Why the Bubble will deflate slowly and painfully
Chuck Ponzi September 12th, 2006
First off, my apologies for the long time between posts. It has been a jam-packed month so far professionally, and I’m happy to say very enjoyable… although it does not allow me much time to blog.
While I may draw some ire from believers in the bubble blogging community with this post, I am compelled to explain why I believe we are in for a protracted slide and not an all-at-once bust.
I have heard far-fetched ideas as related to the housing bubble pop that include 6 months to a year to revert to the mean… based on human psychology, I sincerely doubt that this will occur.
The human psyche is too rooted in its ways to give way to the panic du jour. Some have compared the housing bubble to the stock bubble, while simultaneously forgetting that most stock bubbles take more than several years to unwind from top to bottom. In classical economics, this was referred to as “price stickiness”, but has evolved into a much more intense discussion with behavioural economics
Periodically, I flip to the NewYorker’s articles for some good meaty discussions, but rarely do they have much economic merit. For the most part, they are good at capturing the zeitgeist, but little more on explaining it. A great article recently came to my attention.
The writer takes us on a descriptive walk through the human’s typical response to losing money…
Like many people who have accumulated some savings, I invest in the stock market. Most of my retirement money is invested in mutual funds, but now and again I also buy individual stocks. My holdings include the oil company Royal Dutch Shell, the drug company GlaxoSmithKline, and the phone company British Telecommunication. I like to think that I picked these stocks because I can discern value where others can’t, but my record hardly backs this up. I invested in BT in 2001, shortly after the Nasdaq crashed, when the stock had already fallen substantially, only to watch it slide another fifty per cent. I should have sold out, but I held on, hoping for a rebound. Five years later, the stock is trading well below the price I paid for it, and I still own it.
The writer turns to some professionals to explain the phenomenon…
In order to depict economic decisions mathematically, economists needed to assume that human behavior is both rational and predictable. They imagined a representative human, Homo economicus, endowed with consistent preferences, stable moods, and an enviable ability to make only rational decisions. This sleight of hand yielded some theories that had genuine predictive value, but economists were obliged to exclude from their analyses many phenomena that didn’t fit the rational-actor framework, such as stock-market bubbles, drug addiction, and compulsive shopping. Economists continue to study Homo economicus, but many recognize his limitations. Over the past twenty-five years, using methods and insights borrowed from psychology, they have devised a new approach to studying decision-making: behavioral economics.
This behavioral economics was the topic of a recent response to a poster under a different heading:
realist said…
23,000 homes on the market simply shows the popularity of real esate.Realist…
I had to read your post several times to reall see if you actually wrote that. That is one of the funniest things I’ve read by a poster. That’s a good one. I don’t often get a chuckle from posters, but that really shows how disconnected people can become from economic fundamentals.If anything, excess inventory shows nonpreference, not high utility.
I’m surprised you’re spouting “classical economics” when you’re actually referring to neoclassical economics in your discussion of preferences and utility maximization. Smith would roll over in his grave if someone tried to pin financial manias on his economics theories!
In fact, neoclassical economics best underscores the presense of bubbles through a review of methodical individualism.
Here’s a quote from Wikipedia’s entry on neoclassical economics:
“This classic approach included the work of Adam Smith and David Ricardo. However, some economists began to say that prices for a product did not always reflect the expected value as indicated by the costs of a product. They proposed a theory that the cost of a product was not expressed in its price, but that this can be explained with differences in “utility.” Economists began to explore the way that elements such as supply and demand affected price, and neo-classical economics gradually came into being.”One of the best theories that ever came out of the neoclassical theories of economics is one that San Diegans are about to experience: Marginalism. Essentially, that prices are determined on the margin, not solely based on aggregate demand and aggregate supply.
Behavioural Economics, an offshoot of Neoclassical economics best describes the type of manias that evolve through expected and discounted utility.
Again from Wikipedia:
Cognitive biases have real anomalous effects only if there is a social contamination with a strong emotional content (collective greed or fear), leading to more widespread phenomena such as herding and groupthink. Behavioral finance and economics rests as much on social psychology as on individual psychology.
I recommend people move out of Southern California if they are not happy with current housing prices. Many people are disastrously overleveraged, and will live the worst kind of life to stay and avoid a loss; if you want a better life, you may have to compete with them for jobs, housing, and everything else. Ever tried to use logic to bet against someone who has nothing to lose? Hint: they don’t bluff too easily when they have nothing to lose with an increased bet and an escalated level of commitment.
From Wikipedia:
Escalation of commitment is the phenomenon where people increase their investment in a decision despite new evidence suggesting that the decision was probably wrong. Such investment may include money (known informally as “throwing good money after bad”), time, or — in the case of military strategy — human lives. The term is also used to describe poor decision-making in business, government, information systems in general, software project management in particular, politics, and gambling …
Irrational escalation (sometimes referred to as Irrational escalation of commitment) is a term frequently used in psychology, philosophy, economics, and game theory to refer to a situation in which people can make irrational decisions based upon rational decisions in the past or to justify actions already taken. Examples are frequently seen when parties engage in a bidding war; the bidders can end up paying much more than the object is worth to justify the initial expenses associated with bidding (such as research), as well as as part of a competitive instinct.
We may soon find that sellers are even more stubborn on prices, and buyers even more stubborn themselves to “end this protracted standoff”. On the seller’s side because of ego, on the buyers’ side because of the inability to finance the price. Real estate professionals that are hoping for a quick resolution to the high inventory levels, may find that working them off quickly with an even lower volume of transactions won’t happen.
This is how seemingly benign “slowdowns” can turn into protracted panics. Noone wants to use the exits until everyone else is already there.
The much-written about mean reversion of incomes and rental ratios to housing costs will happen, the only question how long will it take. In my “Soft Landing, Depends on What You Consider Soft” post in April last year, I outlined a “soft landing” scenario (a term actually coined by Leslie Appleton-Young who interestingly enough no longer feels comfortable using that phrase and now publicly wishes she had not uttered it). If you believe in a 22 year less-than-inflation soft landing, I am confident that you will find that there are better investments than housing, even with the advantage of leverage. If you believe in something more accelerated, hold onto your boots, it might be a bumpy landing.
My advice?
Do what makes sense for you, but don’t worry about living your life based on the price of a home. As I said before, California is not the land of the promised, and yes, I believe that there are still areas in America that would not be considered a bubble. With the increasing portability of jobs, companies may find that near-shoring of jobs through allowing employees to work remotely is cheaper than they had previously thought.
Some time ago, I grabbed a quote from a fellow blogger, only to leave it packed on my back shelf waiting for the appropriate time to use it. The source of this quote is here. The poster of this quote is Robert Coté
California affords opportunities that transcend class and socioeconomics barriers.
There is no nation on earth as balanced and blessed as is the nation-state of California.
Everyplace else is enhanced by association with California, diminished by its absence.
California retains the ability to reinvent itself, does not take itself too seriously, and is not afraid.
People continue to flood in at the bottom and trickle out at the top to spread the story.
Optimism, while not the exclusive provenance of California is guiding principle.
Leadership brings criticism. Pioneers suffer more than those who follow. California continues to worry about the future prefering that to dwelling on the past. A big gangly adolescent, there is much for the state to learn the hard way but much promise as well.Don’t ever bet against California. Short the near term sure but go long.
I would like to remind readers that California holds a special spot in my heart, but that it is not the center of the universe. While Robert describes the California of the previous 25 years, it seems that it does not describe the California of today… opportunities are only as good as the backdrop they are in front of. Because of this, California’s opportunities do not look so great right now.
Finally, my apologies for the rushed nature of this post, and my lack of recent posts… I will be contributing more, so please check back on a regular basis to see if anything new has poppsed up!
Anon 9:36,
i can only speak for myself, but i don’t have anything against property owners — what’s wrong with owning property? i don’t even have anything against people who take out carzy I/O neg ams, but I’m not going to cry when they’re out on the street either. but i won’t take offense at your comments, i know it’s just the scared ravings of a terrified real estate agent who sees the end of the ponzi scheme coming. can’t be a good feeling, can it, just sitting there watching your whole world fall apart. i think it’s your fear of impending bankruptcy that makes you sick to your stomach, not the posts on this blog.
Great House Flipping site!
http://thisoldhouseflip.blogspot.com
Today’s LA Times:
http://www.latimes.com/busines.....-headlines
Homeowners should be scared, VERY scared
according to housingtracker.net inventory in OC has gone down 3% in the last month. Could this be sellers pulling their houses off the market? If so we should see prices level off for the moment and start rising again next year.
Hi. I’m a long-term renter who has been too shy to dump my wheelbarrow full of cash anywhere to do much good. No financial genius!
And I admit I want it all to pop. I worked very hard for my money doing a real job, and I saved.
I despise a country full of lazy bums who push paper, and ‘reap’ (rape) big profits, out of other people. The word greed just isn’t strong enough. It’s not illegal but it is immoral to flip, and gouge and grub for free money. Well, nothing’s free.
And though I want it to pop, I fear that the previous poster who said we may all go down with the explosion may be right.
We may all pay for the sins of the flipping jerks, and the collusion of theives called the RE professionals who hyped the sad naive middle class into ruin.
Thanks for listening…
reinthefall,
you mean like the retarded deluded real estate agent with the anonymous post above yours?
hey realtor, maybe if you click your heels together, that will send prices up next year too, you idiot! ha ha ha.
“according to housingtracker.net inventory in OC has gone down 3% in the last month. Could this be sellers pulling their houses off the market? If so we should see prices level off for the moment and start rising again next year.”
whoever posted that is the stupidest human ever. and i bet their parents told them so too.
Hey just wanted to say very well done on the Sept 12 post. Not many people are venturing to write about why inventory is so high and your explanation is valuable, and more fun to read than most of the other bubble blog Madame DeFarge hysteria.
Another thing that hasn’t been pointed out is that the high inventory versus sticky median price is a very scary indicator of where prices are headed. It’s no different than a produce stand or car lot with excess inventory — if you want to sell overripe bananas, mark ‘em down to a nickel a pound and you’ll find buyers will magically reduce your stock.
This will delight all you bubbleheads, NOT!!! UCLA Anderson is forecasting NO SIGNIFICANT PRICE DECLINES. Prices are NOT coming down, if you’re foolish enough to think prices will crash, that is your own loss.
http://www.ocregister.com/ocre.....290210.php
My advice is to do what you can to get into the market especially before prices start going back up again.
For those that can afford it start with a condo and work your way up.
For those who can’t afford housing in SoCal, tough luck, the world is not fair! Move out of California, there are always other places with lower cost housing. My view is that if you don’t make at least $75k household income you shouldn’t even be thinking about buying.
guys, there is no bubble, this is just hype by the media to improve ratings. If you want the real scoop goto:
http://www.dnn.tv
watch the reports that say real estate is still doing very strong in many parts of the country. For SoCal we can’t expect 20% appreciation anymore but I would say 5-7% a year from now is pretty much a safe bet.
“This will delight all you bubbleheads, NOT!!! UCLA Anderson is forecasting NO SIGNIFICANT PRICE DECLINES. Prices are NOT coming down, if you’re foolish enough to think prices will crash, that is your own loss.”
to whoever wrote this: again, you are the biggest retard on earth and you have such enormous powers of denial that you need therapy immediately. the guy who was the brains behind the UCLA Anderson forecast recently left to start his own consulting firm because the forecast has sold out to the industry. and he is predicting nothing but gloom and doom. if you knew anything about real estate in SoCal you’d know this but i wouldn’t expect you to know anything about this since you’re a real estate agent! you people really are such a bunch of clueless know-nothings it boggles the mind. and YOU are the dumbest one of all. p.s. — did you ever get left back in grade school? just once or more than once? i can’t wait until one day when you hear a noise outisde your home and you look out the window and it’s the repo man towing away your Mercedes. HA HA HA HA HA HA HA it’s coming. you heard it here first!!!
“guys, there is no bubble, this is just hype by the media to improve ratings.”
my apologies to the person who wrote about the UCLA Anderson forecast. you are the SECOND dumbest person/real estate agent on Earth after this idiot.
i wonder if somewhere out there is a lonely stock broker still telling us how Yahoo is headed toward $900 a share and how Amazon will be three grand a share any day now. because that’s what the real estate agent who post on this board are — NO DIFFERENCE. the ship has sailed guys. done. over. pull your head out of the sand and open your eyes. how sheltered a childhood did you have that you think money grows on trees? do you still run to mommy and daddy whenever you get a boo-boo?
It’s amazing how terrified you guys are — we can practically see the sweat dripping from your real estate agent brows onto your desperate pleading posts.
you are a sad, sad group of idiots. and the best part about all of you: you’re so easy to have no sympathy for at all. none. start practicing “would you like fries with that?” now because you’ll be saying it for real in a few months. I CAN’T WAIT!!!
This will delight all you bubbleheads, NOT!!! UCLA Anderson is forecasting NO SIGNIFICANT PRICE DECLINES. Prices are NOT coming down, if you’re foolish enough to think prices will crash, that is your own loss.
I hate to break this info. to ya, but the San Diego asking price median is already down more than 10% from its peak made on 09/01/2005 and is currently declining at a rate of 1 to 2% per month.
[Link]
If you can not readily acknowledge this one simple FACT, then you really do have your head firmly lodged where the sun doesn’t shine..
i live on the westside of los angeles. prices have already fallen $200,000 here. what once was 1.2 is now an even million. so what is that, 16 and two-thirds percent ALREADY? and it’s just beginning.
so who are you trying to convince, us or yourselves?
p.s. — the UCLA Anderson forecast said the housing bubble was about to pop three years ago and prices have what, doubled since then?
so that gives you a sense of how much credibility you should give their forecasts. i bet the real estate community wasn’t touting those forecasts when they went against them — i don’t remember too many realtors back then saying “uh-oh, ucla says prices are about to drop so folks, you shouldn’t buy that house i just showed you!” but now, in their desperation, it’s like a buoy in the swamp of their own vomit that they’re drowning in, so they see it come along and they cling to it for life.
i am not one who wants to see the real estate community take a personal hit — what good will that do? these are people with families and most are honest i really do believe. but people, wake up and smell the coffee! especially when it’s burning a hole in your lap!
now I’ve heard that foreclosure properties are sold “as is” without allowing for an inspection? If so, I would take at least 20% off the price right there to allow for any surprises later on. All these foreclosure properties that will begin to flood the market soon may be good buys but as I said always allow that 20% margin if you don’t do any inspections.
The level of stupidity has reached new highs I tell ya! The other day this speculator guy I know was bragging how his condo in Vegas which he bought last year for $143k is now appraised for $177,000. The thing is that units bigger than his in the same neighborhood are selling right now for $135k and the ZEstimate for his particular property itself is $142k. So I am guessing there is a TON OF FRAUD in the appraisal process.
Secondly, what use is appraised value if that is not what sellers are willing to pay for it. And each month his property is declining in value. In a few months I bet he will be out $20-30k and still will not be able to find a buyer.
The rose colored glasses some of these idiots are STILL wearing is amazing! When will these morons realize that they are finished, they tried playing with fire and they got BURNED…simple as that!
Hi everyone,
I’m noticing inventory just now appearing to creep back up in Redondo Beach. A Redondo Beach friend who is not particularly bubble-conscious recently said to me, “Nothing’s moving! “Manhattan Beach blog is starting to note some quick and large asking price reductions.
I’ve just posted the September charts for the south bay area. According to the YOY numbers on the moving averages I take, dollar volume is down 33% in Redondo Beach and 50% in Hermosa Beach. Many of the westside markets look downright sick. Moving averages tend to be lagging indicators so they really only illustrate what’s happened in the near past, they don’t forecast.
Real Estate $$$ Transacted through September 2006
I like this graph:
http://img106.imageshack.us/im.....aphho3.gif
you guys are all FOOLS! It’s right here in the data, -2.3% decline in inventory for the past month alone.
http://www.housingtracker.net/.....eim-Irvine
Why do you think this is? It’s because people are getting back into the market.
re kingpin: you are a sad little man.
Careful Kingpin… positive comments about anything are not welcome here.
RE Kingpin:
Nice Try with the half truth.
After 100% run up in for sale inventory you are crowing about a 2.3% drop.
Those were the much vaunted sellers testing the waters.
Everyone else is motivated, better start chopping those prices.
See for yourself, dumbass.
http://bubbletracking.blogspot.....ounty.html
okay, can we at least agree that it is too early to tell? Let’s wait another 4 months and then we will know who was right and who wasn’t…I’ll guarantee you that much, how’s that?