This series is unrelated to the conversations with Middelkoop that have been previously published on DeepJournal. The new series concerns current affairs, and these conversations will be held with some regularity.Today's conversation deals with the collapse of the American housing bubble, something that is now clearly beginning to take shape and which is expected to have a greater impact than the implosion of the technology bubble.In this conversation we'll also be talking about a new book that's coming out, based on the interviews with Willem Middelkoop by Daan de Wit, some of which can be found on DeepJournal, and some of which have yet to appear.
Read the transcript. Listen to the audio (in Dutch, 14 minutes, 13 Mb).
The Dutch in the transcript below has been translated into English by Ben Kearney.
Transcript of conversation March 13th, 2007Daan de Wit: Today is March 13, 2007. My name is Daan de Wit. On the line with me is Willem Middelkoop. This is a new initiative that we're undertaking alongside and in addition to our existing series of discussions. We're going to be speaking to each other more often and in shorter segments; we'll be concentrating exclusively on the latest news. Willem, two weeks ago Monday, the bomb dropped in China. I read in the paper that billions of dollars evaporated, but meanwhile flowers are blooming like always in spring and and it is not exactly the top story of the tv-news every night. What's going on exactly? Willem Middelkoop: The financial markets have become quite restless again. It started on a day when the markets in China plunged 10%, and they ended up restoring themselves rather quickly thereafter. So it was a rather short wave of panic that in total lasted the better part of a week on the worldwide markets. All the markets were in need of a correction; beginning in July 2006 the markets were trending upwards and everyone was wondering: When will the correction begin? So it started with the drop in Shanghai and what we're seeing is that an awful lot of investors have positions with borrowed money, and so they've taken extra positions, and then when the anxiety begins to mount, the corrections occur, and then people end up decreasing and securing their positions. Oftentimes people are compelled to secure their positions by way of risk management programs offered through banks, and that encourages one sale after the other. And then what we see is a 10 to 15% drop all at once, and that doesn't have anything to do with a crash; it's simply a correction or a very big movement upwards. At the low point of this correction, the AEX had fallen from 510 to 470 points, so that's a 40 point drop, and with that we find ourselves at the same place that we were in mid-December of 2006. It seems like quit a lot, but there's actually not that much going on.
Daan de Wit: So it's really much ado about nothing despite the intensive coverage during those few days.
Willem Middelkoop: The concern, anxiety and uncertainty gets magnified because the American economy is now seriously beginning to weaken. After the American technology bubble burst, we saw how American bankers, the Federal Reserve, dramatically lowered interest rates from 6% to 1% in 2002, 2003, 2004. As a result, borrowing was very cheap. And because of this, auto sales remained steady because auto financing could be offered with 0% interest. A huge wave of speculation arose because of these extremely low rates - you could practically borrow money for free in order to speculate with it. And in order to stem the flow of all these excesses and fight inflation, interest rates had to be raised. That's what we've seen during the last year and a half; rates have risen from 1% up towards 5%, and that has meant that General Motors and Ford can no longer offer such cheap financing. And so now GM and Ford have seen a slump in sales of around 30%, which has led to big problems for the auto industry. What we've also been seeing is that, due to the extremely low interest rates from a few years ago, a new bubble has developed - a new wave of speculation in real estate. One out of every three homes sold was purchased as an investment property, and because interest rates have gone up, housing prices have stopped rising. Now that whole wave of speculation that we've seen expanding over the course of the past few years is beginning to reverse itself. So now what we're seeing is that a lot of speculative investors want to convert their real estate into cash, which has led to a glut of real estate offerings in America, which in turn has led to falling prices. And now big problems are beginning to appear in the American mortgage market.
Daan de Wit: There are so many articles published about this at the moment that you'd think that the housing market is collapsing right now, and with so much money in the market that should produce a loud bang. In the meantime it looks as if things might turn out okay. Is it still the case that a balloon is bursting?
Willem Middelkoop: Yes, it really is a balloon that's in the process of bursting. I really think that if you look back at the past year or two, you can make the case that the collapse of the high tech bubble between 2000 and 2003 was child's play compared to what we're dealing with now - the collapse of the real estate bubble. There have been so many excesses that have occurred with the financing of real estate. A very large share of investment properties have been financed with so-called no doc mortgages - these are mortgages in which you don't have to submit a single document in order to get that mortgage - no pay stubs, no tax forms, etc. In this way, anybody could get a loan to finance real estate, oftentimes for the total purchase price. And it now appears that one sector of the market in America has come to define a large part of the mortgage market - the sub-prime lenders market - in which you pay a bit more in interest, say 8% instead of 6%. This way you can get a mortgage even if you have a poor credit history, and you don't have to hand over proof of income. This sub-prime lenders market comprises about 15% of the entire mortgage market in America - that translates into a 1000 billion dollars in a market valued at 8000 billion total, and that's where the big problems are cropping up. It appears that more than 10% of customers of sub-prime lenders are more than 60 days behind on their interest payment and their monthly mortgage installment. And those ten percent are now faced with the forced sale of their home - losing their home and getting evicted. There are some estimates that between 1.5 and 2 million American families are going to lose their home.
Daan de Wit: The comparison with the collapse of the technology bubble sounds somewhat abstract. What do you think the situation will look like when this bubble will collapse?
Willem Middelkoop: What's actually the same, is that you have a speculative bubble in a specific market; a whole lot of money has flowed into that market. This leads to valuations that are way too high. We saw that with technology shares back around 2000. The prices paid for those shares were way too high. There's too much air in those prices. That air leaks out at a given moment, and that's the bubble collapsing. We're seeing the same thing with real estate now - far too much speculative money has flowed into the real estate market. Because of this, prices paid for homes during the past few years have been way too high. Surges in home prices have been much too strong, and that air is now beginning to escape. The annoying thing about it is that once such a bubble starts to collapse, it often ends up being a process that lasts just as long as the upswing did. The upswing in the housing market lasted about 6 or 7 years, and now comes the collapse of that bubble. Things often move quickly at first, but it can take quite a long time before such a market can stabilize and begin to grow again.
Daan de Wit: And so that's why there really isn't a real loud bang.
Willem Middelkoop: It's a creeping process. It's not a crash like on the stock market where 30% can disappear just like that. Home prices fall 6 percent this year, 12 percent next year and 15 percent the year after that. But over the course of a number of years you'll certainly lose 30, 40, 50 percent compared to current levels. That can happen, but it hasn't started yet. We're at the beginning of this process. But the signals coming from the American mortgage market are nonetheless pretty dismal. There are 37 mortgage providers that have now gone under. New Century Financial is about the biggest - it employs 7000 people and has 220 sales offices in 35 states. It's on the edge of bankruptcy, and it would be the 38th to go. This just creates a domino effect.
Daan de Wit: And very matter of factly: people getting evicted from their homes - beyond that, what else do you see?
Willem Middelkoop: Well, I see that 100,000 jobs in the construction industry were lost last year, and that this year another 100,000 will be lost. Perhaps 2 million of the 80 million American homeowners will be forced to sell their homes. The housing market and everything associated with it, from the copper tubing that has to be procured, to kitchens and everything that goes along with that - that's good for 23% of American industry. So if things get worse in the housing market, and the housing market ends up crashing, then that's going to have huge consequences for the economy overall. And then the possibility arises of America going into recession, let's say within 12 to 18 months.
Daan de Wit: Right, and as America goes, so go we.
Willem Middelkoop: There's still one very important factor. Americans have managed to maintain their buying power this past year because they've extracted an average of 7 percent of their household income from the excess value of their home. So Americans have become accustomed to eating up the excess value of their home, and that adds up to about 7 percent of household income. Now that prices are no longer rising, this effect is going to recede sharply. That 7 percent provided an extra stimulus to the economy. American citizens spent an additional 700 billion dollars per year with this extra money. This effect is now going to disappear, and that's worrisome for the growth of the American economy.
Daan de Wit: What does this development mean for renters and home owners in The Netherlands?
Willem Middelkoop: In and of itself, not really all that much. In America the speculation has been massive, and we actually saw that here during the 90's. It's just that back then the excesses were not as great here as they are in America now. We saw some of the air leak out of prices between 2000 and 2003. In Amsterdam for example, prices fell 15, 20 percent. But because of a strong demand for housing, continued low interest rates, and a growing economy, those housing prices have actually begun to rise again. What is worrisome though, is that a whole slew of pension funds have invested in American real estate. Dutch fund ABP for instance has more than 8 billion euros invested in products. And in order to secure those investment products, ABP has actually acquired American real estate as a hedge. If something really does go wrong with the American housing market, it could also cause problems for pension funds that have invested a lot in those types of products.
Daan de Wit: And very specifically, if you're getting ready to buy a house now... Is it advisable, or not? Rent? What's the smartest thing to do?
Willem Middelkoop: Well, that's really tough to say. You can see interest rates going up somewhat now. It's not only in America that mortgage requirements are being tightened - it's too late to lock the stable door after the horse has bolted, as they say - so now the requirements for getting a mortgage are definitely being tightened up. We're actually seeing the same thing happening in Europe. The requirements are being tightened here as well. It's getting harder to obtain mortgage loans that exceed the forclosure value of the home. That's actually keeping housing prices from being able to climb much higher. But on the other hand there is so much money being created in the world that we're still finding ourselves in a sort of inflationary spiral. If you have inflation, then those housing prices are going to keep going up. That's purely because housing prices rise right along with inflation. The risk of a really sharp plunge in housing prices isn't very great in The Netherlands, unless the economy were to weaken considerably. But as to whether you're guaranteed to make a profit if you buy a house - that's not to be expected either.
Daan de Wit: My interviews with you are being published in book form by Nieuw Amsterdam. What else can you tell us about that?
Willem Middelkoop: Right now I'm busy writing the first book, entitled If the dollar falls. It is a collection of the conversations that we have held during the past year, as well as the columns that I've written in the interim. I'm actually trying to explain the major developments in the economy in a very easy and accessible fashion by way of a hundred answers to a hundred questions. It has to provide insight in a very accessible way into everything that's going on at this moment.
Daan de Wit: When do you expect it to hit the bookstores?
Willem Middelkoop: The goal is for it to be in bookstores sometime in June. [The book will be in Dutch. It is not yet known if or when an English translation will be available].