add chicago to the list of cooled housing markets.

won't a collapsing housing market, and a slowing economy from the construction pullbacks, create defaulting home loans which will then queer the huge mortgage security pools that the (unregulated) hedge funds have been trafficing in?

just asking...

The entire globe has had a syncronized rise in real estate- the concept 'real estate markets are all local' may be a dated idea- since never has real estate risen so long and so high in many geographic regions of the world. Remember what happened when another asset bubble burst- that was fueled by easy money in 1929- the crash spread into a worldwide depression. Shiller's idea's are possible. The US Bubble is still propping up many other world markets- if we chill- they may as well.

It’s the debt bubble that is threatening. The unprecedented expansion of the world-wide money supply is the source of the nominal price increases in real estate in the US, UK, the EU and Asia (as well as the run-up of commodity and share prices). I anticipate the prospect of the coming correction to be global due to the ubiquitous presence of the dollar worldwide.

As central bankers are forced to continue to raise fiat currency benchmark rates (to cool overheated growth, forestall resource and commodity inflation, or to attract investors for refunding the expiring debt of currencies that are losing their purchasing power) marginal debtors with floating rate loans will be forced to sell shares to service debt.

Later in the cycle, some of these debtors will default. Keep in mind the quadrupling of adjustable loans as a percentage of total loan volume over the past few years, and that most foreclosures occur in years three through five of loan servicing. There will follow a cascading reduction of housing prices as REO assets are auctioned to restore capital reserve ratios of banks with troubled loan portfolios (not all loans reside in the secondary market). This possibility has been foreshadowed by the Japanese experience of the past 16 years.

This is a very simplified explanation. It does not include the concomitant effects of a FED (and other central bankers’) policy that will add liquidity to avoid deflation, protectionism to support domestic markets, and the further reduction in consumers’ confidence that may precede additional declines in spending that will further reduce production and incomes. The prospect of a decade or two of “wringing out” the excess liquidity is probably in order. I think the gold market is reflecting this more than the explanations of uncertainty over Iran or uninformed speculation.

Any thoughts on flaws in this scenario?

2 bits to add
A. Even in markets that are not super hot like SoCal there has been a 10-15 year increase in folks using their appreciated house values as a piggy bank. While some have used the extracted funds to keep their mortgage payment stream going most have used the money for either home improvement or just-plain-spending.

That spending will shrink as house price increases tamper off. If house prices fall and ARMs adjust we will see a bunch of foreclosures.

Example: Japan - They are similar in land area to California and at their real estate peak had an aggregate market value greater than the entire USA. Then they crashed.
They pulled all sorts of bunnies out of many hats to keep some major institution functioning but have suffered about 15 years of stagnant economy (even though their export picture remained strong).

1. Cunsumer spending is a huge hunk of the US economy. Riff-ing behind this housing scene is the increase in the credit card minimum monthly payment %. Are those folks diverting cash from spending to retire debt or are they finding creative ways to get cash to pay the higher minimums so they can continue the spending party?

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Nikkei down 2.5%...enjoy....RE looks like it MUST go down, for no other reason than average people cant afford it. The rich, just like this republican congress, always blow it when they ignore the working and middles classes who really support the economy. What do these gold bugs think they are doing? They're gonna eat that gold or trade it for goods? Where? In Thunderdome? You still have to convert it back into currency. Who knows, maybe the dollar will go to hell, but so will everything else...oh well, bears be careful what they wish for.

Beltway Bob...
It is not always easy to predict the timing of market turns (the Japanese Real Estate Bubble went on for a very long time for instance). But arguing that "this time it is different" doesn't have a good history. I'm naturally cautious, and it is true that agressive investment would have paid off over the last few years. That doesn't mean that somebody won't get burnt in the end. I wish you luck.

In my view, all he's saying is that 1) housing markets are more correlated than in the past and 2) a severely declining RE market increases the chance for an economic downturn. There's no guarantee these events will all play out concurrently, but it is possible. An analogy would be the Nasdaq crash. For YEARS in the 70s and 80s knowledgable investment guru's preached about the benefits of international diversification among equity markets, that the correlation between such markets was low.

The last 6 10 years, the correlation between U.S. and other developed countries (EAFE) equity markets has risen significantly, and the correlations are higher still in times of crisis. Only emerging markets remains as a significant diversification benefit; for how long we do not know.

Likewise, real estate markets - formerly not well correlated even among U.S. cities, have shown increasing correlation globally. Whether this is heightened as the U.S. housing market declines remains to be seen, but the precedent is their in other asset classes.

Mr. Wallace,
"What do these gold bugs think they are doing? They're gonna eat that gold or trade it for goods? Where? In Thunderdome? You still have to convert it back into currency."

There are many scenarios between the uncertainty of today and the chaos of a non-fictional Thunderdome, most of which, as you correctly point out, will require currency.

Here's my evaluation. A fixed quantity of gold has purchased the same quantity of basic goods and services for approximately 6,000 years. Yes, past results are not a guarantee of future performance, but I submit for your consideration this fact: no paper currency has held its value for even the relatively short duration of a decade. The "almighty" dollar today will only buy what a nickel purchased when my mother was a teenager. So much for it's store of value.

Because a small insurance premium will buy you a large multiple of coverage, you may consider a reasonable allocation of your assets into gold bullion as a sensible insurance policy in the face of a Treasury that is creating dollars at a rate unprecedented during any period of history.

To whatever level the dollar index falls (shy of default) you'll be able to find individuals willing to exchange depreciating paper for scarce and enduring gold. And if default occurs gold has always been a mutually agreed upon medium of exchange. It can't be created by fiat. It can be assayed to determine exact quantity. It thus has the essential properties of money: a means of exchange with a store of value.

Thanks,

Increases in housing prices are a transfer of wealth - not an increase in wealth. Decreasing prices would also cause a tranfer of wealth. At the end of each direction of transfer a different group of people is happier.

Regarding wealth: the price fluctions in property values are a combination of two things:
* Changes in the annual land rent
* Changes in the discount rate

The value of a property is the value of the building and other improvements, plus the capitalized value of land rent (aka Ricardian rent) after taxes. Increases in the total value come from increases in the capitalized land rent, not the building itself, as the building wears down overtime and hence must become ever less valuable.

A good chunk (perhaps most of it?) of increased value in the recent bubble was due to decreasing interest rates. That means the discounted value of the future income stream of land rent is higher. There's no change in wealth of any kind there, just a change in the discount factor.

Increases in land rent itself represents increased demand for land. It might reflect an increase in "true" value, in the form of a positive externality. (Local government builds a magnet school somewhere; Intel comes and builds a plant. In both these cases the value of nearby homes would likely increase.) But that doesn't mean the actual "wealth" is in the land, but rather that owning the land enables the landowner to capture some of the wealth even though he didn't create it.