Wednesday, December 15, 2004

If it looks like a bubble, and quacks like a bubble, its a bubble.

Howe Street

Often the best evidence in support of a bubble can be found in the absurd arguments of those who deny its existence

The Orange County Register, which services a California region that could be described "the epicenter of the housing bubble," ran a story expressing skepticism about a recent Chapman University study that had predicted a 7.5% decline in area home prices in 2005. Although it was hardly surprising that the local real estate experts (quoted in the story) heaped scorn on the study, their comments inadvertently validated its conclusions, and prove that often the best evidence in support of a bubble can be found in the absurd arguments of those who deny its existence.

First, the very title of the article "Some See No Ceiling for Home Prices" itself provides compelling evidence of a bubble. This “sky’s the limit” attitude typifies the bubble mentality, and is reminiscent of the lunacy which captivated investors during the tech bubble. One real estate broker not only predicted another 15% rise in home prices next year, but declared that such gains would continue uninterrupted until 2020 (at which point, it must be concluded, only multi-millionaires would be able to afford homes).

One critic alleged housing prices would remain strong because parents were buying homes as investments for their college aged students, and advised Chapman to "check with its students" for a more accurate assessment of future housing trends. Such short-term speculative buying has bubble written all over it, as does giving credence to the investment "expertise" of college students.

A local real estate developer who also doubted the study, unintentionally proved to be one of its most convincing advocates, by admitting that its conclusions would be scary if true because "investors need home prices to go up to offset the negative cash flow most local real-estate investments now generate because rents are too low to cover mortgage payments." Unfortunately, in the world in which we live asset prices don’t rise merely because owners need them to. If deliberately buying houses as "investments" despite negative cash flow, with the intention of selling to greater fools at even more outrageous prices, isn't a bubble, then what is?

Also quoted predicting higher prices was a real estate broker, who despite negative cash flows, bragged about having just advised all of his "investors" to buy. Is it just me, or don't prediction of higher future prices despite increasing losses, and brokers whose only recommendations are "buys," sound a bit too familiar? Did Henry Blodgett change his name and get a real estate license?

Such absurd arguments, which themselves support conclusion opposite to those which their proponents intend, are increasingly prevalent on Wall Street as well. A perfect example being last week's CNBC segment featuring an interview with a strategist claiming "definitive proof" that a real estate bubble does not exist lies in the fact that rising housing prices do not result from speculation, but rather increasing demand generated by greatly reduced lending "standards." With rationalizations such as these, the only conclusion one can draw with respect to the Orange County housing market is that if it looks like a bubble, and quacks like a bubble, its a bubble.

1 Comments:

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