It is hard to be objective when your job depends on seeing things a certain way. Many people have a hard time accepting mistakes and would rather lament and lash out at others that contradict their view of the world. I remember posting in a housing forum 2 years ago the same analysis I’ve presented many times here on the blog. Those in the housing industry would dismiss the bubble argument as holding no merit and would simply pull out a nice upward trending chart, and point to the current median price. They were right. All the numbers pointed to incredible appreciation, quick sales, and no signs of stopping. My view was income in many areas simply did not support the current growth of the market. The only way the market was being supported was via exotic financing and bubble psychology. In a bubble market, psychology and perception is just as important as economic fundamentals. So people in the housing industry didn’t have to say much. Here are a few quotes from the former head of the National Association of Realtors during this time:
March 2005: " I believe that in years to come historians will see the beginning of the twenty-first century as the "golden age" of real estate. And I want to persuade you to take advantage of this historic opportunity. "
Source: Are You Missing the Real Estate Boom? Why Home Values and Other Real Estate Investments will Climb Through the End of the Decade-And How To Profit From Them" March 2005, p4. Author David Lereah
September 2006: "With a general background of growing population and favorable affordability conditions, home sales are staying at very healthy levels," said Lereah. "As a result, we'll continue to see above-normal home price appreciation for the foreseeable future."
Source: Chicken Little's revenge, Salon
I talked about the psychology of a housing bull in a previous article. The above quotes demonstrate a common view of many in the industry. One of these beliefs is housing will always go up. This is not true as we are seeing year over year drops in many locations. In some cases, these drops are large bringing down the price of a home by tens of thousands of dollars [see Real Homes of Genius]. In addition, as I pointed out in the Los Angeles County demographics article, population hasn’t exploded to the extent to justify 20+ percent gains for three consecutive years. Again, the chart is still used by many in the industry and they are right since last month Los Angeles hit another record median price in housing prices here in Los Angeles. But they are driving forward looking in their rearview mirror.
Now that the market is demanding economic fundamentals, the man behind the curtain isn’t so strong as we once thought. The unstoppable real estate juggernaut turns out to have an Achilles heel. Those subprime loans were actually a lot more shaky and weak than many had predicted. And this bubble bursting isn’t contained to only the lower nether realm of mortgages, it is also impacting the untouchable prime loans. Since late 2006 over 142 mortgage operations have closed shop. The year over year price appreciation predictions by housing bulls in late 2006 is no longer used as an argument. And this time when they hold up the chart you can see uncertainty in their eyes. After all, what does a mortgage broker care if the median is high if he is no longer in business? Or why would an agent be happy with a $700,000 home if he doesn’t have any clients to drive around?
The argument has psychologically shifted. There is no need to talk in obscure forums regarding the housing bubble. The mainstream media is now carrying the baton. Now the argument of many in the industry is one in which they are blaming all the negative press for popping the bubble. “Income is rising, population growth is occurring, and housing is still strong.” Or so they would like you to believe. Tell that to the tens of thousands of former mortgage workers. And this argument seems more of a self pacifying defense mechanism of convincing themselves that somehow the market will be back to its old tricks again. Deep down they pine for yesteryear when you could get Funky your mangy dog a $450,000 mortgage and move him into a 500 square foot home with no co-signer.
Common sense isn’t so common as the adage goes. Why is this? We all know exercising and eating healthy is paramount in your long-term well-being but why do so few Americans do it? In fact, according to the American Obesity Association 127 million adults in the US are overweight with 60 million categorized as obese. Maybe it isn’t so easy. After all, exercising and eating healthy requires commitment, a desire to better your body, and a belief that keeping yourself in peak shape will benefit you throughout your life. Yet we live in an instant gratification world. Depending on your current condition, it may take you six months to get into good shape but only after working out multiple times a week and eating a healthy diet. When we see infomercials we always here “lose weight NOW!” or “lose 30 pounds in 3 weeks!” The psychology here is that people want solutions quick and fast for something that needs to be looked at as a long-term lifestyle commitment.
Okay Dr. Housing Bubble, what does being overweight have to do with housing? Aside from believing that staying in physical shape should be a top priority for everyone, the psychology behind the numbers speaks to the get rich quick mentality of the last seven years in real estate. Real estate is a great long-term investment. In fact, owning rental properties is part of my balanced portfolio. But you buy it at prices that make sense. Otherwise, it is like the expensive treadmill that so many people buy and later becomes a towel hanger with cobwebs. If you are smart, you’d just pick up the weekly classifieds and buy one at a deep discount from someone who overpaid from the start. There are a few ways to get rich quick: Hit the Lottery, inherit some money from a rich family member, invent something unique and sell it, or steal it. Other forms of getting rich take time like slowly building your business, going into a profession that’ll pay off long-term, and investing wisely. Even though some of the data is old, I recommend people read the Millionaire Next Door. It’ll give you a good idea of the difference between being wealthy and making a lot of money. Unfortunately, I know some brokers who made money hand over fist during the good times and now, are struggling to pay their lease on their brand new Mercedes. I detailed how a high earning couple with no financial plan can go from rich to struggling in one year.
We have all faced circumstances in life where our pride is at hand. It is hard to let go of something you fully believe in, even if you may be wrong. You may be wondering where any economic analysis or data is in this article. There isn’t any. Bubbles don’t follow economical rules. They rely just as strongly on market perception and psychology. By the time people get out of the euphoria and start examining the market with a critical eye economic fundamentals are no where to be found. You may want to read the article on Manias, Panics, and Crashes. Bubbles expand because of greed and pop because of fear. Too much greed and fear is never good in a society. Even after the Crash in October 1929, people in early 1930 still thought the market would rebound. But the market slowly went downward hitting a bottom on July 8, 1932. A plunge of 90 percent from its peak high in September 1929. It took the market 25 years before the Dow Jones ever saw the peak of September 1929. I’m not sure we’ve even seen the major capitulation point yet. Was it the subprime collapse? The hedge fund issues? Liquidity problems? We won’t be able to have an exact apex until 2 or 3 years out as to the exact moment the market gave way. And bottoms take a few years to play out after a bubble collapses. If you don’t think we are in a bubble you can read the article over at TIME Magazine with the title, Your House is Worth Less? Good . They are finally acknowledging that what we’ve lived through is a bubble.
Many in the industry that still do not get it, are wanting the Fed or some other form of government intervention. During the boom times, they wanted the government to be hands off and not enforce even the smallest regulations. Yet now with times shifting they want the Fed to jump in with an orange rescue jacket. This is what we call cognitive dissonance. According to Wikipedia:
“Cognitive dissonance is a psychological term describing the uncomfortable tension that may result from having two conflicting thoughts at the same time, or from engaging in behavior that conflicts with one's beliefs, or from experiencing apparently conflicting phenomena.”
I know how most of you feel about a bailout and I’m glad we share the same sentiments. If there isn’t a bailout for those losing their home there shouldn’t be one for lenders who irresponsibly gave money to everyone and anyone. Senator Dodd’s proposal is absurd regarding lifting caps on mortgages. The last thing we need to do is prolong the bursting of the bubble and waste more taxpayers money. Politicians seem to be throwing out ideas and seeing what sticks. Some city politician wanted to give $10,000 to each family facing foreclosure here in California. Which would only help for a few months and then what? I haven’t heard any idea that I liked until this morning when presidential candidate Barack Obama unveiled his bailout plan:
“Unscrupulous lenders who deceptively sold subprime mortgages to millions of Americans should be fined and the proceeds used to help bail out borrowers facing a wave of foreclosures, according to Barack Obama, the Democratic senator running to be his party’s presidential candidate.
The proposal is among the most radical yet from a leading Democrat and comes as Washington tries to respond to a growing wave of foreclosures and a crisis in credit markets.”
I’ve thrown around this idea in the comment section of this blog and other forums. I was wondering when someone in the public eye would have the guts to put something on the table like this. Whatever you may think, this is the way to approach this issue. Why should you, a financially prudent person that didn’t participate in this credit orgy be forced to subsidize someone’s speculation? And don’t feel sorry for those in the industry because the housing complex has sufficient money to throw at lobbyist in Washington to keep the party going. Instead of lobbying, they can start the foundation called Bail Out America (BOA), not to be confused with BofA, and open up their check books. If they really care about the family on the street, they will not feel so bad about bailing out the folks that got them rich in the first place. It’ll be an interesting 2008.
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