The housing crisis, like all crises, imparts lessons. The most important one is also the oldest: risk never takes a holiday, even though it may appear excessively sleepy for long stretches.
It’s a simple yet powerful message, although that doesn’t stop any one from ignoring it, as many do. But the warning signs are almost always evident, as they were all along in the housing boom that’s now turned into some degree of bust.
Indeed, any time you hear that a financial strategy or investment product is predicated on the notion that the underlying market is largely immune to the bears, one should assume the appropriate response by running for the hills.
Alas, such caution was arguably in short supply as Wall Street securitized $2 trillion worth of home mortgages over the past 10 years, built partly on the idea that the average home sweet home would never suffer a material decline in price. But as the Wall Street Journal reports today,
much of the promise of the new financial architecture — together with its underlying assumptions — has proven to be a mirage. As house prices fall and homeowners default on mortgages at troubling rates, the pain has spread far and wide. An examination of the resulting crisis shows that it is comparable to some of the biggest financial disasters of the past half-century.
Turning assets into securities is nothing new, of course. From credit card debt to commodities, the boom in securitization has been percolating in the financial industry for 20 years. Arguably the difference this time around is that the underlying asset was thought to be impervious to the bears.
It’s understandable how someone might think so. Looking at year-over-year prices for housing on a national basis, for instance, shows no losses for decades. Indeed, you have to go back to the 1960s to find red ink by this standard, and even then the dip was slight and brief. If we stop there, housing as an asset class exhibits the stuff of legend: enduring and virtually uninterrupted gain.
There’s just one problem with that conviction: it’s wrong. True, housing prices rarely go down, or at least much of the second half of the 20th century tells us. But rarely isn’t never. In fact, there were periods of steep price declines, albeit one has to look back to the 1930s and 1940s for the evidence, which readers can do by glancing at a long-term chart of housing prices courtesy of Professor Robert Shiller via Grant’s Interest Rate Observer.