The US housing bubble: which dominoes will fall next?

The US housing bubble created a 'wealth effect' that has underpinned consumer spending. And consumer spending has supported the US economy for some time now. But, one by one, these dominoes are falling. Which have already gone, and which are at the tipping point?

The Sentinel is reporting that in Massachusetts, "State Targeting Abusive Lenders":

"The state Division of Banks is cracking down this month on what it sees as abusive business practices by mortgage lenders and brokers.

"The agency issued a series of new emergency regulations earlier this month, requiring better documentation from lenders and prohibiting them from pressuring consumers into taking out mortgages they can't afford or working without their own independent lawyers.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

"It also forced four companies -- two of them located in Worcester -- to close immediately and place all pending mortgages with another, more established lender.

"Commissioner of Banks Steven L. Antonakes said in a recent interview that division examiners found a pattern of deceptive business practices by some lenders during their most recent round of company inspections.

"We want to spell out in very plain English to send a message to lenders and brokers that these specific acts, whether they're very obviously unfair or deceptive, or more subtle, they weren't going to be tolerated,' he said. And you would put your license at risk by engaging in this kind of activity'

"But the slowdown has also put lenders in a tough position, said Christopher J. Iosua, president of the Mortgage Connection Inc.

'When business slows down the way it has in the past six-nine months, new loan originators and those without a strong base of customers do things they probably wouldn't normally do,' he said

"Abusive lending practices can destabilize the entire real estate market.

"As an example, he described a hypothetical street containing 10 homes, each worth a certain amount of money

"If loans were originated for two of those homes, in which the loan was made that the broker knows the consumer has no hope of repaying those loans, very likely the borrower will become delinquent,' he said. In the worst case, the home will be foreclosed upon, and that kind of activity could result in the home being sold for less than its value and before you know it, you have a domino effect.'"

Domino no. 1: tightening mortgage lending standards

The idea that lenders are doing things they may not have done in 'normal conditions' may have some merit for some lenders, but when 40% of the loans sold in California before the bust were either stated income loans or pay-option ARMs, I think the idea is more fiction than fact. Anything and everything was done to keep the bubble booming, and that was, as I said, happening well before the bust.

With every bubble comes fraud. The two go hand in hand, and housing is not unique in this respect. We are only beginning to scratch the surface of the fraud that supported this bubble. Lending standards are going to tighten as a result, and will continue to tighten as more and more of the fraudulent activity is exposed. I consider fraud and tightening of lending standards to be two big dominoes that are now falling. Tightening of lending standards was previously discussed in "Lending Guidelines/Credit Squeeze" and "The Blame Game."

Domino no.2: consumer spending slowdown

Consumer spending has been propping up our economy for a very long time, so let's take a look at the current state of affairs with that oversized domino. The Associated Press is reporting, "Feds Say Consumers Cut Back Spending by 0.1% in August, Largest Amount in Nearly a Year":

"Battered consumers, faced with weak income growth and rising inflation, trimmed their spending in August by the largest amount in nearly a year. The Commerce Department reported Friday that consumer spending, after adjusting for inflation, dropped by 0.1% last month, the first decline since a 0.3% fall in September 2005, a month when business activity was disrupted by Hurricane Katrina.

"Incomes, reflecting lacklustre gains in employment, rose by just 0.3% in August, the weakest performance in nine months. Core inflation, which excludes energy and food, was up a worrisome 2.5% compared to a year ago, the biggest year-over-year increase in more than a decade.

"The new report underscored how much the economy is slowing this year as consumers have been battered by record-high gasoline prices and a cooling housing market. Falling home prices are making Americans more cautious about spending money, because they feel less wealthy.

"The overall economy grew at an annual rate of just 2.6% in the April-June quarter, the government reported Thursday, and the new report on consumer spending indicates that growth will likely slow even more in the current quarter.

"However, most economists believe the country will be able to escape an outright recession, in part because trends in recent weeks have been more favorable with gasoline prices falling rapidly, helping to boost consumer confidence.

"That development is expected to bolster consumer spending in the final months of this year, giving retailers a decent Christmas sales season. Consumer spending is closely watched because it accounts for two-thirds of total economic activity.

"Consumer spending before adjusting for inflation showed a tiny 0.1% rise, far below the 0.8% jump in the previous month."

Premature reports of the 'death of the consumer' have been heard for quite some time now from various people, and I must admit that group includes me. Consumers have been spending more than they have been making for 16 consecutive months. We have seen our first yearly negative savings rate since the Great Depression. For a nice graph of the negative savings rate, as well as a neat picture of the character Eeyore, please consider "July Personal Spending."

Domino no. 3: Mortgage Equity Withdrawal shrinking

One of the dominoes propping up consumer spending is called mortgage equity withdrawal. In simple terms, people have been treating their houses as ATMs, taking cash out at refinancing and spending it. That source of funding is drying up. Calculated Risk talked about mortgage equity withdrawal in "GDP Growth: With and Without Mortgage Extraction":

"The recent Flow of Funds report showed that household mortgages increased $220.3 billion in Q2 2006, and $436.4 billion for the first half of 2006. Using a simple formulation for mortgage equity withdrawal (MEW), MEW was $81.6 billion in Q2 2006. This is substantially below the record $180.1 billion of MEW in Q3 2005."

Calculated Risk went on to say the "declining MEW over the next few years will be a significant drag on GDP growth." I agree. That falling domino makes it more likely that this downturn in consumer spending is finally the real deal.

Domino no. 4: real estate employment set to fall

Another key domino that is tipping but has not completely fallen over yet is jobs. I recently wrote about jobs in "No Hard Landing." Following is a snip from "No Hard Landing," quoting Mike Morgan of MorganFlorida (a Florida real estate broker):

"Will there be a hard landing? No! Will there be a crash landing? Absolutely!

"For the last two weeks, I've been receiving daily calls from desperate mortgage brokers, real estate attorneys, insurance brokers, title companies, and subcontractors looking for deals and work. This week, I spoke with a real estate attorney closing his office and returning to the corporate world. And several of the smaller builders have called me offering triple commissions to entice sales of their inventory. It doesn't end there.

"Who will the housing crash affect? Everyone. Real estate agents will be first. As a group, they've made a ton of money during the housing boom, and they've spent millions on new cars, vacations, restaurants, clothes, and everything else that comes with excessive discretionary income. That's over now. Agents are not buying the luxury items that helped feed the economic boom, and they are cutting back on business spending like advertising and marketing. That hits the vendors and newspapers revenues.

"But this is all old news for us. The other shoe is dropping now. Loss of hundreds of thousands of jobs created from housing will act like a virus and spread throughout our economy. As real estate agents, attorneys, and mortgage brokers rein in their spending, it will affect restaurants, car dealers, advertising companies, jewelers, remodeling contractors, furniture manufacturers, bank profits, electronic retailers, clothing, and the list goes on and on and on.

"As the primary players are affected, and they cut back on spending, so will the secondary players in this market. These companies will be forced to lay off employees, and the cycle will grow like a virus. Is that it? Not a chance."

The reason this domino has not completely fallen over yet is that homebuilders are still building homes at a high rate. Yes, year-over-year rates show huge declines, but homebuilding is remains brisk on a historic basis. Thus, homebuilding is still providing jobs even as it increases inventories and downward price pressure. So while housing-related trade jobs are slowing, they have not yet collapsed. They will. It is just a matter of time.

Domino no. 5: largest mortgage-lender cutting jobs

The Ventura County Star is reporting, "Countrywide May Cut Jobs by 10%":

"The end of the real estate market boom is forcing one of Ventura County's largest employers to cut 5-10% of its work force over the next few months, a top executive told workers Tuesday.

"Countrywide Financial Corp., the country's largest mortgage lender, with about 5,700 workers in Simi Valley, Thousand Oaks, and Westlake Village, instituted a 60-day hiring freeze and plans to reduce staffing in several areas, Dave Sambol, president and chief operating officer, said in a memo obtained by The Star.

"The memo does not mention layoffs, but several workers leaving the company's Westlake Village office as security guards roamed the parking lot declined to discuss layoffs or said they were told not to talk with the media.

"[A Thousand Oaks woman said] layoff rumors that had been swirling on the Countrywide campus for weeks were confirmed Tuesday morning.

"You found out because your vacation time on your paycheck was gone,' she said

"Sales of single-family homes for the year through July were down 27%, condos are down 60,' said economist Mark Schniepp of the California Economic Forecast Project in Goleta. These are blood-bath levels of declines. I don't see how you can call that kind of a market healthy. There are direct casualties from this downturn.'"

I had the pleasure of talking to George Noory with Coast to Coast radio last Thursday evening. I briefly mentioned Countrywide while talking about housing. I was surprised to receive this e-mail the next day:

"Mr. Shedlock, thank you for your presentation last night on Coast to Coast.

"My husband has been a loyal employee of that company for five years. He has been in the mortgage and lending industry here for almost 20 years. He's had outstanding performance reviews and was recognized repeatedly for running a very profitable branch FOR COUNTRYWIDE.

"Midsummer, without ANY WARNING whatsoever, and after years of outstanding performance reviews, his branch was summarily closed. He and his production staff were RIFED, and then BROUGHT BACK into a failing branch that had been recently started up just a few miles from his branch.

"You see, over the course of several years (and through an ever-revolving door of area managers who were amply rewarded for OPENING NEW BRANCHES), his management had established offices within 1 or 2 miles of each other in the same footprint. This was fine during the boom times of low interest rates, but you can imagine the cannibalism for trained qualified staff and accounts that raised its head during times of ever-increasing interest rates. Instead of working in concert with existing branch managers to establish a consolidation plan, SUDDENLY, AND WITHOUT WARNING, BRANCHES WERE SHUT DOWN and employees were rehired with DEMOTIONS into cramped, tiny startup offices."

Is the housing bubble a nationwide problem?

Is it just Florida, Boston, Phoenix, Las Vegas, and California that are affected by this? Even if it were, that would still be a lot, wouldn't it? Let's look at California alone. Calculated Risk reported back in May, "California: Real Estate Licensees Surpasses 500,000." In other words, one out of every 55 adults in California is a real estate agent. That's a lot of jobs, isn't it? The question to ask next is how many of them have had any sales lately? Technically, they are still employed, even though many agents in many states have no money coming in. The unemployment numbers produced by the BLS are a joke for many reasons, and this is just one of them.

But returning to the initial question, the answer is no. This is not just affecting the coasts and the deserts, but places like Minneapolis and Madison as well.

If you have not yet seen this video about Billings, Mont., please take the time to play it. It is a stunning example of the overbuilding that still continues today in spite of sinking demand. It continues in all of the bubble markets as well. Condos and houses are still going up everywhere. Once that building stops, official unemployment rates will soar.

Other dominoes about to fall: retail expansion and global wage arbitrage

The falling domino from slowing homes sales will soon tip the domino of retail store expansion. Retail expansion, primarily around new subdivisions going up in outer suburbia, supported a multitude of jobs at places like Pizza Hut, Bennigan's, Outback Steakhouse, Wal-Mart, and Home Depot. With the slowdown in housing activity, the slowdown in strip malls will follow with a lag. Retail store expansion is in its final phase.

But pressure on jobs is not just on manufacturing and housing. We are being hit from multiple angles. I wrote about teaching jobs in "Outsourcing Homework" and medical outsourcing in "Medical Tourism," the "Healthcare Fiasco," and the "Healthcare Fiasco Continued."

As you can see, there are many dominoes in various stages of tipping. Right now, it seems like we may be headed for a mass collapse all at once, as opposed to a more linear progression of falling dominoes. In the meantime, no one seems to be able to see the recession that is headed our way.

By Mike Shedlock for Whiskey and Gunpowder

Whiskey & Gunpowder is a free, twice-per-week, e-mail service for more from the team, go to