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Speculation and the New Housing Bubble

David Callahan

Housing prices are coming back and consumers—feeling flush now that their home equity is rebounding—are more confident than they've been in four years. The American middle class is finally getting back on its feet after a half decade of trauma, right? 

Well, not exactly. 

About those housing prices: Yes, they are rising, but it turns out that the primary driver may not have anything to do with the real economy. Instead, as reported today in the New York Times, Wall Street speculators are playing a big role in jacking up prices by buying huge numbers of homes:

Large investment firms have spent billions of dollars over the last year buying homes in some of the nation’s most depressed markets. The influx has been so great, and the resulting price gains so big, that ordinary buyers are feeling squeezed out. Some are already wondering if prices will slump anew if the big money stops flowing.

How many homes are we talking about? According to the article, just one firm—Blackstone—has bought 26,000 homes in nine states. 

This could be a good thing in that "patient capital" is coming to the rescue of a distressed housing market—offsetting all the foreclosures taking place that exert a downward pull on housing prices. 

But speculation should always raise red flags, especially when it comes to real estate. Last time, you might recall, things didn't work out so well. 

It's not just financial firms speculating in real estate. It's also ordinary people, and there are signs that another home flipping craze may be in the works. In Florida, a full 35 percent of homes sold last year were bought by investors. 

It's not as easy as it once was for just anyone to get into home flipping. But it's also not as hard as you might think, given the carnage of the real estate bubble. The mortgage market still remains far less regulated than it was a few decades ago and many of the financial products that speculators used are still readily available. For instance, you can still get super low interest adjustable rate mortgages with rates fixed for a few years before they go up: Perfect for investors who are looking to hold properties for only a short while. 

All this leads to a broader point that I have made here before: America's capital markets do a lousy job of directing money to the best uses. Defenders of free enterprise say all the time that we should trust markets to choreograph economic activity—as opposed, say, to allowing government to play a heavy handed role. But we now have 15 years of evidence of how poorly capital markets do this: first the dotcom bubble, then the housing bubble. Trillions misallocated and wasted in both cases. If it seems like we're heading toward another bubble, that should be no surprise, since nobody has really questioned America's broader trust in markets despite recent history. 

Meanwhile, the New York Times ran a chilling piece over the weekend about the super strategic way that China—which embraces a statist form of capitalism—is investing that country's huge savings and capital assets in a long-term bid for geoeconomic hegemony.

The chess players in Beijing are investing the savings of China's new middle class in emerging markets in Africa and South Asia, while we're leaving in our money in the hands of Wall Street greedheads hoping to make a quick buck in the suburbs of Las Vegas.