Norton on Real Estate: How we can benefit from the recession

It has been said, “It is a shame to waste a good recession.” Well, this is going to be a humdinger! And it has been brewing for quite a while.

Think back to the mid-1990s, when we quickly emerged from the recession and real estate collapse. A “dot-com boom” sparked tremendous capital flows and created thousands of jobs. Values went up and up and up.

Remember Isaac Newton? Whatever goes up must come down. People lost their fear in the 2001-2005 period. They saw minimal or no risk in the investments they were making or in the exploding value of their homes and other assets. The Niagara of capital to the United States created cheap money. The average home mortgage payments were level from 1983 until 2007. Yet the median price of a house increased three times. The warning signs were there, but we ignored it. Well in 2008, risk is back.

The U.S. consumer over-consumed, and we did it with credit, not cash. Many (most?) Americans are way over-leveraged, and with falling house prices, many will be squeezed. We are entering a massive de-leveraging phase. In a five-year period, the housing sector seems to have provided 40 percent of the growth in U.S. GDP and employment. Between 2001 and 2006, an unprecedented number of Americans used their homes as ATMs, turning large chunks of residential equity into borrowed but spendable cash.

So where are we? According to Kevin Phillips in his book, “Bad Money,”: “A rising tide of defaults among borrowers with shaky credit histories has, thanks to the way their debts have been scrutinized and sold globally, triggered chaos in the world’s credit markets as asset holders struggle to re-evaluate their risk.”

But it is not just the United States. Other countries copied these financialization tools. The United States may be the first to unwind, but it is truly a global problem. Why did the Chinese ambassador tell the White House that letting Fannie Mae and Freddie Mac go down was unacceptable? Because China held tens of billions of dollars of their notes. We are all in this together.

Others catching up

It starts with America’s purchase of $1 billion a day of foreign oil. We are 3 percent of the world’s population consuming 30 percent of the world’s oil. This is not rational, sustainable or equitable, and yet to date we have only given lip service to changing our ways. Save Ford and GM? Why? For 40 years, they have ignored the inherent inefficiency of the gas-powered internal combustion engine. Yes, they employ thousands of union workers, but these companies are long in the tooth and show no sign of being able to reinvent themselves into 21st century enterprises.

Some time ago, the United States chose to become a service economy. We would let others manufacture. We would be at the top of the knowledge-based pyramid generating intellectual capital. But we failed to grasp that the world is flat and no one holds a monopoly on knowledge, entrepreneurism and value-added. We are good. We were great, but others are catching up.

So what is ahead? The correction, as we call it in the real estate sector, is a de-leveraging. We (well, most of us) will need to scale back our spending, simplify and work longer to get to a point where full-time retirement pencils out. The baby boomers will need to continue to contribute to GDP.

But it is not just households that are upside-down. Look at our corporations, starting with finance but also manufacturing, tech, energy and services. And what about government? The federal deficit in October 2008 is the largest ever. The $700 billion rescue fund equals 7 percent of the outstanding debts of Treasury and surpasses the previous year’s budget deficit by more than 50 percent. It is as large as the defense budget (prosecuting two wars) and 10 times federal spending on education.

God bless Barack Obama. He has his hands full. It is possible that we will bounce back from this market correction quickly (12 months or so), but I do not think so. Unemployment could reach 8 percent in 2009, and that will take several years to fix. So I hope we will use this recession to make real long-term changes in government, in personal savings and consumption, in education, in the environment and our role as responsible leaders in the world.

Bill Norton, president of Norton Asset Management, is a Counselor of Real Estate (CRE) and a Fellow of the Royal Institution of Chartered Surveyors (FRICS). He can be reached at wbn@nortonnewengland.com.