If
you're looking for the housing bubble to end like
the stock market bubble, you'll be surprised. Housing
bubbles may run
on the same fuel as stock market bubbles, excess money from the Fed,
but they grow and collapse according to a different set of functions
and dynamics.
January
29, 2004
The
last update to iTulip.com was on the topic of the Housing Bubble,
in August 2002. I deemed the housing market was indeed an
asset
bubble. The
main thesis was that rational housing prices are determined by cash
flow, and cash flow is determined by incomes and interest
rates.
Incomes have been falling real terms (9.3% since 2000) while key real
estate markets (read: where most people live), experienced housing
prices rising between 100% and 400% faster than incomes. The
explanation for rising housing prices was too low interest rates, which
also caused the the stock market bubble of the 1990s.
The Fed wrote a recent piece on how housing isn't a bubble,
reminiscent of Greenspan's now famous New Era rationalizations in 1999
for the stock market bubble. The Fed explains that housing
prices
are
high because interest rates are keeping monthly payment costs
low. In
my view, that's not an explanation of rational pricing, only for the
underlying cause of the bubble.
How does it end? On the way up, housing bubbles grow differently than
stock bubbles. They're regional, because folks buy homes near
where
they get their income, usually withing a 40 minute drive. Now
I
realize
that in Northern California that could be two miles away on Rt. 101,
but bear with
me. That means prices fueled by too low interest rates will
manifest
where people and the jobs they drive, take a bus or train, or walk to
are concentrated. Also, they happen in areas where land is scarce, such
as waterfront property; speculation is encouraged by the reality of
land limitations. Popular belief today is that prices won't
decline much in the
future because land is limited relative to the number of people who
want on it. Tell that the the Japanese who have seen real
estate
prices
decline for more than 12 years. Too much land and not enough people in
Japan? No. Even though interest rates have been
near zero
for years,
the problem is that their incomes have been declining.
Low rates are the input of a housing bubble, areas of concentration of
population or scarce land are where they happen, but low interest rates
will not sustain the bubble forever. Just as housing bubbles
are
unlike
stock bubbles on the way up, they're different on the way down, too.
Unlike stock
market
bubbles, real estate bubbles don't pop. Collapsing
stock market bubbles are characterized by a sudden collapse in prices
because stock markets are highly liquid. You see huge volumes
of
transactions at ever lower prices during a stock market
collapse.
Collapsing housing bubbles, on the other hand, are characterized by
illiquidity, a sudden collapse in transactions.Buyers
and sellers seem
to disappear.
The reason is a reversal in the psychology of buyers that
developed at the top of a speculative housing market. Buyers
had
been
buying at prices they knew were too high but on the assumption that
they'd be able to sell if they needed to. The thought was:
"Ok,
maybe
it's overpriced, but at least I'll be able to sell it later for at
least what I paid for it, but likely more." What happens on
the
way
down is that houses go on the market and just about no one
shows up to
look. That's because buyers weren't buying earlier primarily because
they needed a place to live, but because they thought the price would
likely rise and that, in any case, they'd be able to get out when they
wanted with all of their money or more. On the way down,
neither
condition is true. So buyers stay home, so to speak.
Can't buyers be enticed by declining prices, by bargain hunting,
you ask? No. Once housing sale transactions
suddenly fall
from, say,
several hundred a month in a large community to, say, one or two a
month, this creates fear and loathing about prices. Long
periods
of
time pass when there are no transactions at all. Think of it
this
way.
What's the comparable on your 3000 square foot home in San Mateo when
the last sale was, say, seven months ago? Is it 10% less than
the
last
sale of a similar home on the area? 30% less? This happened
in
Japan,
and prices nationally are still more than 60% below peak prices in
1992, where real estate prices continued to climb for several years
after their stock market bubble popped. Sound familiar?
If you'd like to read more on this topic, Blanche Evans, the editor of
real estate professionals' site RealtyTimes.com, has written a good
series titled "The Perfect Real Estate Storm".