Do you really want to know where all that money went? I'll tell you.

[HamdenRice]

I've read a number of posts that ask the valid question of where all the money went. I don't mean the bailout money, but the mortgage loan money that got us into this mess in the first place.

Some of it indeed went to inflated fees of real estate brokers who churned the market. A lot of it went to fees to Wall Street bankers who packaged the loans as mortgage backed securities.

But step back and look at the big picture. The prior two items were largely in the scale of basis points on mortgages. They were vampires on a much larger set of transactions.

When a family borrowed $300,000 for a house valued at $310,000 with assurances that it would soon be worth $350,000 (based on a history of the real estate market over the last few years that made that claim reasonable), and when that house instead declined in value to $250,000 or even $200,000, we ask ourselves, where did the money go that put this family "under water."

The answer: It went to the family that sold the house. It wasn't the reckless borrowers who pocketed the money; it was the prudent sellers. Every bubble -- stock market, tulips, houses, whatever -- eventually gets to what is called on Wall Street, the "greater fool" stage. The "greater fool theory" is well known in finance and economics.

It means that an investment that looks foolish -- paying, say $275,000 for a house that recently was selling for $150,000 -- isn't foolish, as long as there is a "greater fool" willing to pay $300,000. If you managed to make the seemingly foolish investment, but got out by selling to a "greater fool" then you weren't so foolish after all. The theory is also sometimes called the "bigger fool theory" and more descriptively, "survivor investing."

It's basically musical chairs. The people in trouble are the people who purchased real estate and could not find a greater fool.

Everyone who sold real estate before the bubble burst, sold it to a greater fool, and walked away from the market without buying even more inflated real estate, left the game with a small fortune. They are the survivor investors.

They are the people who have the money that broke the system.

[dkf]

1. Yup. People who are underwater are the bagholders...

[RUMMYisFROSTED]

2. An ever diminishing set of chairs. Sounds like a Pyramid/Ponzi Scheme.

Sounds about right.

[TwilightGardener]

3. Yep. A lot of people simply gambled and lost--may not have seemed possible

two years ago that a house could lose so much value, but when the music stops, someone won't have a chair. Them's the breaks, unfortunately. My properties probably have lost some value, because I bought them both within the last 6 years--I probably bought high (compared to today's falling prices), so I'm no real-estate investment brainiac either. My house and my land are worth more to me if I just hang on to them now than if I sold them.

[Skinner]

4. I'd be curious to know how many people actually "walked away without buying even more"

I don't know anyone who sold a house during the bubble and then rented. Most people who sell a house buy another one.

That's what my wife and I did. We sold our house after it went up in value quite a bit. And with all that "profit" we bought another house, which is steadily losing all the equity that we built up in the last one. For regular people like us -- who own one home at a time and buy a new one whenever they sell -- it's basically a wash (provided you got into the market before the bubble took off).

I suspect that the people who *really* got the money you're talking about are home builders, real estate brokers, and the like. They made lots of money from the bubble, and they didn't turn around and use their profit to purchase another inflated house which then lost value.

And the people who *really* got screwed: New buyers who got into the market after it was too high.

[blondeatlast]

5. Life circumstances ahve me looking at a smaller home of much the same value

and same neighborhood--which in my area means very new.

I find it interesting that new builds are NOT dropping much in value--only existing homes. The builders are in good enough shape to scale back and ride things out, it appears. They have not discounted anywhere near in proportion to the loss in value in this area.

I'm stuck in a bigger house than I can keep up (marital situation) and can't possibly move--plus all the equity I've accumulated is kaput.

[HamdenRice]

6. A lot of them walked away into the grave or retirement homes

I was thinking about this because my next door neighbor is one of those struggling homeowners who purchased at the very height of the market. I was very close to the person who sold to her -- my former elderly neighbor. She had trouble selling because she sold at the very apex of the market, just as prices started falling, but she did indeed sell, and went into an assisted living facility, the cost of which was financed by the increase in value of her home from around $16,000 when she and her late husband bought it in the 1960s, to around $500,000 when she sold it. A certain number of other sellers were estates of the deceased -- so the heirs of homeowners got the money and they didn't necessarily turn around and buy. Some were retirees who sold in order to downsize to smaller or cheaper houses.

It's true that many sellers immediately bought. But if you step back and look at the big picture, at the end of every daisy chain of buyers and sellers, there were people who took money out of the market.

To sketch another big part of where the money went, I should have added home equity loans. There were lots of people using the increase in value in the homes to do home renovations or just to get spending money. At the end of the day, Home Depot and local contractors got a lot of that money that was lent out to the mortgage market.

On edit: Because I live in NYC where the housing stock is very old, my perception is probably more skewed toward "daisy chains" of sales of existing homes. If you live in a new suburban area, then yes, the people who walked away with value were basically developers and builders.

[Phoebe Loosinhouse]

7. First of all, I agree with the Greater Fool Theory because it has as a given

AT SOME POINT SANITY HAS TO KICK IN! Just as tulips were never worth thousands of dollars a bulb, that dog house in San Diego was never really worth 650K either. Although the tulip WAS worth thousands of dollars if someone bought it for that and so was the doghouse worth 650K if someone was willing to pay that. It's just that, unfortunately, they WERE the greatest fool and it's all downhill from there.

I've experienced 2 bubbles as a homeowner - once in the late eighties, early nineties, and the recent one. Here are the warning signs when you are approaching the height of a bubble:

People who normally never talk or care about real estate start to talk and care about real estate and share latest sales figures with each other - "Hey! Did you see that that little piece of shit house on Kumquat Lane sold for 399K? My house is twice as big as that house!"

Your moronic brother-in-law quit his job at the fish gutting factory in order to "flip houses".

By the way, your equity in your house is your security of last resort. I don't think you should EVER tap it for things like cars, TV sets, etc. It makes no sense to finance a depreciating shorter lived asset with your house equity despite all the geniuses who will tell you it makes sense "from a tax perspective". It makes more sense to tap it for repairs or maintenance or improvements if you must, but why not do things the way our parents did - save and then spend. I think we will go back to that more frugal model out of necessity.

[HamdenRice]

8. I read recently a semi-humorous article blaming Home & Garden TV for the bubble

Your comment:

People who normally never talk or care about real estate start to talk and care about real estate and share latest sales figures with each other - "Hey! Did you see that that little piece of shit house on Kumquat Lane sold for 399K? My house is twice as big as that house!"

Your moronic brother-in-law quit his job at the fish gutting factory in order to "flip houses".

<end quote>

Well, H&G TV, The Learning Channel, etc., had all these preposterous shows like "Flip This House," Moving Up (?), etc., that convinced so many people that they could make a years' salary buying some piece of shit house, putting in $30,000 in repairs and selling it for $100,000 more than they paid.

Who was it who said of Wall St., that you know you are in a bubble when shoe shine boys start giving stock tips?

[Phoebe Loosinhouse]

10. Those shows were preposterous

And who REALLY benefitted from those shows? Home improvement companies.

They usually ended the show with the flippers "projected" profit IF they sold IF they got their price. They never showed real estate commissions, sellers closing costs, or Short or long term capital gains. I use to sit there and total those apects in my head and go ca-ching!ca-ching!ca-ching! = LOSS! Then they started putting alittle warning at the end of the show like the warning they have on cigarette packages - Warning! House flipping is not for every one and has been deemed to be potentially harmful to your financial health, or something like that.

Some of the later shows went back and did and update and that is where you see that very few have the kinds of returns that they dreamed of - a couple, but not many.

[HamdenRice]

13. It did reflect a short term speculative atmosphere

I realized there was a bubble when two local bartenders -- both young women working mostly for tips -- were trying to flip million dollar houses. One, a Brazilian immigrant, was trying to flip a three family rental property in Newark, New Jersey.

The other was from Ireland and was trying to flip something back home.

When your barmaid is a paper millionaire in assets (but with a million in debt), you know you're in a bubble.

[ejpoeta]

9. some people just did want to buy a house, and the prices were so inflated

that most people couldn't even afford to get a house. i think that is part of how we ended up with people in homes they couldn't afford. The inflated prices. I mean, in many ways, it's like the family with 2 kids buying a big hummer or something. why!! why do you need that big huge suv when you live in the suburbs and have 2 kids!! someday you might go off road or in the country or something!! I remember when i worked out rochester way, and I would drive towards work and see a subdivision back behind the houses on the road. and there was this one house that had two hummers sitting in the driveway. i would just shake my head. Then there were people with 1 or 2 kids who would buy these massive jumbo sized houses. i never could understand it myself. sure, it would be nice to have a great big house, but we didn't need it. we had one kid at the time. our house now is 3 bedrooms, but we have 2 kids.... and it was huge to us compared to our previous home that was less than 1000 square feet.

whenver i see those big huge houses, my first thought is always how much work it would be to keep clean. LOL! crazy, huh.

[ecstatic]

11. Musical chairs is a great way of looking at it

I wanted to sell for a reasonable price (before all hell broke loose) but was urged to price my place more. If I had stuck with my original price plan I probably would have made it out on time too. I suppose the same thing happened with my mortgagor, WF. I was being shipped around left and right but since everything went haywire, they've remained my bank for quite some time.

[seabeyond]

12. i have been looking to buy little house to rent to niece. 15 yrs ago i paid 31k

really a good deal (in amarillo, texas, houses are much lower than other places) even in this area. brick, good neighborhood. two bedrooms one bath. looking 15 years later i am being told these very same homes are selling for a 100k. makes no sense to me at all and i keep putting offer much much lower. i refuse to pay that kind of increase.

realitors think i am whacked.

i may be

i dont know. it just seems wrong.

[ljm2002]

14. I don't think your theory accounts for all of the money...

...not if the figures bandied about are accurate. Mortgages don't account for the trillions and trillions of dollars that seem to have vanished into thin air.

So while I think you are right about where *some* of the money went, I think it is only a small part of the larger story, which is that trillions of dollars were essentially created out of thin air as bits and bytes and complex "financial instruments" that were bought and sold in a another bubble market by unscrupulous financial gamers. There, too, we have seen an outcome somewhat like musical chairs. Now in the USA, the taxpayer is the one left holding the bag. Oh, it was the banks and financial institutions who really were caught at the end with nowhere to sit, but the powers that be have decreed that it is Not Allowed for "certain" people / institutions to be caught up in that way, so we'll just Change The Rules now that the game is over, and reinstate the natural order of things, which is that Only The Little Guys Are Left Holding The Bag.

[HamdenRice]

15. Most of the stuff was built on mortgages though

That's what's at the base of the crisis. Banks made millions bundling mortgages, but they could only make so much. On a bundle of say $500 million, the fees were around a million or two. The big losses were actually down there at the bottom where the defaults on mortgages are happening. Everything else pyramided on that.

[ljm2002]

16. "pyramided" being the operative term...

...look, we've all read the reports that there were trillions of dollars based on derivatives, whizzing around the globe. And we've all read the reports that, if the government wanted to, it could just pay off the bad mortgage debt once and for all -- which would be a lot cheaper than what they are actually doing.

So you tell me, how does that add up to the mortgage defaults being the root of the problem? Sounds to me more like the mortgage defaults were just a catalyst that allowed the holders of those AAA-rated financial instruments to realize they'd been had. But even that does not account for the bogus amounts of money involved.

No, I'm sorry, I still believe that what has really happened is the exposure of massive amounts of fraud in the financial systems, and the fraud was not due to the little guys at the bottom but to the fat cats who skimmed every step of the way while they sold overvalued and fraudulent financial instruments to every bigger fool they could find.