Chuck Ponzi October 24th, 2006

It appears that the world has lost it.

Yes, I know, it sounds melodramatic, but there is now so much information in the mainstream media about the Housing Bubble, one wonders if something so well reported can actually happen? In fact, many have now begun to believe that the Housing Bubble is already over. This is both tragic and laughable.

Let’s think about this for a moment… One of the problems with the term “Housing Bubble” is that it conveys different meanings to different people. Some believe that 10% change in prices is a bursting bubble. Others define nothing less than a 50% haircut. Thereby, each writer determines that there is or isn’t a bubble based on their specific definition.

Consulting the Oracles

Maybe it is better if we just define what a bubble is.

Wikipedia states:

An economic bubble (sometimes referred to as a “market bubble”, a “financial bubble”, or a “speculative mania”) refers to a market condition in which the prices of commodities or asset classes increase to absurd or unsustainable levels (that no longer reflect utility of usage and purchasing power)

Let’s use some of those definitions… Since you cannot use a word to describe itself, the concept of a “market bubble” or “financial bubble” are just plain out. Maybe “speculative mania” is more fitting. Let’s see if this imposes any specific numeric requirements…

speculative
Of or relating to an asset or a group of assets with uncertain returns. The greater the degree of uncertainty the more speculative the asset.
www.dictionary.com - Wallstreet Words Database

ma·ni·a
n. An excessively intense enthusiasm, interest, or desire; a craze
www.dictionary.com - American Heritage Dictionary

So, an economic bubble is an excessive intense enthusiasm, interest, or desire for purchasing assets with uncertain returns.

Well, you say, real estate always goes up, so it does not have uncertain returns. This is a falsehood, and can only be viewed in the light of the mania without sounding completely ludicrous. Housing does not always go up. Yes, they are making more of it, and Yes, it doesn’t matter if you’re running out of land. We have seen Japan’s speculative housing bubble unwind for 15 years in slow motion. They aren’t making any more, and they have a lot more people per mile than we do, hands down. Even rents are not certain returns, as there is some margin for error, and possibly declining rents. You would need to fully dicount cash flows for potential rents, which all economists are confident won’t come close to selling prices for real estate in Southern California.

Speculative Manias

How often do they really occur?

The truth is, humans are no strangers to financial manias and rampant speculation. Much can be said about the Wild West’s preoccupation with saloons and gambling, but the fact remains that the Dutch, English, Germans, French, Thai, Japanese have all had their own manias. And, it appears this most recent of real estate manias has gripped much of the developed world, and even parts of the undeveloped.

Many cases are well documented in several books I highly recommend:

Manias, Panics, and Crashes: A History of Financial Crises
Devil Take the Hindmost: A History in Financial Speculation

Just to name a few among many, many others. For a current version, see Robert Schiller’s famous “Irrational Exuberance”.

Near to the time when I began my blog, I wrote an article titled “Strong Hands, Weak Hands” that I think bears repeating in the context of what is currently happening.

1. Prior to 1930, “business cycles” were quite common
2. Expansion would lead to speculation, speculation leads to overcapacity, overcapacity leads to bankruptcies
3. Assets would pass from weak hands to strong ones, and the process would begin again
4. Typically, these cycles lasted about 5 years.
5. We have convinced ourselves that public policy could do away with these “cycles”
6. Bankruptcy is an efficient way for assets to pass from weak hands to strong hands.

In Wall Street jargon, a strong hand/weak hand relationship is derived primarily from the holding times of assets. Strong hands hold assets a relatively longer time than weak hands.
I continue on the discussion.

One of the most important observations that he makes is that at the bottom of the cycle, assets pass from weak hands to strong hands. To state it another way, through the ensuing upswing, either the entities that hold the assets become weak (not intending to hold the asset), or weak hands acquire the asset (pure speculation). For a definition of weak and strong hands, look here. Therefore, one signal of an asset bubble is that assets could be passing from strong hands to weak hands.

It is most definitely a time of weak hands. Flipping is all the rage.

Despite much of the media fervor over a financial mania, or Housing Bubble, there is no end to the number of tv shows describing flipping, people interested in flipping, and general commitment to house flipping.

We even have some here in Aliso Viejo flipping million dollar homes (Bought Aug 2006 for 1M, selling now for 1.1M). Competing with virtually identical homes selling for nearly a quarter of a million dollars less…in the same neighborhood. Can you tell which is which?

That is the reason that you can’t tell… they are virtually identical homes, with virtually identical views, both with custom granite counters, stainless steel applicance, and built at approximately the same time, both on single-loaded cul-de-sacs.

This is irrational exuberance

There is a saying that I believe is attributed to Warren Buffet: The market can remain irrational longer than you can remain solvent.

In light of this, I highly recommend staying out of the current real estate market if you doubt in any way your ability to pay off a beheamoth mortgage.

The problem with this approach is that no matter what smart quips are given by the most accomplished investors that most perfectly underscores the current mania, once someone has drunk the kool-aid du jour, there is no convincing them.

On a recent conversation with a former real estate agent (couldn’t sell a dang thing for over 6 months at the height of the bublbe so he quit), he mentioned that he just has to find a house, and that he has spent every weekend poring over foreclosure lists, attending auctions, and that it has disrupted his family life in his search to find a house. When I mentioned that housing prices (asking, and for sure equivalent selling prices) are off by nearly 10% since last year, he launched into a tirade that it was “just a blip down” and that he has to buy as fast as he can in the current environment or be priced out forever. His wife is also riding on him constantly since they have 2 small children. I pity the fool. Even if there weren’t a bubble, that is no way to live, constantly tortured about the price of a home and unable to buy one.

Which brings me to the other fools, the ones waiting for greater fools. One might have wondered why I haven’t mentioned Casey Serin of www.iamfacingforeclosure.com. It’s for good reason. He is a despicable human being who should be afforded no leeway, and dealt with according to the full extent of the law. Although, judging by his entries, he feels no remorse. Funny enough…he has recently posted a picture of a plaque in a bankruptcy attorney’s office that he recently visited. I’ll post the quote here because I know it well, and the speaker of the quote, J Reuben Clark.

Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation; it never visits nor travels; it takes no pleasure; it is never laid off work nor discharged from employment; it never works on reduced hours. It never has short crops or droughts; it never pays taxes, it buys no food, it wears no clothes and owns no home; it has no expense of living; it has no love nor sympathy; it is as hard and soulless as a granite cliff. Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, or orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.

This quote dates from April 1938. Here is a present-day discourse the Mormons give. To put it in context, J Reuben Clark admonished mormons to “avoid debt as we would the plague”.

Unfortunately, the world would have you believe otherwise. Debt in their minds is a path to riches… leverage to move worlds. This is not a sermon, but all should be clear that debt is not your friend, and anyone wanting to loan you money is only doing it to make money for themselves, it is not immoral, just amoral.

Which leads me to the final question:

Who is still buying homes?

OK, that’s not a real question. We all know that only greater fools are still buying. But, at least I can leave you with a funny comment today, right? If you think your day is bad, think about this guy’s.

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