. This happening to one person may not seem like a big deal, but on a grand scale where millions of people decide to stay home for Christmas instead of travel, or decide to spend a little less on presents this year, or decide to fix the old car instead of by a new one, suddenly the markets that are effected begin to experience a slow-down. What may worsen the situation is the posibility of layoffs related to a decrease in spending. Which in turn may spark another round of home selling, further flooding the housing market and driving home values even lower.

This is how this problem finally reaches our "Happy" Home Owners. With the slow-down now filtering into other markets, those markets begin to cut jobs. So this group of "Happy" Home Owners begin to be sucked one by one into the Refinancers group. Those who lose their jobs will spend less on even more types of markets. They will begin to spend less on even the essentials. Shopping less often and buying items that will feed their families more efficiently. This simply spreads the economic decline. Causing more jobs to be lost, and even further decline in spending.

This vicious cycle continues until some one can find a way to capitalize on the situation. The companies in a free market system are must react to the market's status. The Free Market is the most powerful human generated force on planet, because of one overriding factor. The free market is driven by the most universal human element: survival, procreation, and most of all greed. A Free Market is self correcting because it people react to the changing markets. Not only do people have to adapt to survive, people naturally desire to prosper. If people are spending less on certain more luxurious items, those companies which show real long-term value to the public, will eventually gain ground on companies that refuse to react and continue to do business in the old way. The companies that don't react will fail and be weeded out, those that adjust to a new way of doing business will easily be able to fill the vacuum left by the large failed dinosaurs. As those companies grow larger, people who've lost their jobs in other sectors will regain employment.

So there is hope. It will take time to rebuild our faltering economy. However, when we do we must remember the lessons we learned from this bubble pop: the free market is self correcting, although the government may have good intentions tampering with the market can have unforeseen effects, and lastly when think about investing in a market with an incredible face value, we must dig to it's base to make sure it is built on sound economics. If we can learn from these lessons we can avoid another Housing Bubble.