The Credit Bubble

While I was in college, I watched my father make a respectable living during the California real estate boom of 2004-06. Where I grew up, there are no jobs to speak of, and just one resource: space.

In larger and larger numbers, families were leaving the Greater Los Angeles Basin and the Inland Empire to come live in the high elevation desert along the 15 freeway to Vegas. The main reason being that they could buy a huge house on a lot of land for the same price as a cramped house in the L.A. suburbs.

Rocketing real estate prices in and around L.A. made lenders feel safe offering massive gluts of credit to less than credit worthy borrowers (because they could always refinance as more equity materialized out of thin air). This rush of credit fueled the mass exodus and the subsequent building surge in the desert. Vast suburban tracts popped up more or less overnight.

Building homes, however, takes quite a bit more time than just offering somebody $750,000. Naturally, there was a constant lag between the demand for new housing and the supply. My father, during that time, would often remark that he could not keep up with all the calls for buyers he was getting and did not worry at all about a deal falling through, as there seemed to be five potential buyers waiting in line to take up the slack.

As a result, the gap between housing supply and housing demand (the corporate home builders, like Pulte, were slow to get in the game) spurred outrageous real estate price hikes (exact numbers). These, in turn, further justified loose and aggressive lending.

Before I had gone to college, I had worked as an electrician’s assistant, running copper through the frames of these rapidly erected houses. In some of these housing communities, the conspicuous consumption was not all subtle. Families would refinance or take out second mortgages on their homes in order to buy a massive boat or RV. Even at seventeen, I had only one reaction: “What asshole buys a fucking huge boat when the nearest lake is in Nevada?” As far as I could tell, I was pretty much alone in this sentiment. The madness of the boom had taken everybody.

There were both immediate and long-term repercussions to this madness. For each house built, the city would get a sizable fee, on the order of 10K. It was clearly in their best interest to attract builders, especially large corporate builders. Large-scale builders, however, only wanted to build what they could sell–homes–not parks, schools, roads or other infrastructure.

It is to be expected that an elected council acceded to the large builders in allowing them to build homes for tens of thousands of families without requiring them to invest in any sort of infrastructure for the city. Ostensibly, the 10K fee should have been put aside for these purposes, but instead was used to satisfy immediate needs.

So the city was left with vast tracts of housing and no infrastructure to support the incoming families. And when the market collapsed, they would be left with fields of homes which, I suspect as happened in the real estate collapse of the early nineties, will become massive low income neighborhoods difficult to police and rife with crime.

It is easy for me in retrospect to say that I had seen it all coming–that I had recognized that real estate prices were grossly inflated and that the end was coming. I recall imploring my father to reinvest his proceeds into something that might provide a stable, pleasurable vocation for a semi-retired man, like buy and manage a hotel by the ocean. I can, however, say with certainty, that I had had no idea *when* the bubble was going to pop.

I think I can say fairly easily what the blindness-in-the-market was then: speculation. Speculation created a market for asset-backed derivatives which grew to such proportions that eventually the value of a bundle of mortgages as a bond to be traded eclipsed its value as a stable source of banking income. When this happened, banks began to “originate and sell,” that is, issue mortgages for the purpose of selling them immediately to companies who would repackage them as derivatives.

This rush to create paper naturally (artificially) increased the value of property, which brought the second wave of speculation–on property itself. Soon, investors were buying swaths of desert land in the hopes of just turning a profit.

Market incentives created the wrong environment. It created a massive spread of cheap housing in an area that had enough water to support one fifth of the population and required air-conditioning eight months out of every year. Furthermore, everybody’s job was still in the LA basin, which meant that commuters were spending prodigious amounts of fuel everyday carting themselves to their jobs–about a ninety minute drive away.

Who profited, and who took a loss? The homebuyer, if they held onto their home, took a loss, and if they didn’t, they took a major hit to their credit. The homebuilder made a sizable profit, but had to close up shop when the market soured, and had to eat any inventory that they were stuck with (raw land, houses). The traditional banks that made shoddy loans and shouldered their own risk took a huge hit, while “originate and sell” lenders made massive profits (their risk had been sold off to be repackaged as asset-backed derivatives and peddled to the national investor–ultimately the U.S. government would insure that risk).

What would a “healthy” market have done? Well, my opinion is that a healthy market does not reward usury. Billions of dollars were made selling bonds of insurance policies insuring derivatives constructed out of mortgage bonds made of many many mortgages. To what social purpose is this level of financial abstraction? To what social gain is this inflated pile of leveraged paper? A “healthy” market is one which rewards those who provide a service of some social benefit.

“Speculator” is not a job. As far as I am concerned, a speculator is a professional gambler–somebody who is trying to subvert risk in order to exceed the natural time-value of money. Notice, of course, that I am not indicting venture capitalists, who by virtue of their investment and labor, create a company, a technology, a service, an innovation. It is an indictment of an economic structure which attracts its best and brightest to the effort of shifting piles of paper and inventing new, more abstract ones to no social consequence.


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