When the entire structure collapsed, there was nothing the government could do except to pass what later become known as the "Bubble Act" aimed to prevent a future recurrence.
Similarly, in the early 1900s, the Panic of 1901 occurred in the wake of a failed attempt to create a massive railroad monopoly; the Panic of 1907 followed a failed attempt to corner the copper market; and the Crash of 1929 resulted, to a large degree, from collusion among brokers, bankers and tycoons.
In nearly every case, the government gave select companies or individuals special privileges, waived critical regulations and encouraged great concentration of power. And in nearly every case, the government made desperate attempts to salvage the boom long after the bust began. But it was ultimately powerless to avert a collapse in the very structures it had helped to create.
Unfortunately, the same, or worse, could happen in the Great American Housing Bubble: The U.S. government created two monopolies that made England's eighteenth century South Sea Company and America's twentieth century industrial monopolies look small by comparison. Their names: Fannie Mae and Freddie Mac.
The U.S. Government gave these companies monopolistic control over America's largest debt market ”” mortgages. And then, beginning in the early 2000s, the government spurred these monopolies to compete aggressively with private subprime lenders.
Not surprisingly, the results were similar to those of earlier bubbles: Extreme complacency, excessive risk-taking, and, ultimately, fraud.
In September 2004, the Office of Federal Housing Enterprise (OFHE), Fannie's and Freddie's primary regulator, issued a special report revealing massive accounting irregularities. And four years later, in September 2008, the companies had still not cleaned up their act, prompting the Securities and Exchange Commission to launch new investigations into accounting deceptions.
The biggest deception of all: In their official filings and public pronouncements this year, Fannie and Freddie consistently and wildly overstated their capital, while understating their risk. Supposedly built with mortar and steel, Fannie and Freddie were actually houses of cards in disguise.
Repeatedly, the company executives swore on oath that they had more than enough capital. And even on the eve of their demise, their regulators testified before Congress that the companies were solvent.
Based on their smoke-and-mirrors accounting, perhaps. But based on the basic rules that you and I must abide by, not even close. For longer than anyone cared to admit, Fannie and Freddie had been insolvent. Meanwhile, their chief executives hid behind carefully camouflaged facade, marched into riskier corners of the mortgage market, and trashed the trust of millions of Americans with no sign of restraint and little expression of regret.
Between 2005 and 2008, for example, Fannie Mae purchased or guaranteed at least $270 billion in subprime mortgages ”” high-fee loans to high-risk borrowers. That was more than three times as much as it had bought in all its earlier years combined.
Yet no one seemed to bat an eyelash.
Quite the contrary, Wall Street and Washington cheered loudly, encouraging them to take on even more risk.
Why such enthusiasm? Because the rapid growth in fees supercharged Fannie's stock price. Because big revenues meant huge bonuses for executives ”” $90 million for one, $30.8 million for another, and $10 million for a third. And because the easy money flowing to unqualified borrowers indirectly helped politicians buy millions of votes.
Suddenly, however, in September 2008, it was finally recognized that all the financial statements and all the sworn testimony about solvency were unabashed lies. Suddenly, the two largest mortgage lenders on earth, supposedly rich and prosperous, were thoroughly bankrupt. And suddenly, underscoring the depth of their demise, each company needed an unprecedented $100 billion injection of government funds just to keep it alive.
The potential bill to taxpayers: $200 billion. But that figure assumes an end to the credit crunch, no more debt collapses, no recession, and certainly no depression. If any of these assumptions should prove wrong, $200 billion will barely cover what is fast becoming history's largest cesspool of sinking debts and commitments ”” $5.2 trillion in mortgages guaranteed or owned by the two companies, their $1.5 trillion in debts, and their $2 trillion in derivatives.
Boom-Bust Element #4: Collapse!
How much could home prices ultimately decline in the Great American Housing Nightmare? We have no way of knowing with certainty. But we can draw some lessons from similar bubbles and crashes throughout history:
In the Dutch Tulip Mania, investors lost nearly all of their money if they bought for cash; more than all of their money if they bought on the slim margin of just 2.5%.
In the South Sea Bubble, the cost of the shares investors bought fell from a peak of 1,000 to less than 100, a loss of 90% or more.
In the Crash of 1929 and the ensuing 3-year bear market, investors lost 89% of their money even in America's largest industrial stocks.
In the tech wreck of 2000-2002, when a myriad of Internet and technology companies collapsed, investors lost 78% of their money invested in the average Nasdaq stock; and 100% in companies that went under.
In Japan's long bear market, which stretches from 1990 to the present, investors have lost 82% of their money from peak to trough in companies that make up the Nikkei average, and much more in smaller companies.
And in the financial crisis of 2008, investors lost 99% or more of their money in some of America's most respected financial institutions.
My argument: The speculative bubble in U.S. homes is as extreme as each of these historic examples; and in the most hard-hit regions, the resulting price collapse could be equally extreme. Indeed, the Great American Housing Nightmare is progressing in three phases:
Phase 1. The bust in the subprime mortgage market. This is now history.
Phase 2. A severe U.S. recession. As of this writing, this phase is just beginning.
Phase 3. Depression and deflation. Still ahead.
Therefore, no matter how far home prices in your area have already fallen and no matter how cheap they may appear, they could still fall a lot further.
In the hardest hit regions, an individual home that was once priced for $400,000 at its peak could fall to as low as $200,000 by the end of Phase 1. But don't blindly assume that's the bottom. In Phase 2, it could fall in half again, to $100,000. And in Phase 3, it could fall by at least half for a third time, to as low as $50,000 or $40,000.
Homes with peak prices of $1 million could sell for as little as $100,000; some, originally priced for $10 million may have no buyers at all ”” even with asking prices as low as $1 million.
Nationwide, the median home price will not fall nearly that far. But that factoid alone will do nothing for homeowners in bubble areas like Florida, Nevada or California. Nor will it help those in blighted regions where factories are closed and unemployment rises far above the national average.
Never before in history have we witnessed home price declines of this magnitude! But that fact alone does not make them implausible, let alone impossible.
Remember: Never before in history has so much debt, speculation, government manipulation, fraud, corruption and consumer abuse been heaped onto any housing market! And if there's one thing that history teaches us, it's that unprecedented causes lead to unprecedented consequences.
Lessons To Learn Now Before It's Too Late
Lesson #1. Don't blame yourself. Virtually every realtor and expert in America told you that investing in homes was a "sure bet"; and any lender in the country that accepted your loan application was, in effect, telling you that you had the means to make the payments.
Lesson #2. Don't look back. Forget what your property was worth at its peak. And try to forget what you paid for it as well. That's water under the bridge. Instead, look at what's happening today ”” in the headlines, in your neighborhood, at companies in your area.
Lesson #3. Don't count on the government to save the day. There are bound to be a series of public programs to help some people some of the time. But they will be spotty; they won't turn the housing market around; and you may not qualify. For example, the FHASecure program rolled out in late 2007 essentially created three classes of homeowners with mortgages:
Homeowners current on their mortgages and not at risk of foreclosure were mostly not eligible for federal assistance;
Those already in foreclosure were also not eligible; and ...
Ironically, only home owners falling behind in their mortgage payments could get government help.
Not only did that make it very difficult for most people to qualify, but it also gave a strong incentive to households to deliberately fall behind on their mortgages. People asked: "Why should I cut my food budget or give up on my nights out when my neighbor is having all the fun, skipping his mortgage payments and getting rewarded by the government for his imprudent behavior?"
Ultimately, these kinds of government programs are fundamentally flawed and doomed to fail.
The most important lesson of all: Don't underestimate the potential depth, speed and duration of the decline. As the debts are unraveled, the economy comes unglued and the deceptions are uncovered, home prices could continue to plunge much further.
If you are able and willing to sell your properties, do so now. Don't wait.