From naked capitalism 3/19/07: [Last week] Jim Rogers stepped into the U.S. subprime fray on Wednesday, predicting a real estate crash that would trigger defaults and spread contagion to emerging markets."You can't believe how bad it's going to get before it gets any better," the prominent U.S. fund manager told Reuters by telephone from New York.We agree with a lot of what Rogers says. Liquidity is at historically high levels, which has led to cheap credit (cheap from the borrower's standpoint, overprice from the lender's). There is asset price inflation in almost every market (although thanks to subprimes, the air has come out of the riskier parts of the mortgage market and commodities prices have fallen a bit too). We've pointed out that the Economist estimated that the US housing market was overvalued by 20% in 2005, and a recent chart indicates Americans are paying even more of their incomes than then (meaning the overvaluation has gotten worse). And housing bubbles, when they collapse, usually decline to the point where prices are undervalued relative to incomes and rents.
"It's going to be a disaster for many people who don't have a clue about what happens when a real estate bubble pops. …
The fund manager, who co-founded the Quantum Fund with billionaire investor George Soros in the 1970s and has focused on commodities since 1998, said the crisis would spread to emerging markets which he said now faced a prolonged bear run.
"When you have a financial crisis, it reverberates in other financial markets, especially in those with speculative excess," he said. …
"This is the end of the liquidity party," said Rogers. "Some emerging markets will go down 80 percent, some will go down 50 percent. Some will most probably collapse."
[Top investor sees U.S. property crash, Elif Kaban, Reuters, 3/14/07]
A 20+% declince in housing prices would be devastating, both because America hasn't seen anything like it, and because so many people view their home equity as a usable part of their balance sheet (e.g., they use it for home equity loans, they depend on it to fund retirement).
But that also means the powers that be will do anything they can to stop that from happening. The unknown question is whether they will be effective. In the past, when the monetary authorities have provided liquidity to the markets, investors have piled back in. If for some reason investors didn't respond the same way, we could fall into what is called the liquidity trap, where interest rates are so low that no one has any incentive to invest. That happened in Japan in the post bubble years.
With Fed fund rates at over 5%, the Fed has a good bit of room to rates if the wheels came off (but of course, that just keeps the Ponzi scheme going and probably make the eventual day of reckoning even worse, unless the Fed is able to moderate the decline, rather than attempting to prevent it from happening). So things likely won't get quite as awful as Rogers forecasts. But directionally, we believe he is right. Things will get a lot worse than most people are willing to consider.