The Nattering Nabob has a very pithy (and astute) observation of what makes a bubble:

Manias share four common characteristics:

• A feeding frenzy sends prices parabolic.

• The public jumps in with both feet.

• Valuations detach from economic reality.

• Rationalizations abound for why valuations are reasonable and the trend will continue.

There are several reasons I have been reluctant to call the Real Estate market a bubble — yet.

- The market is regional; San Francisco, NY and Boston do not = the entire US;
- Its an illiquid market, and properties take a while to sell (as opposed to being flipped intraday);
- Most buyers care little about purchase price — they are concerned with monthly carrying costs. Insurance and Taxes have remained fairly stable;
- 40 year low interest rates allows people to buy more expensive homes, so long as they can afford the monthly nut.

I do expect the hottest areas to fall by as much as 30%, if rates keep rising (as many expect they will) . . .  Is that a bubble popping — or merely a retracement of outsized gains?

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

5 Responses to “Defining Bubbles”

  1. Andy Nardone says:

    Point 1: I just read an article about a flipper in Wisconsin. I don’t believe the “it’s regional” hooha. The low rates we are getting in NY tri state area are the same (or quite close) rates folks in the flyover states are getting. If they can bubble here, they can bubble there. Maybe prices don’t move to the same degree, but the low rates are certainly causing price distortions.

    Point 2: In the hottest markets this doesn’t seem to be true. Sometimes properties are flipped multiple times before contruction. This I would agree may be regional activity and it may not be intraday but it’s getting darn close in some cases.

    Point 3: I see this quite differently. When all prices do is go up this isn’t a bad perspective to take. However, to focus on monthly payment as opposed to a true value doesn’t make sense if you’ve grossly overpaid. And given the low to no down payments many of today’s buyers put up, they’re really just glorified renters. When the going gets tough they’ll hand over the keys. It’ll become Countrywide Real Estate Company.

    Point 4: See above.

    I’m glad I didn’t see it on your list because I love the idiocy of the bullish argument of “They ain’t makin’ any more of it” – just what Japanese homebuyers were squawking in the late ’80s-early 90′s. And they live on an island!

    This ends ugly.

  2. lee says:

    Whether you call it a bubble or not, a 30% retracement in price would certainly bankrupt a whole lotta folks—given the leverage being employed to afford homes here in Calif.

    The last boom/bust cycle was 85-95 with the top in 89-90. Homes in SoCal declined in price 20-30% during the 5-yr bust.

    Starting in ’91 and continuing thru 95, lots of homes were sold at a loss. In fact, in ’93, fully 42% of all homes in Calif were sold at a loss and over 60% in OC, SD and Ventura. The avg loss was about 30K.

    Homes are 3X more expensive now, so a similar scenario would see nearly half of all sellers taking a six-figure bath at minimum in the years following the peak of the current boom.

    Will be a tough decision for many. Some will be forced to stay in homes/areas they don’t want to live in because they can’t “afford” to sell.

  3. lee says:

    Whether you call it a bubble or not, a 30% retracement in price would certainly bankrupt a whole lotta folks—given the leverage being employed to afford homes here in Calif.

    The last boom/bust cycle was 85-95 with the top in 89-90. Homes in SoCal declined in price 20-30% during the 5-yr bust.

    Starting in ’91 and continuing thru 95, lots of homes were sold at a loss. In fact, in ’93, fully 42% of all homes in Calif were sold at a loss and over 60% in OC, SD and Ventura. The avg loss was about 30K.

    Homes are 3X more expensive now, so a similar scenario would see nearly half of all sellers taking a six-figure bath at minimum in the years following the peak of the current boom.

    Will be a tough decision for many. Some will be forced to stay in homes/areas they don’t want to live in because they can’t “afford” to sell.

  4. Barry

    The problem with asset bubbles is that everyone can identify them with hindsight, but when they are happening it is not always obvious.

    A recent Fed economic working paper, “Econometric Tests of Asset Price Bubbles: Taking Stock” by Refet S. Gurkaynak, found that asset price bubbles cannot easily be detected. You can find it here:
    http://www.federalreserve.gov/pubs/feds/2005/200504/200504abs.html

    I’ll probably write this up in my blog tomorrow.

    Cheers

  5. bhaim says:

    PMI Mortgage Insurance now estimates that the two riskiest markets are Boston and San Jose.
    The Ten Riskiest Housing Markets:

    Likelihood that Prices Will Decline In Next Two Years
    Metropolitan Area Probability
    Boston 53.3%
    San Jose 53.0%
    San Francisco-Oakland 47.9%
    San Diego 43.3%
    Providence 39.7%
    Sacramento 36.9%
    New York 36.3%
    Los Angeles 35.9%
    Riverside-San Bernardino 31.6%
    Detroit 27.4%

    Source: PMI Mortgage Insurance
    and http://www.ti.org/vaupdate51.html