April 03, 2007

Manias, Panics, and Crashes: 2007 First Quarter All-Stars – Foreclosures, Subprime, and Politics. Five Characteristics of a Housing Bubble.

“Much has been written about panics and manias, much more than with the most outstretched, intellect we are able to follow or conceive; but one thing is certain, that at particular times a great deal of stupid people have a great deal of stupid money”
–Walter Bagehot

As we look back at the first quarter, we realize that 2007 will be historical in terms of the housing bubble bursting. It is well documented throughout history that ordinary folks are capable of unbelievable spending and gambling. Examples include the South Sea bubble in London, the Mississippi bubble in Paris, The Great Depression, and more recently the dotcom bust. It would seem that financial speculation transcends a fixed point in time. Each bubble that forms follows a set pattern that we have witnessed in the 21st century with global real estate and the massive credit that floods the world’s marketplace like Scotch at an upscale bar. Just open your Sunday paper and look at current housing prices if your stomach has the fortitude of a tiger; if you are in one of the many overpriced metropolitan areas welcome to a firsthand account of an asset and credit bubble.

We are starting to hear massive jawboning about what is the correct path to address this financial mess and the word bailout is threaded in many a conversation. It would seem that the political de jour of the day is the subprime fallout. Well this would make sense since foreclosure are up a mouth dropping 145% in California. That is stage one followed by the fact that the subprime business market is being gutted one by one as if a mechanic is taking out an engine to rebuild it. I have addressed the subprime blow out many times and have an inkling that the mainstream media will start to run with it. As the first quarter ends, we see that foreclosures are through the roof, the subprime market is imploding, and political jockeying is starting. Historically, these are symptoms of a mania but pundits would like you to believe otherwise claiming that we are facing a new paradigm or some sort of abracadabra black magic. I have listed 5 key points that are addressed in an old great book called Manias, Panics, and Crashes by Kindleberger and relate them directly to the current state of the housing market we are living in. If you look at the below stages we are in step 3 of the 5 stage process.

#1 – Speculation

No fire can expand without fuel. This is a law of nature. And no bubble can grow without and audience to inflate it. In the first stage of the housing bubble, we see a flight out of the stock market into safer illiquid assets. This was spurned in large part by the events of 9/11 and the absolute pants dropping of the Fed interest rate. Most people in the public have very little understanding of fractional banking or how the Federal Reserve controls the flow of credit to commercial banks. After 9/11 and the short recession that was felt, money flowed into hard assets and people started spending. If you recall Bush addressing the American public that spending was a patriotic duty and instead of pulling out Desert Eagles we should pull out our Visa and Discover Cards. If spending is patriotic we must be peeing red, white, and blue after these last few years. What better way to blow your cash than to slap on a virtual ATM to the side of your house and loot all your equity. This leads into the credit expansion.

#2 - Credit Expansion

How can you spend money that you don’t have? You create it out of thin air. This isn’t some David Copperfield routine in Las Vegas but the ammunition that fed the housing bubble. The average American family carries $9,200 in credit card debt. In addition, we have a negative savings rate that is similar to the Great Depression. Home equity loans and lines of credit are the fastest growing debt areas:

Volume of Home Equity Lending by Type of Financial Institution (billions of dollars)


Home Equity Loans

Home Equity Lines of Credit




















2004 (first half)





*source FDIC

Not only that, but the mortgage market is a behemoth at $6.5 trillion outstanding; with that we are expected to see $1 trillion of that reset in 2007. With all this free money floating around is it any wonder why we have seen massive asset inflation and a declining dollar in the past seven years? There is more green than the Amazon forest but this is why we don’t feel richer as a society. The problem of course is, if you use your credit card or HELOC you are essentially creating money out of thin air. How? Well if I go and buy a $3,000 Plasma with money that I don’t physically possess, how is this not tantamount to me being my own bank, underwriter, and ATM? At a certain point, interest and prices become so disconnected with actual values that we start seeing cracks in the foundation. The next step is where we currently sleep, the financial distress state.

#3 - Financial Distress at Peak

As I mentioned foreclosures are up in the triple digits here in California. Phoenix is seeing the largest inventory on its books. Detroit is selling homes for cheaper than cars. Florida isn’t facing a soft landing but a rather hard one. Does this sound like a healthy housing market? By any measure, this housing mania is rampant throughout the United States.

Early in March, we saw the light that ignited the housing bust. The subprime mortgage implosion has brought into question the resiliency of the US economy in the face of a declining housing market. With the data presented above it would appear we are very dependent on the housing market. Now what is typical at the peak of any bubble is the emergence of absolute malfeasance in financial prudence. Welcome court jester New Century Financial, once the third largest subprime lender in the US is now belly up and trading on the OTC. A company now worth approximately $80 million in market cap owes $8.4 billion; now that kind of leverage you will never see in a late night infomercial. Other subprimers such as NovaStar and Fremont face the same fate as New Century. Now we are seeing this virus spread into builders such as the recent announcement that Beazer homes will be investigated.

The public is catching wind of this storm and is hungry for blood. Why wouldn’t they be? They are starting to suffocate on interest payments and the only beacon of hope was a rising housing market. Now that appreciation is reverting and many homes are now underwater, folks are angry. The ATM is now blinking in big red letters “out of money, will refill TBD.” Which leads us into the next stage.

#4 – Crisis

How the crisis will unfold is anyone’s guess but it will unfold in some familiar manner if history is our guide. Now that the discussion of a housing bubble is rather mute because most sane folks acknowledge that we are in a housing bubble, we are starting to understand the intricacies of corruption and greed that are prevalent at the peak of a bubble. With this crisis mode in full swing, we are hearing both Senator Dodd and Hillary Clinton utter the words bailout. Amazing how all these free market capitalist and laissez faire theorist argue that the government needs to stay out of the market completely and all of a sudden many are asking for government assistance. They were utterly happy to flood the market with funny money but now that the market is turning off the spigots, they want to go on life support with Uncle Sam. The irony is so thick we need a chainsaw to cut it. This moral posturing is unbecoming and companies such as New Century will prove to be the future Enron’s once we enter crisis mode in the near future. To paraphrase Buffet, we’ll see who is swimming naked once the tide is out.

#5 – Crash and Panic

Most bubbles pop quick and utterly fast. The unwinding of a bubble is likened to a cat grabbing the end string of your favorite grandma’s knitted sweater and darting off. Nothing can prevent the collapse because it is literally built on a house of cards. If an economy is build on the belief that housing will always go up and credit will always be freely accessible then it will fall. Whether this was explicitly stated does not matter because the large part of the American public voted with their wallets. This is obvious; as much as we would like to believe that redwood trees could grow to the heavens they do not. This housing bubble will go down in the history books with all the other manias. We are not special in the eyes of economic fundamentals and basic human nature. Why would someone pay $500,000 for an 800 square foot home? Why would someone pay $200 for a share of stock in a company with no earnings and no prospect for growth? Why would someone sell off all their livestock for a tulip bulb? I guess hindsight is always 20/20 and making an easy buck will eternally live in the human psyche.


Chris said...

Excellent explanation, as always.

Finally we're getting to the point where people are realizing that rampant speculation (fueled by loose credit) had driven prices well outside the range of affordability, rising about 275% within a few years. So now that the cheap and easy $$ spigot is slowing down, we're seeing pricing move in the other direction, with Y2Y prices dropping around 5%.

UCLA's Anderson Forecast is predicting prices to drop 10% this year, largely because of the sub-prime mess:


What I'm wondering about though, is this:

On the rising slope of a bubble, 10-20% annual increases in home values justified higher pricing when viewed purely as a short-term investment, since there was a widespread concensus that the market would only climb. Put simply, houses were worth more from year to year, primarily because they WERE worth more. How's THAT for circular logic?

But regardless, that $500k home in Buena Park MAY have been worth it's asking price in 2006 if the Bubble HADN'T burst, simply because the next owner may have enjoyed similar profits from 2007-2009 that the prior owner enjoyed in 2004-2006.

Of course, such pricing trends and double-digit appreciation are completely unsustainable and irrational over the long-term, but in the short-term (e.g. 2002-2004) it actually made sense to buy an 'over-priced' asset when the buyer was reasonably assured they could exit the market and extract a healthy ROI before the Poniz game collapsed.

Obviously this rationale is pure market psychology, and has NOTHING to do with fundamentals of performance (e.g. P/E ratios, etc).

But let's keep playing this game: we ALL concede that housing had been treated as the target for rampant speculation, so let's play the same pricing game on the downslope, OK?

Now that we're in the year 2007, we all KNOW the market WAS driven by speculation, and we're even seeing year-over-year depreciation. The market is GUARANTEED to depreciate, at this point.

So WHY exactly would such high price be justified now, when it was run on based on the promise of FUTURE profitability? That's gone, people.

Am I supposed to give the seller the cheddar, just so they can extract the "easy money" equity from the home, letting them move into Easy Street? Should I overpay on a house now that'll be available next year for at least $50k less?

Market crashes have a nasty habit of correcting such manias rather suddenly, and even an illiquid asset like housing is know to take awhile to correct price-wise, but the handwriting is on the wall here.

Now that the illusion of the continuous double-digit returns has been definitely shattered, and MAY be replaced by double-digit depreciation in the next few years, where do you go as far as pricing?

Oh, yeah: back to fundamentals, such as looking at things like affordability indices, the rent to own calculation, etc.

Here's a good example of old-school thinking:


The sellers don't understand their house is not worth what it was back in 2005, for no other reason than they didn't sell it in 2005! If you're playing the market speculation game, then your house is only worth what someone is willing to pay for it (whether it's too much, or too little).

Dr Housing Bubble said...


Thanks for the links and analysis. You bring up additional good points. I think that many people were buying with the intention of flipping or the idea that double-digit appreciation was locked in. Now that we are facing depreciation, or as the pundits like to call it "an adjustment", what is the incentive to buy right now? The answer to that is that there isn't any reason.

In terms or what a home is worth, it is worth what someone will pay for it, this is true. But this price is based on perception of higher future appreciation or some other reason. Now that funding is cut off it will be hard for many people to jump in. I know some people jumped in with option mortgages and used the place as a rental. Now they have a larger balance and can't refinance. Its not like they can up the rent by $1,000 but their lender will do this.

Bubbles are circular in nature because they are based on the greater fool theory. The sucker is born every minute theory. But the game is done and we have a long way down to go. Hence as long as humans are humans bubbles will pop up.

Even the Shiller futures market is pointing to negative year-on-year prices in California this year.

Again I say trust your gut. Show me an article that was published in 2000 or 2001 that talked about California prices going up 150%. So in reality, no one knows how far and how quickly prices can go down but they will go down.

sed said...

I was in the process of selling off my stocks and moving the cash into T-bills, but then I read that interstitial ad you've got for pheromones and I'm plunking it all in there. How are all the bankrupt guys at New Century going to attract females...could be the next tulip.

sed said...

How about this one, Dr.?


Dr Housing Bubble said...


That shirt is hilarious. I also like the one that has a retro couple with bags of cash saying "thanks housing bubble!"

Kevin said...

In the Baltimore Housing Bubble, sellers are having a hard time understanding that their houses are not worth as much as they are trying to sell them for. What I like to do to fuel the soon coming onslaught of decline is to go to open houses and offer 50% of their asking prices. I know this seems cruel and unusually, but when the seller and their agents jaws drop, I simply point to the price on their open house flier and I drop my jaw too. Then I point to their hanging 60 inch plasma TV and I say, "My price also includes you throwing in that TV too." This is point that I usually get thrown out.

It not like I was offender the other buyers...I am almost always the only person looking at their home. I then proceed to walk next door to the neighbors house and proceed with my script. I can spend a whole afternoon doing this in just one neighborhood. Call me sadistic, but I find this truly entertaining to see the seller reactions. Even better is the agents reaction. Sometimes I even pull out my check book and start writing a check. This usually get sellers angry. So to make it even better, I start to write a second check out for 30% of the selling value, but I post date it for 9 month later and I ask the seller which they would like. One guy called the cops on me. I decided to wait and see what the cops would do. I explained to the cop that I was trying to buy a house. The cop tells the seller that if they are having an open house then I am allowed to come and make an offer for their home. I trying to get a movement started. Anyone care to join?


sed said...

ROFLMAO...holy cow, I can't stop laughing. They called the cops, ROFLMAO....they'll wish they had taken the first check. Thank you, thank you.

samohts said...

Kevin, what you are doing makes complete sense to me! My husband and I do it every weekend - although not to the extreme :)
A lot of sellers are still in 2005 with their asking price. It's a different market - they need to wake up. The sellers certainly reacted when buyers were offering over-asking price for their house a few years ago. Now it's time they wake up and realize they'll be getting a lot less.

Anonymous said...

Dear blog owner,

this is an exciting blog, but reading white over dark grey strains the eyes of internet surfers and navigators, which have them strained before hand from countless hours spent staring at the screen. Could you do black on white, or black on creme or beige? thanks.

graphrix said...

Dr. HB - You made a comment on BMIT about who is the lender and if you don't already know about this site some others may find it useful http://www.absnet.net/home.asp

I am not recommending anything but Deutsche seems to be a common name for property owners in OC.

robb888 said...

what about using replacement costs plus labor plus some added % to come up with a value on a property

Dr Housing Bubble said...


Nice site. I was looking at some information on there this morning. Amazing how many players are in this game especially when looking at CDOs and Home Equity.


All I can say is wow, that is one strategy of lowering the price. I normally put in an offer already in writing and that is that. But these are for out of state deals. In California we are nowhere close to finding deals. Banks still think they can shave 5 to 10% off the mortgage balance and be okay. The REO market is picking up steam.


I've noticed replacement cost an accurate market indicator in midwest states. On coastal areas it is rarely used as a measure of appraisal. Many homes in LA County are 50+ years old. If anything, land is the major cost in a property. Theoretically the only difference between 1,000 square foot home in Kansas and one in California is the location; and this is true that location is everything in real estate. Yet this means the location needs to support the prices via wages, industry, growth, and some underlying sort of value even if it is scenery.

Anonymous said...

OK, there's no email or about page on this blog. I wanted to send you a link to this post, thought you might like it (US home prices since 1890 plotted as a rollercoster): http://www.boingboing.net/2007/04/04/us_housing_prices_gr.html

Anonymous said...

thanks for this site, very well written. Scares the piss out of me too.

here's my thing. by total and i mean total luck, i bought a condo on the river in phila in 97. 83k then. I can sell it even in this market for 280k. (was higher).... phila has a local dynamic of empty nesters in the suburbs moving back into the city.

we paid this off and we own it. should we sell it and rent? The only thing is we do love it.

i figure between condo fees and taxes we pay 900 per month now. To rent this place would cost 1200-1400. So should I sell now or just shut my eyes to depreciation. i am torn.

Anonymous said...

TO BUY OR NOT TO BUY...? I live in the western Chicago suburbs and am thinking about buying a home in the near future. SHOULD I CONSIDER WAITING A WHILE LONGER BEFORE BUYING? Right now I can buy a 1400 SF 3BR 2BA home for about $300k. Is this about as low as the market it going to go? I am under no real urgent obligation to buy a home other than to stop paying rent and move into somthing a little larger. If we are at the bottom of this 'housing bubble' then wont home prices begin rising soon? Any advice would be greatly appriciated!!

Anonymous said...

Are you crazy..??? We're still in the stage #3 of housing crash. There are two more stages before I hit the bottom. If you buy right now, you gonna regret big time in another two years.

Anonymous said...

A few miles west of Boston the situation is denial, denial, denial. House sales volume has shriveled even in wealthy zip codes, asking prices are flat or even up slightly and sellers believe warmer weather will fix things. Meanwhile the state is losing jobs and productive citizens because of corrupt and incompetent government at all levels making daily life more difficult and expensive. People who can are voting with their feet which exacerbates all the financial problems. The government's solution ? Increase taxes to make up for the decline in taxes they will take in now and in the future. Good luck to those crooks, last one out of Massachusetts shut off the lights.

Dr Housing Bubble said...


That was a great video. Nice touch at the end. Notice the amazing climb at the end?

anon 3:47,

You have an interesting dilemma. You bought the place for 83k and would get 280k. Let us run the numbers then. If you sell, minus the 6% fee, you should net $180,200. As you mention, you are already paying $900 a month in HOA and taxes and to rent the place you would expect to pay $1,200 a month.

If you put the $180,200 in a 5% savings account, you would get a monthly payment of $750. So you can break it down right now as:

Current situation: $1,200 a month in rent - $900 in current fees. Different of $300 but you'll be getting $750 a month (minus taxes of course) from your savings. So technically you'd be up $450 a month.

Keep in mind that you currently have the piece of mind of owning your place and if it is prime location, it may handle the downturn better if it is in a low demand area. Being by the river I imagine the demand is high even if it is a condo. I'm not sure what other factors are in your life but owning your place free and clear is nice (although your HOA and taxes seem high for an $83,000 place).

Chris said...

If you bought it not as an investment, but as a home to live in, then I'd say stay put. You've built up a nice equity cushion, and presumably that's one protection you have that many others don't.

I didn't hear you complaining about the run-up in prices while it was happening, so there's no reason that you shouldn't expect a bumpy ride at times, too.

The ones who are going to be in trouble are those who:

1) bought recently, and will soon owe more than their houses are worth, OR

2) those who've paid off the mortgage, and may have even owned the house free and clear, but then re-fi'ed etc to get themselves back on the hook.... Bad juju there...

zoax said...

Dr. Bubble,

As I'm getting caught up on your blog, I read this past entry and its comments.

I followed the link to ABSNet by graphrix and was curious as to what your thoughts were on the more recent (8/7/07) ABS Market Headline regarding the SEC ease of rules for modifications, etc., and how that might impact the market (forecloses, specifically).