Southern California Bubble blogger

Part 6: Meet the Bubble Bloggers: 'John Doe'

Friday, February 16, 2007

Inman News

Editor's note: Talk of a real estate bubble, brewing for many years, has spawned an assortment of real estate blogs devoted to bubble talk and statistical analyses. These bubble sites offer a counterpoint to industry data and mainstream media coverage, and have gained a following among consumers and industry analysts alike. Several "bubble bloggers" -- some named and some choosing to remain anonymous -- have shared their views with Inman News. (Read the intro to this series, "The rise of real estate bubble blogs.")

Name: "John Doe" -- real name not given
Background: MBA, bachelor's degree in accounting, economics hobbyist
Blog site: Southern California Real Estate Bubble Crash Blog

Q: What makes you a real estate bubble believer, a bubble debunker, or bubble neutral?

A: I'm a real estate bubble believer, of course. Having lived through the tech bubble and subsequent meltdown, I early on recognized some of the symptoms of the housing bubble. However, it wasn't until we read stories about people camping outside of model homes, multiple over-asking-price bids, preconstruction contract flipping and lavish parties that I was sure this was a financial mania. I researched as much as I could about manias, bubbles and crashes. In my university studies I was a student of economics -- admittedly, primarily around conventional economics. It was at this time that I discovered behavioral economics that I could solidify and justify a mania.

Q: How do you define a housing bubble?

A: A housing bubble is based on two factors: First, it is psychological in nature, requiring great emotional commitment by buyers. Second, the price of an asset is driven beyond the fundamentals of the asset's supporting value. Every person favors certain things, feelings or thoughts. In economics this is called "utility." In addition, each object has alternatives or substitutes. It is when the utility of an object becomes so great that it can no longer be rationally supported by its relationship to substitutes. In the case of housing, the primary choices are related to risk-taking, buying or selling. Generally, renting removes the risk to the consumer of price fluctuations. In the case of mortgages, the lender is a co-consumer. The market began to exhibit bubble characteristics when both buyer and lender lost their ability to discern any risk in a purchase. The housing-price bubble we are seeing today is supported completely by a credit bubble. The credit bubble is also what will cause the housing bubble to crash. Credit markets historically are much more subject to fits of fancy and terror. And the demeanor can change quickly. This is why credit markets have specific terms such as "credit crunch," "credit event" and a number of others.

Alan Greenspan stated a very prescient comment: "Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums."

Risk premiums are at some of the lowest of history, and have remained compressed for a very long period of time. I have exhibited that (at the blog site).

Similar risk premium compression occurred immediately preceding the previous housing bust in California.

These risk premiums are compressed because co-parties to the bubble no longer believe that prices can go down. Their complete faith in the asset is tempered only by how much risk other parties will allow them. It is much like a drug addiction that can cause ruin when people become obsessed with the love of houses. However, manias require large numbers of people to become indoctrinated. Much like the Jonestown massacres, large parties can be led to believe nearly incredulous things from the perspective of outsiders. Much of the undeveloped world would be amazed at our preoccupation with four walls and a roof. To them, it is shelter and nothing more. It is not a means to wealth and for them never will be. When the desire wears off (and it will), few will admit to having participated in the manner they actually did. After the tech stock market crashed, few admit to being caught up in the hysteria, even though many people's investments were heavily weighted toward them.

Q: How does this definition fit (or not fit) the national housing market? Which regional or local housing markets have exhibited the most bubble characteristics?

A: Housing markets are local, but credit markets are national (and in certain ways global). While my focus has been on the Southern Californian area, the primary markets here which exhibit the most bubble characteristics are Ventura County, Los Angeles County, Orange County, the Inland Empire, and San Diego County. Nearly the entire area is inflamed with a passion for real estate that did not exist prior to 2000 (or at least was held in check by the risk of another pop).

During the credit boom, there was (is?) no risk aversion. Nearly anyone could (can?) borrow any sum of money with little or no collateral. Some of this was caused by the European and Japanese carry-trades, while a depressed Chinese yuan depressed treasuries. With depressed returns from no-risk treasuries, some insurance companies, pension funds, banks and even the stock market sent its money to the next best thing. Much of the unfunded pension plans' problems are directly a result of the Federal Reserve holding rates low to begin with, and then market actions holding them low afterwards. At a certain point the risk of the investment exceeds the return. In the case of real estate loans these are often separated by years, which cause the environment of low-risk premiums to exist. Low-risk premiums on a widespread basis reinforce higher asset prices, which continue until the cycle breaks (often years too late).

Q: Which bubbles burst? Which ones have deflated? Which ones are inflating? Which are about to pop?

A: All bubbles burst; there is no such thing as a slowly deflating bubble. San Diego has burst, and so has Ventura. The Inland Empire is in the process, and Orange County and Los Angeles will be last. Bubbles implode inward since speculation is widespread at the fringes. First, the outer rings collapse, later the collapsing of the outer rings causes insolvency of key parties, and the inner rings collapse as well. Housing bubbles take a relatively long time to correct. It could take three to 10 years to return to long-term trends.

Q: Are there any common traits among the bubble markets?

A: As stated before, the credit availability and widespread belief that risk no longer exists are traits, but they must be pervasive manifestations within a market. Bubbles can be global or localized. For example, housing prices are exhibiting bubble characteristics in many countries and many cities, but not all. Beanie Babies, for example, were not a German or French phenomenon.

Q: What is your best evidence for or against a housing bubble?

A: Unbelievably low lending requirements and risk premiums and the perception that an asset is a "can't lose." That one is simple.

Q: Is it possible to accurately identify the existence of a bubble before it is gone? Explain.

A: It is very difficult since the primary driver is psychological in nature. This is not easily quantifiable, nor is it easily diagnosed. However, high levels of brazen speculation are almost a sure sign of a bubble.

Q: How are bubbles born and how do they die?

A: Each bubble is born differently, and dies differently. They are apparitions that appear out of thin air and return to thin air. While each has a number of forces that drive its formation (technological advancements, demographic shifts, etc.), each one is unique within a generation, which completely fools the participants of the bubble. They always last longer than rational minds believe they can, which only reinforces their status as "can't lose." Early warnings are "disproved" by bad timing. However, since bubbles are born of irrationality, there is nearly no rational way to predict the formation or end of manias, panics, crashes or bubbles.

Q: Why do people get so fired up about the concept of a housing bubble?

A: House values have covered up the lack of increasing wages and faltered stock market. The Federal Reserve has depressed returns for savings, so this is the thing that makes up for all of those bad things. If it weren't for the housing bubble, we would have likely entered a protracted recession or depression beginning in 2001. We might have lessened the severity or simply postponed the inevitable. Human nature is to forget failures and remember successes. When someone suggests that his/her primary source of success is a financial mirage that could disappear in a short time (even if that's not the message), it foments anger.

For example, if I told you that next year your boss would give you a bad review, put you on probation and possibly even fire you, you might ignore the idea, deny it or become angry. If you consider yourself a good employee, you might really become embittered to me. I wouldn't be the one giving the performance review, yet I would still be the one you'd be angry with. This is why the phrase "shooting the messenger" exists in the English language ... it is such a common reaction in humans that it has become ingrained into our speech. If the fundamentals of the housing market are in question, the only way to truly test the thinking is to begin to doubt your initial reaction. In the case of your job, you'd need to ask yourself if it were true that your boss could give you a bad review, considering it a possibility, and then testing your perceived facts against that and testing your hypotheses. The housing market is no different. All reasoning by the best impartial economists has concluded that housing prices are out of whack with fundamentals, yet they are neither psychologists nor behavioral economics specialists. Because the field of behavioral economics is in its infancy, we might well see numerous analyses in a few years' time related to the euphoria and ensuing panic.

Q: Will there ever be an explanation for bubbles that we can all agree upon?

A: No. As long as there are commissioned salesmen for assets, there will be arguments against bubbles. Interested parties can almost never identify a bubble before or even after one bursts.

Q: Will there ever be a time when the discussion about bubbles goes away? Is this just a passing fancy?

A: Yes, it is just a passing fancy. In a few years, when no one wants to talk about housing and many are shy or embarrassed about their own participation, it will simply fade away. Human nature is to forget failures and remember successes. Much like Beanie Babies, friendship bracelets, Cabbage Patch Kids and Tickle Me Elmos, they will simply fade from the larger population's consciousness.

The greatest reason that makes it difficult for industry professionals to gauge that a bubble indeed exists is because their personal commitment level varies little from before, during and after the bubble. Many Realtors will continue to sell real estate, and loan officers will continue to arrange loans. However, the outside public consciousness has changed already.

Many in the real estate industry see bubble bloggers as "raining on the parade." We all love real estate, otherwise why would we spend countless hours researching, writing and commenting about it? However, because we have no vested interest in prices going up we are more able to see the fundamental psychological shift in those around us. No one can spot a bubble without being a student of human nature and an astute observer.

Q: What has motivated you to participate in the bubble discussion and what have you learned? What has happened with traffic volume at your blog site as the U.S. housing market has slowed? What is your background in real estate/economics?

A: I found the mania exciting, the debate lively and the questions mentally challenging. Who knows how many may be convinced by hard facts and cold data mixed with sound economic theory and a fundamental understanding of human nature that a bubble exists. My work is primarily to enrich others. I devote a significant amount of time to inputs to my blog and responding to those who happen upon it. My ad revenue basically covers the cost of the site, which is being upgraded to a third-party hosting service at www.socalbubble.com. Many would argue that you get what you pay for, but I believe that readers benefit far more from my reasoned and impartial analysis than from most paid professionals.

Traffic volume has doubled, tripled and quadrupled within the last year. There is likely to be a leveling-off period once prices actually begin to come down. Priced-out parties will likely then begin to feel more self-confident, and the debate will go away.

I hold a (bachelor's degree) in accounting from one of the top accounting programs in the United States, and I hold a master's degree in business administration from a California State University. Economics has been a preferred optional course of study during my time in school and a personal hobby. (My) most recent studies were on game theory and behavioral economics. I hold no specific designation with regards to real estate; it is simply another asset class to me.

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