I recently got into a discussion with my father about the housing bubble and its subsequent decline. During the discussion he said to me, "You know what the real cause of the problem was, don't you? It was those subprime mortgages." He went on to explain how those big, bad mortgage companies had taken advantage of ordinary home buyers. This analysis seems to echo the narrative told by the news media and America's politicians. While I don't want to let the mortgage lenders off the hook for fueling the housing bubble in its later years, they are by no means the primary culprits. The housing bubble had been well underway for several years before subprime mortgages became a significant part of the market.
The primary cause of the housing bubble is the same cause of all asset bubbles—the mass psychology that says the asset of the moment is the best way to get rich quick. Today that asset class seems to be commodities. A few years ago it was real estate. Before that it was stocks. At other times it has been everything from Beanie Babies to tulips. The problem with blaming "big corporations" for all the world's ills is that "the little guy" is never asked to accept responsibility for his own behavior.
Has everyone forgotten the tales of potential home buyers engaging in bidding wars and paying more than the asking price for homes? It wasn't the mortgage companies forcing people to bid above the asking price. That was the home buyer's own decision. Has everyone forgotten the real estate flipping TV shows like "Flip this House," "Flip that House," and "Property Ladder" that made home-flipping look like a quick way to get rich?
I remember numerous friends and family members during the upside of the bubble happily telling me how much their home had increased in value. I remember being told that real estate is the best investment you can make. I remember being told that by renting, I was throwing money out the window. I'm sure many other renters across the country heard the same advice from their family and friends. The message was clear: Jump on the bandwagon or you'll be left behind. It was the psychological bias known as "social proof" in full force.
You cannot buy an asset for more than its intrinsic value without losing money. As soon as people start to believe that the price they pay for an asset doesn't matter, financial disaster awaits. That is the real cause of the housing bubble—and its decline.
Subscribe to:
Post Comments (Atom)
Posts
Remember the letters? Buyers would be so desperate to get THAT HOUSE NOW, that they would not only jack up their bids and waive inspections, but they would write letters to the sellers pleading their case?
ReplyDeleteNow most of these people are upside down on their mortgages. Because they had to have THAT HOUSE NOW, even if it meant degrading themselves and practically begging. A total collective delusion.
hmmmm ... James. What is intrinsic value? Are you somehow implying that the cost of the labor and materials alone are what should determine the price of a house? Oh, and perhaps you'll agree that the land under the house figures in to it? (I mean I think we can all agree that a half acre in Manhattan is obviously worth a lot more than a half acre in Chantilly.) And how do you value that land from an "intrinsic" perspective? Do you think it's possible that as that desirable land (say in Manhattan) gets "demanded" by more and more people, that more and more people will be willing and able to bid up the price of it? After all, as you have so often said, prices are set at the margins. So, if instead of having 10 super-millionaires (or I guess in today's inflated economy the term would be super-billionaires), you now have 100 of them in a given area (say Manhattan), do you think it's possible that these extra folks with more money than they ever had can bid up these prices set on the margin?
ReplyDeleteThe result of some 25 years of post-Reagan economics has caused an acceleration of "haves" out there that can push that marginal price up and therefore push the "intrinsic" value of property.
Your father was right. You are wrong. He rightly recognizes that those properties "on the margin" are correctly priced (yeah, the suburban "me too" properties were in deed overpriced since by and large the wealthy "haves" were never going after those homes), and your dad is correct in that the problem started when the banks made loans they weren't sure they could collect to those "me too" buyiers.
>The primary cause of the housing bubble is the same cause of all asset bubbles—the mass psychology that says the asset of the moment is the best way to get rich quick.<
ReplyDeleteThat's not true, it's an over-generalization, and doesn't get at the ocean of complex varying motives of the buyers. You're basically saying that anyone who bought house say from 2004 and on was a greedy tool.
And the subprime mortgages were only one cause, one of many, of the asset bubble. The housing bubble was allowed to happen.
Lance said...
ReplyDelete"hmmmm ... James. What is intrinsic value? Are you somehow implying that the cost of the labor and materials alone are what should determine the price of a house?"
No. You are way off. Perhaps if you had read the Wikipedia article on the subject that I linked to, you'd realize it has nothing to do with building costs.
From Wikipedia:
"The 'intrinsic value' of real estate is therefore defined as the net present value of all future net cash flows which are foregone by buying a piece of real estate instead of renting it in perpetuity."
Basically, when it's cheaper to rent than to buy, housing prices are above their intrinsic value.
Heh, I remember about 2 years ago Lance was singing an admiration song about "innovative financial products", "new banking technologies", "this time is different", etc, etc. I thought - what a stupid little prick who didnn't understand what he was talking about. Now, when these "innovating products" blow in his face (and in the face of all of us) he still doesn't get it. Lance, dear, isn't the "the correct" price of the asset is determined by someone who is willing to match the offer?
ReplyDeleteB747
Yes, that is classically how a bubble forms. And yes, this was a bubble. But the current economic crisis has only something to do with the bursting of the bubble itself. More importantly, it has to do with leverage on a massive scale and a world of money looking for a safe investment that yields a higher than average return.
ReplyDeleteThe leverage wasn't just at the level of the individual mortgagor. It was on the part of the creaters and holders of derivatives based (loosely) on mortgages. And when the bubble was obviously bursting at the very end of 2006 and early 2007? Those guys -- the smartest guys in the room -- all doubled down.
And because, through a convenient fiction, securities and derivatives based on mortgages were rated as safe as treasuries, essentially, institutional investors worldwide held them. They were much more risky than that, in reality, and hence the current problem.
Your father is wrong. You are right. But the situation is more complex than that, at least at a macro level. And people who were not taken advantage of, and who were a traditionally good risk on a mortgage (prime lending and jumbo prime) will be in trouble if the values dip too far.
History is always conveniently revised to suit the narrative that we want to hear. We just happen to be witnessing it in a condensed time frame.
"Basically, when it's cheaper to rent than to buy, housing prices are above their intrinsic value."
ReplyDeleteJames, you'd have to know what all future rents will be to make that calculation. I.e., you can't (and shouldn't) assume rent won't go up.
"... Seriously, the buyer definitely could have rented a comparable place for less. Therefore, he must be a fool."
ReplyDeleteIf you (he/she) have tons of "dough", I don't see a problem in overpaying for RE I would like. Think of it as a nice toy you can afford, but don't really need and don't care about some "futue appreciation", that's it.
Cheers!
B747
Cheers! B747
ReplyDeleteHi Neil! How much longer before the terminally ill airline industry starts to produce its first corpses?
"How do you guys know where Lance lives?"
ReplyDeleteThey're netstalkers, Internet vermin, same as spammers and trolls.
Provide content
And appropriate commentary.
Seems to me that this economic thing is bigger than and different from a "housing bubble".
Lance talks about buying a place to live in and hold for the long haul.
It's the flippers, those who overpaid, and wannabe investors who are losing money.
The article at the Post sounds bad but it's about high risk investing gone bad. That builder was putting up "Spec Homes" and is losing his investment.
That's not what a homeowner does.
James, yes I know what a discounted cash flow is. But that doesn't help you if you don't know what the future rent payment will be. And you don't. As I've been saying for a long time now, the inflation that's knocking on our door will inflate rents (and everything else) at a rate well beyond what we've seen in the last generation when inflation was nearly non-existent. The thing about buying a home is that you are locking in your known payments. Even that minoirty of borrowers who have adjustable rate mortgages have locked in their payments to the extent by which their payments are capped.
ReplyDeleteYour dad is right. Go talk to him. It's not that he's smarter than you, just that he has experience that you lack. You've somehow completely overlook the unknowns which inflation brings in to the picture. Hint: someone buying a 4 bedroom suburban house going for something like $75,000 in 1980 could have rented that same house for something like $500 per month. If one did a net present value based on $500 per month, one would grossly underestimate the true costs of paying rent over 30 years.
"How do you know how much he earns?"
ReplyDeleteHe has put enough information about himself out there that anyone who has basic reporter skills can know everything about his entire life - he is a prime potential identity theft victim.
It is his own fault for having such need for attention.
I see that the comments about Lance's property were deleted, probably due to privacy concerns.
ReplyDeleteThat is completely understandable.
But let us not overlook the fact that home prices on his block are on the rise, with a nearby $1.4+Million sale this year.
Does everyone not understand that a sh!tstorm is brewing out there? Apparently, someone who bought a $1,400,000 home near Lance in the midst of the worst housing and economic downturn in the history of this country understands what is happening.
If you live in the outer suburbs and you aren't rich, You Are Disadvantaged. The supply chain to deliver goods and services to your neighborhood is looooong. And it is completely dependant upon fossil fuels.
You're going to want to be in the midst of a diverse economy (like Lance), a place with jobs, services and amenities nearby; a place with population density: AKA an "Economy of Scale".
If the economy within a 20 mile radius of your home is based upon strip malls and chain restaurants, and you must sit in traffic to get to a job outside that radius which enables you to make your monthly payments (rent, mortgage, heat, electiricy, food) - then you are Financially Disadvantaged, at best.
"If you live in the outer suburbs and you aren't rich, You Are Disadvantaged. The supply chain to deliver goods and services to your neighborhood is looooong. And it is completely dependant upon fossil fuels."
ReplyDeleteHave you been to the Wegmans in Ashburn? Compare that to ANY supermarket in D.C.
Food is made and grown in rural areas and trucked in. The worse traffic is in cities, the capacities of the deliveries decreases and the extra fuel costs increase.
You might not drive to market, but you'll pay for the food getting there all the same, and then some.
Think before you post.
DC is served by interstate highways (295, 395, 495, 66), in addition to:
ReplyDelete- Freight Rail
- Light Rail (MARC, VRE, Amtrak)
- Passenger Rail (Metro)
There are also dozens of bus routes and public bicycle sharing systems, not to mention the fact that most city neighborhoods are walkable A large percentage of the bus fleet runs on natural gas.
How do Ashburn's transportation options stack up in comparison?
DC hosts a dozen or more Farmer's Markets, year-round; both downtown and in residential neighborhoods. Here are a few: Fresh Markets
Supermarkets? Try the huge new Safeway in the center of the city;
City Vista Safeway
Or the 50,000 square foot Harris Teeter currently under construction near Union Station; which is The Hub of Rail Transport in the Region.
50,000 square foot Harris Teeter
Again - think: "Economies of Scale"
Also note that more than 1,000,000 square feet of office space are currently under construction in the city. Why? What do the people with huge sums of money to invest in real estate know that you do not? (those are rhetorical questions)
Did you know that Loudon county is facing a $200,000,000 budget shortfall next year?
http://www.wjla.com/news/stories/0908/554443.html
"The worse traffic is in cities, the capacities of the deliveries decreases and the extra fuel costs increase.
Increase? When it hits $10 per gallon, traffic will DECREASE. Metro and VRE hit ridership records this summer. Get it?
Did you hear me say "Sh!tstorm"?
"First of all, the housing bubble should more properly be called the suburban bubble, because most of the activity came in the form of "greenfield" housing subdivisions, and included all the additional crap-o-la accessories required by them -- strip malls, power centers, Outback steak houses, car washes, et cetera. The suburban expansion has been based entirely on cheap-and-abundant supplies of oil. Similarly, it was not an accident that the suburban project faltered briefly in the 1970s, when America's oil production entered its long decline, OPEC seized the moment, and oil prices shot up. Notice that the final suburban blowout occurred after 1990, when the North Sea and Prudhoe Bay oil strikes came into full production, disabling OPEC, and a world oil glut finally drove prices as low as ten dollars a barrel in 1999. That ushered in the climactic phase of suburbia, as represented by things like the standard 4000-square-foot Toll Brother's McMansion and the heyday of the super-gigantic SUV to go with it."
ReplyDeleteThe Suburbia Bubble
Oil will be at $70 a barrel.
ReplyDelete"Oil will be at $70 a barrel."
ReplyDeleteI am Bill Gates. I'm putting my money into potato pancake futures.
Hey, another hearing about the desire to widen I-66 inside the beltway: widen 66
ReplyDeletehttp://wtop.com/?nid=600&sid=1491487
Why do they want to do that? Where do they want to get to/from? Why is the road so congested in the first place? Why doesn't everyone just stay in Ashburn? And work in Ashburn? And shop in Ashburn?
One other mode of transportation to consider: Waterways.
ReplyDeleteThe city has access to the Potomac and the Anacostia rivers, and ultimately the Atlantic Seaboard.
How about Ashburn?
WSJ had a nice article within the last 2 years showing that bubbles and bursts aside, house prices climb at the rate of inflation +1%. The gains are mostly offset by the cost of repairs, insurance, and property taxes. And don't forget that mortgage interest can more than double what you pay for a house.
ReplyDeleteThey were using a 20 year time frame. Houses bought at the top and ridden down do much worse, and the inverse is true.
If you want a house, buy it, live in it, and don't move for a long time. If you move a lot, rent. Never spend more that 20% of your net on house payments even though they'll loan more.
Net on net, people lose as much on their house 'investments' as they gain. Investment is not a compelling reason to buy over renting.
I'm glad people have finally ended their bubble denial. Yes, it was a bubble. Yes, it is bursting. Yes, there is more downside. Yes, it will take 10 years or so to recover, just like the last several bubbles.
We are far enough into this to start shopping. We're going to look around south FL and if we some something we like, we'll put a cash bid 20-30% less than the asking price. If they've suffered enough, they'll take it. If not, they will in another year.
ReplyDeleteThe Wegman's in "Ashburn" is actually in Sterling. A place on the decline and that is land-locked by traffic, and is seeing the rise of gang violence.
ReplyDeleteWegman's is a thrift market, which is why they located in Sterling. Harris Teeter is up-market, which is why they are locating in DC.
"the housing bubble should more properly be called the suburban bubble"
ReplyDeleteMany miss that important point. Prices did not get out of line in the better, close-in areas.
In fact, I've suggested to associates that they consider buying in or near the city. Their response, "I get more for my money in .... " Leesburg, Manassas, etc.
I pointed out the lengthy commute but they wanted the "big, new house".
Many miss that important point. Prices did not get out of line in the better, close-in areas.
ReplyDeleteYou just wait....prices in close-in areas will be the last to fall but FALL THEY WILL. Prices in close-in areas tripled or quadrupled! That is why the outer burbs eventually boomed. I didn't think their were still people with their head in the sands. The end is coming...and noone will be safe.
I moved to another city altogether where the economy is stable and my mortgage is 1000 per month. DC is built on debt! And I wouldn't take my cue from real estate developers as to where the future growth of America will be....they are as lost as the rest of our leadership.
>I moved to another city altogether where the economy is stable and my mortgage is 1000 per month. DC is built on debt! <
ReplyDeletelove these narcissistic cookies.
"Please kill yourself soon - today, even."
ReplyDeleteHa! Touch a nerve? Apparently so, if death is perceived as the appropriate response to a comment about supermarkets!
"I moved to another city altogether where the economy is stable"
ReplyDeleteWashington's economy is unstable compared to your new hometown?
Care to name that town?
"I moved to another city altogether where the economy is stable"
ReplyDeleteWashington's economy is unstable compared to your new hometown?
Care to name that town?
America is broke dude, wake up! What do you think the future holds for DC's spending spree???
Actually, my comment was: were the economy is stable AND my mortgage is 1000 dollars [for 5 acres wooded, no neighbors, 3000 sq foot new custom construction, double garage, 2 driveways, 3 kennel runs, mountain views....]
And it's 20 mins from state capital of a state with no budget shortfalls, 3.7% unemployment, salaries 90% of DC, and property values STILL RISING.
I won't tell you where - I don't want any DCers showing up.
You guys still don't understand - the U.S. is shifting back and the credit-dependent glamour coastal cities are fading along with our dollar.
Now go put your head back in the sand.
"for 5 acres wooded, no neighbors, 3000 sq foot new custom construction, double garage, 2 driveways, 3 kennel runs, mountain views....]"
ReplyDeleteThe Stars & Bars are flying high over the pole building, NASCAR is coming in loud in clear on DishTV, Ball Park Franks are grillin' over the fire pit, and the hound dogs are makin' sure there ain't no minorities tryin' to sneak onto the compound.
Utopia! LOL! You seek out isolation from the rest of humanity, and you accuse others of having their heads in the sand?! Ignorance does seem like bliss, but I wouldn't know...
""for 5 acres wooded, no neighbors, ...."
ReplyDeleteGot any women-folk nearby? Or do you plan to kidnap hikers? Or perhaps you will get friendly with some guys in a canoe? (You're a big fan of Deliverance, ain't 'cha?)
ReplyDeleteUtopia! LOL! You seek out isolation from the rest of humanity, and you accuse others of having their heads in the sand?! Ignorance does seem like bliss, but I wouldn't know...
Got any women-folk nearby?
I got one waiting at home...
And you are intimating that I AM IGNORANT? HA HA HA
I don't seek isolation - I seek safety and affordability and quality of life and reasonable rush hours and friendly people and housing prices supported by normal income multiples.
Good luck with that deflating asset you live in and the riots that will be happening in your neighbor's driveway. At least you will be able to feel superior to the rest of the country while our nation burns.....
"I got one waiting at home... "
ReplyDeleteYou "got one", eh?
I know you are ignorant, because you have demonstrated that you are ignorant.
Enjoy pumping gas into your pickup in order to gain access to food.
"Enjoy pumping gas into your pickup in order to gain access to food."
ReplyDeleteStop putting your considerable lack of basic knowledge on display you bitchy queen.
You clearly have no idea what you are talking about.
Anonymous said...
ReplyDeleteHey, another hearing about the desire to widen I-66 inside the beltway: widen 66
http://wtop.com/?nid=600&sid=1491487
Why do they want to do that? Where do they want to get to/from? Why is the road so congested in the first place? Why doesn't everyone just stay in Ashburn? And work in Ashburn? And shop in Ashburn?
66 doesn't go to Asburn.
By the way, if terrorists or a rogue nation ever nuke DC, the people in Ashburn will live.
ReplyDeletejames, you are right, and it'll happen, just no one knows if it'll happen tomorrow or in 20 years.
ReplyDeleteI worry about it. I often think I'd like to sell my house and buy a condo so I won't lose as much money when it does happen.
But your larger point is even if I lose my condo, if I am here when it happens I'll be dead, or wish I was.
By the way, if [terrorists|aliens|ruskies|red coats] ever nuke DC, the people in Ashburn will live.
ReplyDeleteIt was always ever thus.
No, it really wasn't. Many who have lived here their entire life never feared anything would happen here until the Sept. 11 and anthrax attacks.
ReplyDeleteHere's a thought, yes housing bubble absolutely rediculous prices, the pin.... dramatic rise in oil prices. Higher food, transportation, utilities, consumers living at the edge of their means what do they give up? you gotta go to work and eat that means the car and gas and food, drop the shelter first cause you can rent. The terrorists wanted to bring down Wall St, their allies control the oil, just food for thought
ReplyDeletejames, you are right, and it'll happen, just no one knows if it'll happen tomorrow or in 20 years.
ReplyDeleteI worry about it. I often think I'd like to sell my house and buy a condo so I won't lose as much money when it does happen.
But your larger point is even if I lose my condo, if I am here when it happens I'll be dead, or wish I was.