In the midst
of local house-buying manias, the classic mark of the end is when
buyers line up to buy a house and bid against each other. This is
the best way to sell a house and the worst way to buy one.
Why do buyers
do this? Because they have missed out again and again by offering
less than the listed price. The buyers who offered the listed price
bought the house.
did this in February, 2005 for my home. The other family thought
that $90,000 for a 4-bedroom house was too much to pay. They were
Then the panic
escalates. Those offering the listed price get left behind. They wait
too long. “Too long” means more than one day after the house comes
on the market. They hesitate. He who hesitates is lost in a seller’s
late 2004, I found a 2-acre commercial property listed at $30,000.
The normal price in the area was $90,000 an acre. I got there on
the first day it was listed. There was no For Sale sign. I visited
it again the next day, a Sunday afternoon. A For Sale sign had been
up for one hour, I later learned. I submitted my offer — $30,000
(no haggling) — on Monday. When something is priced 83% below
market, don't dilly-dally.]
Then panic appears.
A group of buyers will line up in front of a property before it officially
goes on sale. The list price is merely the minimum bid in what soon
becomes an auction. In an auction, buyers overpay. They become frantic
that they will miss out again. The presence of other bidders makes
them desperate. They think: “This is the last time I will be able
to buy. It’s now or never.” This is always wrong. They are in fact
buying at the peak.
in Southern California in 2005. It happened to town houses in the
Washington, D.C. area in 2006. In March, 2006, this story ran in
the Washington Post: “Median
Price Breaks $400,000 Barrier."
a year marked by frantic bidding wars among buyers anxious not to
miss out on a house, any house, the median sales price for the region
jumped 27 percent to $419,000, up from $330,000 in 2004, according
to a Washington Post analysis of government sales records
for single-family houses and townhouses.
condominiums escalated even more steeply, rising 34 percent to
That was the end.
Toward the end of the article, the report offered this bit of information.
volume of single-family and townhouse sales during the year fell
about 2 percent to 104,827. Some of this drop-off may be the result
of a slowing market, but some may also be a statistical artifact.
It was not
a statistical artifact. It was the end of the bubble. In late September,
Post reported on a very different market. Sellers were
not lowering prices, buyers were biding their time, and homes were
In that region
of the country, income comes from American taxpayers. The flow of
funds into the region rarely slows. Federal hiring never ceases
to grow. So, sellers are not desperate to sell. But they are stuck
inside their houses. Buyers are not being stampeded.
This has not
been the case in California, Florida, and Las Vegas. There, foreclosures
are steadily motivating sellers to come to terms emotionally with
the new conditions. When a home owner is forced to move, he leaves
his home empty. That is a tip-off: “Motivated seller.” Then more
For Sale signs appear. The motivation increases.
admit to themselves that they made a mistake, that they should have
sold in 2005 and rented. They pretend that their home is different.
Why? Because they own it. They think this makes a difference. But
the home isn’t different. What varies is the degree of desperation
of the sellers.
In some regions,
home ownership is still sound policy. But that policy is going to
be less and less sound, depending on the size of the house and the
demographics of the neighborhood. If jobs in a recession dry up,
real estate will fall.
MANIA IS ENDING
It was not
just Greenspan’s Federal Reserve that pumped new money into the
housing market. All over the industrial West, central banks inflated.
The commercial banks then imitated the United States and extended
credit to real estate buyers. The whole world became subject to
the carry trade: creditors who borrowed short to lend long at higher
real estate has for a century been the carry trade of preference
for lenders. In the United States, this has been especially true
because of subsidized FDIC and FSLIC insurance programs that guarantee
Now the real
estate carry trade is unwinding. It has a great deal of capital
to unwind. Trillions of dollars and other currencies have been funneled
into residential real estate. New credit extended to this market
is going to decline. There will be fewer buyers making offers.
as with all other prices, are set at the margin: the latest exchange
between buyer and seller. What conceals this is the difference in
markets: locations, income levels, and expected opportunities. It
is not like the commodity futures market, where the products are
tightly defined and interchangeable.
Prof. Piet Eichholtz, a real estate professor at Maastricht University,
has been using records of house prices on the canal to trace the
rise and fall of booms and busts. He has traced this back 350 years.
There are few time series more comprehensive in the literature of
Eichholtz has come up with a non-spectacular thesis: bubbles always
He has studied
more than just the price moves on the Amsterdam canal. He has been
following world real estate price movements in recent years. He
concludes that we have been in the midst of a worldwide bubble.
It has now reversed. We should prepare ourselves for double-digit
price declines in housing. These declines will be even greater in
countries with falling populations. This includes South Korea, Japan
and Eastern Europe.
professors Shiller and Case take Prof. Eichholtz’s studies seriously.
In 2005, in his book, Irrational
Exuberance, Prof. Shiller cited Eichholtz’s work and warned
that the real estate bubble was close to the end. It was. Prof.
Eichholtz’s assessment is today very grim.
are long periods where prices go up and prices go down. Over the
centuries there is no uptrend or downtrend,” said Eichholtz. “The
index teaches that the house market is volatile and in real terms
doesn’t go up or down structurally.”
says home-owners have short memories when it comes to big price
falls: “When there is volatility every so often people are very
myopic and tend to forget,” he said.
fall of 30 to 40 percent is rather common and cannot be ruled
out for the United States and Britain.”
has the bulk of his capital tied up in his home — a consumer
good, not an investment asset — and he finds that he has suffered
a 30% loss, this will affect his plans. His confidence about the
future will decline. His plan to live inside his capital base until
his death, with his widow inheriting it and living there until going
off to a retirement facility, is called into question by a 30% fall.
mania has spread to many nations, the slowdown will hit them all.
This is going to hit with varying intensity, nation by nation. The
home-owning public will react differently. Where the recession is
most likely, such as in the United States, the decline will be sharper
and sooner. It has already begun. Where there has been less speculation
and homes are owner-occupied, the decline will be more gradual.
what happens whether you believe it or not. Reality is now intruding
into the housing markets. People had better re-think their plans.
A change is
coming to the American political scene. In my April 4, 2002 issue
of Reality Check, I wrote:
to the Presidential administration that gets caught during a temporary
interlude when the Federal Reserve stabilizes the money supply.
Leverage then inflicts pain and decreases mobility. Soon, that administration
will move out. In American politics, the changing seasons are marked
by the delayed effects of changes in Federal Reserve policy.
The future is
now. The presidential administration is now on its way out. It is
under a cloud economically. Bernanke’s FED gave us tight money policies.
It looks as though the FED has now reversed. But this is too late
to avoid the recession that almost everyone denied last December.
It is going to hit the economy before the voters go to the polls.
They will vote their pocketbooks. They will demand change, meaning
economic recovery, meaning higher price inflation.
If their homes
are falling in price, their ability to refinance will be limited
if they refinanced within the last three years. Their equity is
lower today: falling prices, more debt. The use of home equity as
a credit line is still possible for people with good jobs, high
credit ratings, and lots of home equity. But this is not the average
of 2003, I
reported on the warnings of Richard Benson regarding the coming
crisis of the real estate industry. His warning concerned the inability
of the government-sponsored enterprises Fannie Mae and Freddy Mac
to sustain the bubble they had jointly created. His warning was
too early. So was mine. But the scenario he described then has now
surfaced. The accounting scandals at Fannie Mae and Freddy Mac erupted
in 2004. Here is what Benson wrote in 2003.
honest opinion is that Fannie Mae and Freddie Mac are running massive
Hedge Fund balance sheets. The equity base is 2%, leverage is over
50 times. The GSE’s derivative positions are in the Trillions of
dollars, and their accounting is totally opaque, and impossible
to figure out. Mortgage holdings of this size are impossible to
hedge without blowing through the GSE’s eggshell thin equity layer.
Moreover, there are serious concerns for credit quality, moral hazard,
and simply being on the wrong side of the “housing bubble.”
He cited a
report from Franklin Raines, head of Fannie Mae, on the rotten
accounting procedures of Freddy Mac.
But it was
Raines who got the axe. He announced his retirement in December,
2004, under the cloud a suspicion regarding accounting practices.
In 2006, he was sued by the Office of Federal Housing Enterprise
Oversite, which regulates Fannie Mae. Why? The OFHEO said he had
been given payments of $84.6
million on the basis of vastly overstated profits. He had previously
served as the head of Clinton’s Office of Management and Budget.
problem is still there. This is being threatened by the defaults
in the subprime mortgage market. The equity of both organizations
CAN YOU PROFIT?
In May, 2004,
my case for avoiding a major loss. I also described how to profit.
estate today is an asset bubble. Rents usually won’t cover mortgage/
tax/ insurance costs. But real estate can conceal the bubble longer
than any other class of asset because it can be occupied by the
borrower. He pays his mortgage on an asset that has lost 20% or
more of its value. He doesn’t want to lose his credit rating. If
it is residential real estate, he doesn’t want to lose his home
in a foreclosure. Surely, his wife doesn’t. So, he pays more in
mortgage, taxes, and insurance than it would cost him to rent a
comparable property. He is in fact paying an ego premium. This allows
him to pretend that he made an error by buying too late.
expose such self-deception. People lose their jobs. They can’t
pay their mortgages. They are forced to move. This is when the
true value of local real estate is exposed for all to see. The
“For Sale” signs go up like dandelions in spring.
estate prices leap by over 20% a year in a region, you know you’re
seeing a bubble. This is happening in Los Angeles and Boston.
It is the time to sell and rent or sell and move. When the bubble
ends, buyers get locked into their jobs because they must pay
their mortgages. They lose mobility geographically, which reduces
“I must buy now.” They think the market will never stop rising.
But prices always do stop rising. There is always a hard-pressed
seller who has to walk away from ownership. You buy the other
guy’s mistake. You shop for mistakes.
I was a year
early. But, generally speaking, the person in Los Angeles or Boston
who did what I said is ahead of the game today. If he has equity
money in reserve, he is going to be able to buy at substantial discount
before this cycle is over.
think this housing market is going to reverse in 2009. I am not
among them. This is an international phenomenon. The decline in
on-paper wealth is going to shake the confidence of hundreds of
millions of home owners.
that you prepare for an international economic slowdown. The people
who thought they were real estate rich are going to face a new reality:
rising property taxes, rising expenses, rising utility bills, and
declining equity. This is not the scenario for bull market investing.