Andy Xie of Morgan Stanley has written some of the best commentary describing the innerworkings and problems of the Chinese bubble (don’t ask me if there is one, although it sounds like there is, I have not done my homework, as I’m sure Andy has).
Some time ago, he wrote Chinese asset markets have become a giant Ponzi scheme that perked up my ears and got me to thinking.
But, his more recent piece in Caing has me thinking he’s talking about Southern California:
The overwhelming desire for getting rich quick dominates every nook, fissure and strata of Chinese society.
Ok, replace “Chinese” with California, and you’ve got a definite match.
Bubbles exaggerate reality but are not formed out of thin air. Cheap money and strong growth are the usual ingredients for bubble-making.
This is almost exactly what I wrote with “What is a bubble?” several years ago. However, most interestingly is what is happening in China, and happened in California:
China’s property market is creating winners and losers based on timing. All other factors – including education and experience — have been marginalized as the economy rewards speculators. And as more play the game, the speculator ranks rise and fewer people work, perhaps contributing to a labor shortage.
This is exactly what happened during Southern California’s property bubble. Many people got rich simply by being in the right place at the right time. Many of them were incapable of understanding the circumstances of the rise, and so therefore simply did more of the same (buy real estate) without understanding the underlying problem that widespread repetition of that practice would cause a housing shortage (too many people “storing” housing instead of allowing it to be bought). Rents reflected the “real demand”, and appreciated strongly. Meanwhile, properties exploded with enough appreciation in 2 years to account for 30 years of inflation to support the prices.
The most poignant in my mind was a short-sale that Brad (my co-blogger and realtor) and I visited. The original owner was trying to sell from a purchase made in 1996 at more than 300K lower than the short-sale. The “owner” was so destitute that when the pool pump broke and they were unable to replace the $800 unit, the resulting ground shift due to hydrostatic pressure when quickly emptying the pool caused many more thousands in damage to the surrounding concrete. They had been trying to support a 600K+ mortgage with a single income from working at Macy’s. When regular equity withdrawals worked, the Ponzi scheme continued.
In normal times, the ponzi would have never worked, but because of the bubble, it allowed the “owner” to continue to persist in a property many times more expensive than they could support. At the peak of the market, this would have sold for more than $1M, requiring the income of several well-paid professionals, not a single retail salesperson’s income. The world did not make sense in 2006.
This separation of is true of a speculation/investment-centric economy. This is part of the reason why most people make terrible investors; the concept of time is nebulous and fraught with uncertainty. Indeed, I wrote (and bolded) in What is a Bubble? the following:
The most fundamental concept of investing is the concept of timing. The most fundamental flaw in most participants logic is that the asset provides more than just money… everything that costs money is an investment and can be traded again for money, nothing more.
This Southern California phenomenon of irrational belief has been covered extensively in another blogger’s repertoire, Irvine Renter’s Southern California’s Cultural Pathology.
We are quickly approaching the Day of Reckoning in our housing market. In my view this will be Armageddon for California debtors: the spending will stop, they will lose their homes and with it their illusion of wealth, and they most definitely will not be enjoying life. The cause of all the weeping and gnashing of teeth will not be some exogenous event, but rather a direct result of the circumstances they themselves created.
