9/25/08 - real estate

In today's encore excerpt - prominent investor George Soros, commenting on the real estate crisis well before the meltdown of the past few weeks:

"The [real estate] crisis was slow in coming, but it could have been anticipated several years in advance. It had its origins in the bursting of the internet bubble in late 2000. The Fed responded by cutting the federal funds rate from 6.5 percent to 3.5 percent within the space of just a few months. Then came the terrorist attack of September 11, 2001. To counteract the disruption of the economy, the Fed continued to lower rates -- all the way down to 1 percent by July 2003, the lowest rate in half a century, where it stayed for a full year. For thirty-one consecutive months the base inflation-adjusted short-term interest rate was negative.

"Cheap money engendered a housing bubble, an explosion of leveraged buyouts and other excesses. When money is free, the rational lender will keep on lending until there is no one else to lend to. Mortgage lenders relaxed their standards and invented new ways to stimulate business and generate fees. ...

"From 2000 until mid-2005, the market value of existing homes grew by more than 50 percent, and there was a frenzy of new construction. Merrill Lynch estimated that about half of all American GDP growth for the first half of 2005 was housing related. ... Martin Feldstein, a former chairman of the Council of Economic Advisors, estimated that from 1997 through 2006 consumers drew more than $9 trillion in cash out of their home equity. ... By the first quarter of 2006, home equity extraction made up nearly 10 percent of disposable personal income. Double-digit price increases in house prices engendered speculation. ... By 2005, 40 percent of all homes were not meant to serve as permanent residences but as investments or second homes. ...

"Former Federal Reserve governor Edward M. Gramlich privately warned Federal Reserve Chairman Alan Greenspan about abusive behavior in the subprime mortgage markets in 2000, but the warning was swept aside. ... Charles Kindleberger, an expert on bubbles, warned of the housing bubble in 2002. Martin Feldstein, Paul Volcker (former chairman of the Federal Reserve), and Bill Rhodes (a senior official at Citibank) all made bearish warnings."


George Soros


The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means


Perseus Books Group


Copyright 2008 by George Soros


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