August 30, 2007

Pride and Prejudice: Examining the Psychology of Those in the Housing Industry.


“It is difficult to get a man to understand something when his job depends on not understanding it.”

-Upton Sinclair

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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22 Comments:

cit_hpns said...

Barack Hussein Obama is a mental midget, a socialist who would make our problems much worse.

Djoka said...

Hmmm...
Personally, now that we've finally reached the point of the bubble explosion, I wouldn't like to see any sort of bailout. It is too soon - we need to reach the state of panic first, and see the prices plunge, and at that point, any news about helping out a flipper or two won't make much difference. Let them burn in their own fire pit first.

I just sent a couple of letters to my congresswoman and senator protesting any ideas of a bailout.
The problem is, we are a minority in this issue.

One thing I do not understand about this 'free-market economy' society and country is that when the speculation is working, the government stays on the sidelines, but when things go sour, then the FED jumps in, bails out the largest speculators, and puts a huge inflatory pressure on all of us.
And now the talk of the bailout. Such hypocrisy!!!

As for Obama, he seems like a much better candidate than the cold, calculated, heartless senator from NY, as far as I'm concerned. Still we have to choose between the two evils - let's not forget that Mr. Clinton enjoyed his huge popularity due to the .COM bubble, which then helped set stage for the housing bubble. Similar to Mr. Bush's situation with the housing bubble. Unfortunately, unless the Republicans can quickly find another bubble (corn fields, perhaps? :-)), Mr. Bush is left holding the bag. What a magnificent way for Democrats to frame him.

Dr. HB, what do you make of the conflicting reports regarding the state of the economy? Economy grew at 4% yearly adjusted rate, yet the unemployment is us, and the consumer confidence is down? Seems pretty chaotic - a sign of a forthcoming depression?

Dr. Shke

Djoka said...

Oh, and buy the way, I do believe that the current president is a result of the nepotism in American politics, and that he is fully incompetent, so I do not feel sad about his destiny at all.
Dr. Shke

mrfnuts said...
This comment has been removed by the author.
mrfnuts said...

@cit_hpns:

That might be true, however, it is the only bail out plan that actually accomplishes this whole all important goal of helping the 'poor-hard-working-American' (sarcasem). The other plans all 'say' they will do that, but, they are in fact a complete bail out for the banks that made the stupid risky loans (and should have known better -- almost makes me think the banks were expecting a bail out when the made the loans).

For the record, I'm NOT in favor for ANY bail out of any shape or form. I don't even think entities such as Fannie Mae, Freddie Mac, Ginni Mae, etc, etc should even exist.

I find it rather annoying that in effect all these government programs hit me twice. Once in the taxes I pay that fund these, and a second time in that they provide more liquidity to the market, and in a sense, if I were to go buy a house, I would in effect have to compete with my own money in the bidding process -- thus, I have to pay higher prices. Double whammy!

Unfortunately, this 'bail-out' talk is not going away, So, if a bail out 'must' happen, then I'd prefer they keep out of my wallet.

srla said...

It is amazing how, in all this talk, no attention is being paid to savings interest rates, which still hover at near zero at major banks (0.2% currently at BofA). The Fed Funds rate is ALREADY set within the low range historically dictated by slowed economic growth, even though the economy is supposedly still growing.

The Fed's continued suppression of interest rates has continued to discourage savings (who wants to save when the real savings interest rate is negative - interest paid is several points below the rate of inflation).

While this is fueling a net negative savings for the first time since the Depression, it is also currently acting as a means of redistributing wealth from savers to home owners and speculators. And this is all with the CURRENT Fed Funds rate. If they were to cut it again, the effects would only further decimate the savings rate and the finances of anyone with cash savings.

Add on top of this a potential taxpayer funded bailout, in addition to the Fed-enabled escalation in home prices that has been keeping many of these responsible savers from being able to buy homes for a number of years now.

Any further Fed rates cuts would simply increase the damage done to savers while further rewarding those you are describing - the shortsighted "live for today" crowd. It is nothing less than a redistribution of wealth from the responsible to the irresponsible.

Of course, if the fools in charge continue such policies - discouraging savings when savings rates are already abysmally low - we all will pay the price as a nation down the line.

mrfnuts said...
This comment has been removed by the author.
mrfnuts said...

There has always been a war waged by the government against the savers in the country.

The obvious effort by the FED to inflate the credit market, and thus the housing market, and eventually every thing else you want to buy with US Dollars, will result in grand misery for those who have saved money in dollars.

Sadly, the government of this country also also has a track record of penalizing and outright theft from those who diversify out of dollars, or choose to hold real money such as Gold. Dare I look up in history the date of April 5th, 1933. A despicable executive order issued by that despicable president at that time.

Dr Housing Bubble said...

You need to read this article from St. Petersburg Times talking about the rough market for Realtors there:

"Like an operator working a buzzing switchboard, Liz Seither deftly juggles the two phones that never stop ringing in her kitchen.

The 67-year-old Clearwater Realtor's eyes are puffy below unkempt flaming orange hair. She begs your pardon for not looking like one of Pinellas County's top home sellers, but her allergies flared up when her dog's fleas bit her.

Equally irritating are the bank warning letters laid out before her on the kitchen table. Seither invested - unwisely it turns out - in expensive Clearwater waterfront property at the peak of the recent boom. Lenders are after her for millions of dollars in debts.

After juggling 15 calls from debtors, creditors and clients, Seither lays the phones aside and delivers a pep talk to herself.

"I'm not a real estate bum," the president of Executive Preferred Properties announces. "I wear diamonds, Rolexes and necklaces. I'm a classy Realtor."



Full Article

mrfnuts said...

Dr. HB, great link!

I think one of the most telling comments from the article is:

One of [Marottoli's] biggest frustrations as a Realtor is the sellers who cling to high asking prices. On the beaches around Clearwater, the average list price for single-family homes is $1.46-million, up over last year's $1.3-million.

"Out on Gulf Boulevard on Belleair Beach there are folks still looking to triple their money. Even in this dead market. See how greed plays?" Marottoli says.


I think we're seeing a lot of that 'clinging' to high asking prices.

Doug said...

when the speculation is working, the government stays on the sidelines, but when things go sour, then the FED jumps in

Well, um, but the tax code is asymmetric the other way, when you are making money on interest or cap gains the government is your partner in crime, but when you have losses, they only let you deduct $3,000 per year, meaning some people won't ever recover their losses even if they live to be 120.

hehe said...

Can somebody explain to buy house for average 650,000,my income monthly payment,taxes insurance and other payment and required income.
I am average person with salary of 80,000.

hehe said...

I agree for bailout of common man by the feds,but why my tax dollars go bailout for investors. I purpose to keep interest at 6% to all who bought houses to live in so that they can continue to pay for homes. Feds can surely help,but question is can I buy 650,000 home in orange county with 80,000 salary.Please help help, may b feds can give me some money about 200,000 to help me pay affordable monthly payment

Renter_IE said...

Dr Housing Bubble

I CANNOT believe that they are actually going to help the F*** buyers that are not being able to make their payments. With this move by Bush, home prices will continue to remain insanely high, even in the Inland Empire. Me and my girl are in our mid 20s. We make around $80k combined and have around $40k to put down. But we are priced out of this market. assuming prices will not be going up, we will have to save for another 5 years to get a decent place (around 2000 sf in Riverside). because right now those are priced around $400k and we cannon afford a loan much larger than $250. I refuse to buy at these prices... I just won't

Renter_IE said...

I migrated to the IE in the mid 90s and have been living here ever since. I am telling you guys this: there was a time when a hard working man can take care of his family, buy a decent home, and put his kids to college on a $40k yearly income in the IE. I know this because my dad is that person. Now my partner and I earn a bit more than he did and we have nothing... If we purchase the same house as my father did, then we would have to spend most of our take-home pay.... how sad... 11% of the houses out here are affordable to a "median" family... mostly condos ???

Liberal said...

People, you need to stop this insanity. Call your Representative, your senator and whoever you can think off. 80% of the foreclosures in my neighborhood are "Speculators" with more then one house, zero down, balloon, adjustable. The rest is defaulting on houses in the 250k range, same story. All drive brand new cars and are keeping up with the Joneses. It is an absolute disgrace what is going on!
If you can't pay your rent you get kicked out, if you speculate or live way above your means you get rewarded! What is the matter with this country?

Oso said...

I've written to my congresswoman and our state senators opposing any bailout of homeowners, for exactly the reasons Liberal stated. While I would not oppose some sort of assistance to honest homeowners who bought within their means and have problems making their payments (job cutbacks, health issues)the speculators and yuppies can all go to hell. And Sria is right, cutting interest rates is pouring gasoline onto a fire. the cheap $ is what a big part of what got us into this mess.

John said...

Bush and the Fed want to bailout the bad loans because the govt has a vested interest in keeping the housing bubble going.

The govt was to keep up the illusion that people making $30,000 a year can afford to buy a $650,000 home.

Why? Because that $30,000 a year wage earner won't question globalization, outsourcing, illegal immigrant labor, and other government policies that are economically disenfranchising him.

If that $30,000 a year guy has a huge home, flat screen TV with satellite, and a leased SUV in the driveway, then in his mind, he's middle class, and there's no reason to question his elected officials about economic policies.

Renter_IE said...

Forget about the market... this is the current administration's strategy for "making them look good". It just kills me that those spend like there's no tomorrow are getting rewarded while my savings are growing at a snail pace due to low interest. unlike many on this post,I barely earn above median income. i am telling you guys, it is tough for me and my girl to save more than 25% of what we earn because everything costs so damn much, even though our rent is only $1250. I can remember when my father's mortage payment on a 1900 sf house here in the IE is around that... and there's NOTHING I could do about it... sad...

Steve said...

This is no issue with a bailout. A primary reason that no-doc loans were used was because most of the sub-primers can't fill out forms and their ability to read is suspect.

There is no way these folks will figure out a way to a complete a government form.

susanne.kruppa said...

Yes, economy was growing by 4%. But why? Because consumers went on a shopping spree with the borrowed money from their refinanced house. The growth over the last couple of years was financed by funny money. So far for the growth numbers....

punjabi buffett said...

to the savers,
i dont understand why you dont buy shares of berkshire hathway(run by renowned value investor , warren e buffett). each of the b shares now cost around 3900 $. but it has returned > 10% in the last 10 yrs.
pls research it and learn to create wealth instead of paying banks to lose your money

punjabi - a buffett fan