I Predict a Riot

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Tensions are mounting as the housing bubble nears its limits.

Last February the sirens howled in Hollywood as the LAPD rushed reinforcements to the corner of Sunset Boulevard and Western Avenue. While a police captain barked orders through a bullhorn, an angry crowd of 3,000 people shouted back expletives. A passer-by might have mistaken the confrontation for a major movie shoot, or perhaps the beginning of the next great LA riot.

In fact, as LAPD Captain Michael Downing later told the press, 'you had some very desperate people who had a mob mentality. It was as if people were trying to get the last piece of bread.' The bread riot allusion was apt, although the crowd was clamouring in fact for the last crumbs of affordable housing in a city where rents and mortgages have been soaring through the stratosphere. At stake were 56 unfinished apartments being built by a non-profit agency. The developers had expected a turnout at most of several hundred. When thousands of desperate applicants instead showed up, the scene quickly turned ugly and the police intervened.

A few weekends after this tense confrontation, another anxious mob - this time composed of more affluent homeseekers - queued for hours for an opportunity to make outrageous bids for a single run-down house with a cracked foundation in a nearby suburb renowned for its good schools. 'The teeming crowd', wrote LA Times columnist Steve Lopez, 'was no surprise given the latest evidence that California's public schools are dropout factories.'

Los Angeles's underfunded, overcrowded and violent schools, according to a recent report by Harvard researchers, currently fail to graduate the majority of their black and Latino students, as well as one third of whites. Parents, as a result, are willing to make extraordinary sacrifices to move their children to suburbs with functioning public education. This gives the old adage that 'location is everything' in real estate a new twist: housing in Southern California is universally advertised and graded by the prestige of local school districts.

The Southern California housing crisis, of course, has a sunnier side as well. In the last five years median home values have increased 118 percent in Los Angeles and an extraordinary 137 percent in neighbouring San Diego. Homes, as a result, have become private ATM machines, providing their owners with magical unearned cash flows for purchasing new sports utility vehicles, making downpayments on vacation homes, and financing increasingly expensive college educations for their kids. Second mortgages and home refinancings, according to a Wharton Business School survey, have generated an astounding $1.6 trillion in additional consumption since 2000.

The great American housing bubble, like its obese counterparts in Britain, Ireland, the Netherlands, Spain and Australia, is a classical zero sum game. Without generating an atom of new wealth, land inflation ruthlessly redistributes wealth from asset seekers to asset holders, reinforcing divisions within as well as between social classes. A young school teacher in San Diego, for example, who rents an apartment now faces an annual housing cost ($24,000 for a two-bedroom in a central area) equivalent to two thirds of her income. Conversely, an older school-bus driver who owns a modest home in the same neighbourhood may have 'earned' almost as much from housing inflation as from his unionised job.

The current housing bubble is the bastard offspring of the stock bubble of the mid-1990s. Housing prices, especially on the West Coast and in the Bos-Wash corridor, began to rocket in the second half of 1995 as dot.com profits were ploughed into real estate. The boom has been sustained by sensationally low mortgage rates, thanks principally to the willingness of China to buy vast amounts of US treasury bonds despite their low or negative yields. Beijing has been willing to subsidise American mortgage borrowers as the price for keeping the door open to Chinese exports.

Similarly, the hottest home markets - Southern California, Las Vegas, New York, Miami and Washington, DC - have attracted voracious ant columns of pure speculators, buying and selling homes in the gamble that the prices will continue to rise. The most successful speculator, of course, has been George W Bush. Rising home values have propped up a stagnant economy and blunted criticisms of otherwise disastrous economic policies.

The Democrats for their part have failed to seriously address the crisis of millions of families now locked out of homeownership. In a bubble city like San Diego, for instance, less than 15 percent of the population earns enough to finance the cost of a median-value new home. Accordingly, if 'values' were the basis of the Bush victory last November, they were property values, not moral principles or religious prejudices. In the face of the perverse housing bubble, the Kerry campaign was simply running on empty. It offered no compelling alternative to the status quo.

But the Republicans have more serious things to worry about than Democrats. The bubble has already burst in San Francisco, and Business Week (11 April) recently headlined fears that a general deflation - perhaps of international magnitude - is nigh. What will life be like in the US (or Britain or Ireland) after the home-equity ATM shuts down?

The business press, as always, reassures passengers that they are headed for a 'soft landing', a slowdown rather than a crash, but even a mild jolt may be sufficient to end the anaemic recovery and throw all the dollar-pegged economies into recession.

More ominously, some eminently respectable Wall Street economists, like Stephen Roach of Morgan Stanley, have been warning of a dangerous negative-feedback loop between the foreign-subsidised housing bubble and the huge US trade and budget deficits. ('The funding of America', he has written, 'is an accident waiting to happen.')

US military hegemony is no longer underwritten by equivalent global economic supremacy. The housing bubble, like the dot.com boom before it, has temporarily masked a mess of economic contradictions. As a result, the second term of George W Bush may hold some first class Shakespearian surprises.