Many of you may be familiar with the show American Greed on CNBC. The show highlights examples of greed and corruption in rather dramatic case examples. This weekend, they had a couple of Southern California men from Compton, that decided to swindle church goers by convincing them that they could buy luxury cars such as Mercedes and BMW models for as low as $1,000.

One of the men, who had what appeared to be a case of inflated ego and an addiction to Pai Gow, claimed that his adopted father had left him millions in an estate which included these cars. At his father’s request and graciousness, he wanted only to sell the cars to people of faith. The two men recruited two women to be the front people of the scam which spanned the entire nation.  The women portrayed themselves as good church goers usually winning over their victims with a subtle approach. As they would sell the story and an offer too good to be true, the cashiers’ checks started rolling in netting them $500,000 per month. When all was said and done, the scheme brought in $21 million. In the end, investigators were able to collect $12 million of this money while the other money was gone through gambling here in Southern California casinos or other vices.

As they interviewed the people in the story, many wanted to believe with their heart that this fantastic offer was true. After all, how can these people that seem so honest and appear so trustworthy be perpetuating an elaborate scam? Who doesn’t want a luxury car for $1,000? The show really gives us an example of consumer psychology and human nature. I would venture to guess that many people watching the show thought, “how can people be so naïve?” while they live in homes that they believe are worth inflated values that probably go beyond the $1,000 many had deposited for the cars sight unseen.

It is an astonishing fact that last year, the median home in California lost $3,000 per week and home prices are being slashed at record rates. Yet somehow, people still don’t look at the housing market as a risky speculative play. In many cases, current sellers are simply wishfully hoping that they get higher prices without having any basis in economic fundamentals. The reluctance for many to accept that real estate values were hyper inflated is still an issue that they wrestle with since it contradicts years of ingrained housing belief.

Even the actions of market participants shows a tinge of denial. For the large part, the number one suspect of all this mess was made out to be credit. The primary cause is bubble prices and the fact that credit is tighter is only a symptom of the disease, not the core issue. Yet the narrative going around the media is centered around sub-prime, credit crunch, and foreclosures. We don’t hear stories with the headlines, “today, we are facing more problems due to the overpriced housing market.” What we get is a dialogue that focuses on the disease and not the underlying cause.

This is highlighted by the lack of discussion regarding “lost” equity that simply has vanished into thin air over the past year. The Case-Shiller 20-City Index shows that home prices have declined 10.7 percent. This index is probably one of the best indicators of overall national home price increases and declines since it does a good job representing the nation looking at 20 metropolitan areas. Looking at data from the Census Bureau, we find that:

31.8% of all U.S. owner occupied homes do not have a mortgage

According to the Federal Reserve Flow of Funds Report, $10.5 trillion in mortgage debt is outstanding as of December of 2007

We also know that homeowner equity is at 47.9% at the end of the fourth quarter, an all time record low since the Fed started keeping track of data in 1945.

Given this information, we can estimate that the current total residential housing value is roughly $20.15 trillion. ($10.5 trillion in mortgage debt + $9.65 trillion in equity)

If we then extrapolate this information with the recent Case-Shiller Index decline, we realize that over $2.41 trillion of residential housing value has evaporated into thin air

($20.15/.893)=($22.5644) | $22.5644 – $20.15 = $2.41 trillion

Keep in mind that we are not using the peak price of the market. Estimates range from $23 to $24 trillion. It is becoming rather clear that when all is said and done, we may be seeing 20 to 30 percent nationwide declines in home prices. How much more equity will this destroy? Let us run the scenario further:

Drop	Equity Lost
Current 10.7% drop	$2.41 trillion
20% drop	$4.28 trillion
30% drop	$6.29 trillion

The problem of course is not necessarily with those with no mortgage, but many who bought at peak prices with very little equity. Those that went in with no money down, 5, 10, even 20 percent down stand to be underwater when the market reaches its bottom. Recent estimates place 8.8 million households underwater. Given that there are 51,234,170 households with mortgages in the U.S. that puts 17 percent of those with mortgages underwater. Nearly 1 in 5 people with mortgage debt now have zero equity in their home.

It was for the most part a large faith in housing that kept this bubble going for so long. The faith that home prices never fall. The belief that selling a home would always net a profit. The idea and trust that was put into Wall Street and those in the real estate industry. There is an excellent passage in Lords of Creation by Frederick Lewis Allen, written during the Great Depression in 1935 that highlights the current mob mentality:

“In part, the vast prestige of business was due to the vigorous pressure of majority opinion upon the heretical, a pressure most heavily felt in the small city or town. The orthodox thing to do was to boost the town, to follow the lead of the Rotary and the Chamber of Commerce, to accept without question the policies of the economic masters of the community; the heretic might retain his technical freedom of speech and of action, but there were a hundred ways in which he might be made uncomfortable. To question the soundness of a local real-estate development, to question the rates set by the local electric-light company, to believe in labor unions, was in many communities to be considered queer, or unreliable, or even “un-American,”-to have trouble, perhaps, in getting credit at the bank, or getting a job, or making sales; to meet opposition when one sought admission to clubs and other organizations; to be looked at askance at social gatherings; to be, in short, at a general disadvantage in the great race for success and prestige.

Yet even the flood of propaganda and the pressure of majority opinion could not have been effective unless most men and women had not wanted to believe that the business man was the heir to the ages, that independent business was the great American cornucopia of plenty. In part, the chorus of acclaim which we have been analyzing was quite spontaneous. As prosperity advanced, a natural market was created for the flattery of big business. The reason why The Man Nobody Knows, which described Christ as “a startling example of executive success,” was for two years the best-selling American book in the non-fiction class, was that ordinary men and women had become ready to listen to endorse such preposterous doctrine. The business propaganda of those days is not to be thought of as the dark device of a minority to convert or bamboozle a skeptical majority. It merely reflected and intensified the views of the crowd, merely added somewhat to the size and velocity of a snowball which was already rolling downhill.

For seven years the big business man enjoyed a golden age of power and public obeisance. For seven years the public distrust of Wall Street steadily diminished, until by 1928 and 1929 the big financiers, like the big industrialists, had become the object of a general veneration. Rich men predominated in the Cabinet at Washington; cartoons which depicted the millionaire as a portly gentlemen with a greedy face and a huge dollar-mark on his convex waistcoat became a rarity; the dissenting voices of the radicals and the skeptics were drowned in the hosannas of the faithful. It was the rulers of big business who held the golden keys to a golden American future.”

And so we are having the end of our seven fat years of housing. The mass psychology will slowly turn as it always does in major economic downturns. Sometimes things are too good to be true and housing going up as it did required a faith that propelled those in the dot com era to believe that companies with no earnings had a value of billions of dollars. The only time that equity was real is if you sold your home and after escrow closed, you left with a cashiers check and not one for a BMW in some Central American trust. Otherwise, you are waiting for a housing Ferrari to drive up in your driveway.

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