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An enlightening article, titled “In Come The Waves,” from the most recent issue of The Economist declares that the global real estate bubble is the largest financial bubble in history, not just in nominal terms, of course, but in relative terms.

“According to estimates by National Debt Relief, the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries’ combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America’s stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.”


It goes without saying, then, that house prices are more overvalued than at any other previous peak in the real estate market. I’ll say it anyway: “Calculations by The Economist show that house prices have hit record levels in relation to rents in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. This suggests that homes are even more over-valued than at previous peaks, from which prices typically fell in real terms.”

Simply breathtaking – but that’s not all. The article does a great job at debunking a few of the main arguments put forth by real estate bulls that attempt to show that, “it’s different this time.”

The main argument I’ve heard bulls propound is, “there just isn’t enough supply of houses to meet demand.” My response has usually been, “look at Japan, the the definition of limited supply: an island. Real estate prices there have gone down every year for over a decade.”

The article does one better by reporting that, “Economists at Goldman Sachs point out that residential investment is at a 40-year high in America, yet the number of households is growing at its slowest pace for 40 years. This will create excess supply.”

So supply is being created at a rate faster than any time in the past 40 years. The demographic stimulus for demand is the slowest it has been in the past 40 years. If that doesn’t convince the bulls that the lack of supply argument is flat out wrong I don’t know what will.

Another argument put forth by bulls is that, “interest rates are so low right now. Prices won’t stop going up until interest rates rise.” I’ve already argued otherwise in “Eminence Front,” however The Economist trumps me once again reporting, “The lesson from recent experience in Australia, Britain and the Netherlands [where bubbles have already begun deflating] is that, contrary to conventional wisdom, a big rise in interest rates is not necessary to make house prices falter.”

In fact, one very likely cause of future problems in real estate here in America is the prevalence of alternative mortgage products like ARMs, interest-only and negative amortization loans. These loans are so prevalent in hot markets that San Diego Union Tribune reports, “82.4 percent of San Diego County buyers in May chose adjustable-rate mortgages, about double the rate five years ago.”

This actually makes sense. Since only 10% of home buyers in San Diego county, using convential financing, can afford the median-priced home in the area, they are forced to use such risky loans. That is, if they feel they must buy.

The problem with these loans is that after the teaser-period of the loan expires, the rate jumps up and can very well double the payment of loan. So the people that are now stretching to make that $1,500 payment on their half-million-dollar home will all of a sudden find themselves in over their heads.

The New York Times reported this week that,This year, only about $80 billion, or 1 percent, of mortgage debt will switch to an adjustable rate based largely on prevailing interest rates, according to an analysis by Deutsche Bank in New York. Next year, some $300 billion of mortgage debt will be similarly adjusted. But in 2007, the portion will soar, with $1 trillion of the nation’s mortgage debt – or about 12 percent of it – switching to adjustable payments, according to the analysis. The 2007 adjustments will almost certainly be the largest such turnover that has ever occurred.”

This is where the largest financial bubble in the history of the world meets the largest consumer credit crunch in the history of the world. And all the bankers and real estate speculators, responsible for blowing up the largest bubble in history, will find themselves with gum all over their faces.

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