Belated Take on Jim Rogers’ Prediction of Housing Market Meltdown

A couple of days ago, we took a dim view of an “alarmist” (and more important, inaccurate) analysis of alleged real estate losses at commercial banks. The reason we took issue with it was that is was wrong on several critical counts, and its conclusion was therefore off base.

We use the word “alarmist” with Jim Rogers for different reasons. We think he is likely correct (although it is possible that the powers that be will somehow keep the confidence game going). We just think he’s unnecessarily dramatized his viewpoint to make sure he got air time.

A Reuters story last week, “Top investor sees U.S. property crash,” Rogers predicted that the explosive growth of liquidity will go into reverse, and will take down inflated asset prices rapidly, including US real estate and emerging markets:

Commodities investment guru 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.

“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.

“It is going to be a huge mess,” said Rogers, who has put his $15 million belle epoque mansion on Manhattan’s Upper West Side on the market and is planning to move to Asia.

Worries about losses in the U.S. mortgage market have sent stock prices falling in Asia and Europe, with shares in financial services companies falling the most.

Some investors fear the problems of lenders who make subprime loans to people with weak credit histories are spreading to mainstream financial firms and will worsen the U.S. housing slowdown.

“Real estate prices will go down 40-50 percent in bubble areas. There will be massive defaults. This time it’ll be worse because we haven’t had this kind of speculative buying in U.S. history,” Rogers said.

“When markets turn from bubble to reality, a lot of people get burned.”

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.

“Right now, there is huge speculative excess in emerging markets around the world. There will be a lot of money coming out of emerging markets….

When the last bubble burst in Japan, said Rogers, stock prices went down 85 percent despite the country’s high savings rate and huge balance of payment surplus.

“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.”

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.

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 coures, 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.