Escalator Short-Circuit

"Trickle Down" Economics to 'Bubble Up'?

Soft drink aficionado's may recall "Bubble Up" as a long-ago rival to 7-Up.

It may also be the best label for today's, post-crash, post-Trickle Down economy.

Notwithstanding the latest, dire Case-Shiller statistics, Realtors in many cities nationally are reporting more and more instances of multiple offers for deeply discounted, bank-owned foreclosures.

The phenomenon is the logical result of several, reinforcing developments: record low interest rates; a passel of incentives aimed at new home buyers, ranging from the federal government's $8,000 tax credit to local programs that in some cases are even more generous; and dirt-cheap housing prices that compare favorably with the rental market, even after factoring in the fix-up costs associated with many foreclosures.

Which begs the $64,000 question: will emerging strength in the bottom rungs of the market "bubble up" to the middle and higher rungs of the housing market -- and indeed, the overall economy?

The short answer: possibly, but not directly, and not in the way(s) you'd necessarily expect.

Escalator Short Circuit?

If the housing market is an escalator, anything that strengthens the lower rungs theoretically benefits the higher rungs, too.

That's so because entry-level Buyers allow "move-up" Buyers to, well, move up. In turn, owners of middle-bracket homes who can suddenly sell their homes can graduate to Buyers of upper bracket housing (assuming their jobs and credit scores hold up in the Recession -- see below).

Unfortunately, today the linkages between the various parts of the housing market are attenuated, for three reasons.

One. By definition, banks, not individuals, own the foreclosed homes being snapped up. As a result, when a deal closes, the Seller doesn't automatically become a Buyer for another home. Rather, the bank-owner simply credits "cash" on its books and debits "REO" (real-estate owned).

Assuming that the home is sold below the banks' carrying cost for the home -- a safe assumption -- the difference is booked as a loss. And a loss diminishes the bank's capital, and with it, presumably, its ability (and appetite) to lend.

Two. Financing costs for upper bracket homes are still abnormally high. In a market where "conforming" loans (under $417k) can be had for under 5%, jumbo loans still cost around 6.5%. The difference on a million dollar home: an extra $10,000 a year.

Three. A 20% down payment on that $1M home -- preferred by lenders, and the threshold for avoiding mortgage insurance -- is a cool $200,000. Assuming that that money was in stocks, it's likely to have shrunk to something like $150k today, even after the recent stock market rally.

In a tighter credit environment, closing that gap with a bigger mortgage may not be feasible.

None of the foregoing is to say that strong activity in the foreclosure market isn't beneficial. It's just that the benefits are indirect, and not necessarily immediate.

Specifically, shrinking the supply of foreclosures on the market removes a major depressant on home prices; outlays for home repairs, contractor labor, etc. increase economic activity and improve the housing stock; and creating a new class of homeowners with hard-earned "sweat equity" bodes well for future "move-up" housing demand (today's sweat equity is tomorrow's down payment).

Now if there was only a name for this new economic era that didn't have the word "bubble" in it . . .