I recently responded to a post at another blog from a reporter looking for info on bubble blogs. He would probably like to hear from any posters who would like to respond. He allowed me to remain anonymous. I have no idea if he is planning to use any of this material. His email address is: glenn@inman.com

Below is our Q&A:

InmanNews

This is what I’m working on:
  
Many blogs have been born around the notion of a housing bubble. The definition of housing bubbles;  explanations for their formation and fate, size and location; and the very existence of housing bubbles have fueled arguments among real estate enthusiasts and experts alike for several years. And everybody seems to have an opinion. The debate has inspired T-shirt designs and sales of other bubble-related memorabilia. Is this the real estate equivalent of the global warming issue?  Will there ever be a unifying bubble theory or are we doomed to never find a consensus?
 
Some questions:
1) What makes you a real estate bubble believer, a bubble debunker, or bubble neutral?
I am a bubble believer, or more accurately stated, I am a bubble observer. It is not like religion where you either chose to believe or not believe in absence of evidence. IMO, there are bubble observers, and those who chose not to see it.  The phenomenon is real and observable.

2) How do you define a housing bubble?
A housing bubble, like any financial bubble, is an unsustainable increase in prices generally followed by a price decline back to fundamental valuations. It is the departure of prices from their fundamentals that most clearly defines the recent price increases in real estate as a bubble.
 
The fundamental value of all housing prices is comparative rents. Rents tend to keep pace with wages and generally outpaces inflation by about 1%. There are times when supply and demand issues in local markets create fluctuations in this relationship, but as a generally rule, rents track wages pretty closely. Rents define the fundamental value of real estate because rental is a direct proxy for ownership. Both rental and ownership provide for possession of property. In a normal real estate market, when prices go up and the cost of ownership exceeds the cost of rental, people choose to rent rather than own, and the resulting drop in demand depresses home prices. The proxy relationship between rental and ownership generally keeps home prices tethered to rental rates.
 
However, sometimes when demand pressures greatly exceed supply, prices rise rather acutely. People react to the rise in prices with greed and try to buy in order to make a quick buck (flipping) this adds more demand which makes prices rise even faster. This is where prices detach from their fundamentals and rise simply because they have been rising. This is only sustainable as long as there are greater fools in the market to continually pay higher prices. When the supply of greater fools is exhausted, sales volume drops off dramatically (which we have already seen), prices stabilize briefly, then they begin to fall. Once prices start to fall, people realize there is no fundamental value supporting the prices, and panic selling begins. The selling continues until prices are driven back down to fundamental values where investors begin the cycle all over again.
 
The event which triggered the spike in demand this time was the entry on the scene of sub-prime lending. Suddenly a whole group of people who were previously excluded from the housing market now had the ability to buy. Downpayments were eliminated, lending standards were lowered, and demand increased dramatically. The sub-prime lending market started the boom, fueled its increase, and it will prove to be its demise (did you see the 2 day decline in share price of New Century Financial?)

3) How does this definition fit (or not fit) the national housing market? Which regional or local housing markets have exhibited the most bubble characteristics?
First, there is no true national housing market. All real estate is local. There are national trends that may impact all housing markets such as the conditions which created this nationwide bubble. The coastal markets in California and Florida are severely inflated. Las Vegas is not far behind.
 

4) Which bubbles burst?  Which ones have deflated? Which ones are inflating? Which are about to pop? 
Several markets are already in the first stages of the deflation. San Diego, Boston, Sacramento, and some others have already seen YOY declines in excess of 6%. San Diego in particular was a leading market. The bubble started there about a year earlier than other markets, and it has been leading the markets on the way down as well. Look for huge declines in San Diego this year and next.
 
5) Are there any common traits among the bubble markets?
Separation of housing prices from their fundamental value. Dramatic increases in house prices without commensurate increases in wages and rents. The increase in the use of exotic financing including interest-only and negative-amortization loans. The markets where these loan products are the most prevalent are the markets that will be most adversely impacted by the deflation of the bubble.
 
6) What is your best evidence for or against a housing bubble?
I think I outlined that above. Detachment from fundamentals caused greed and enabled by sub-prime lending.

7) Is it possible to accurately identify the existence of a bubble before it is gone?  Explain.
Real estate bubbles are relatively easy to identify because their fundamental valuation (comparative rents) are easy to determine and relatively stable. When the cost of ownership exceeds the cost of rental, a bubble is forming. When it greatly exceeds it, as it does now, the bubble is very obvious. The only difficult thing to identify with a real estate bubble, or any bubble for that matter, is how big it is going to get and when it is going to pop.
 
Back in 2003 we were at the top of a bubble that would have resembled the 1989 bubble peak. It was mostly built on conventional mortgages. Interest-only was starting to creep into the picture, but it wasn’t ubiquitous or even particularly problematic. At that point, if lending standards were not thrown out the window, we might have had an early 90’s kind of slow deflation. But that isn’t what happened.

Affordability problems caused interest-only to become the norm in 2004/2005 and prices pushed up even higher. By the spring selling season of 2005 affordability was again a problem, so negative amortization came on to the scene. By 2006 interest-only and negative amortization dominated the scene.

Now we have a real problem. A slow deflation like the early 90’s is no longer possible. Catastrophic, equity crushing, price declines fueled by an unprecedented rise in foreclosures is the only way forward from here. Possibly late this year, but more likely in 2008 there will be a massive supply dump and very few buyers to absorb it all. Price declines in 2008 of 20% or more are possible. There will be nothing "sticky" about prices on the way down during the foreclosure phase of this crash.

8) How are bubbles born and how do they die?
Bubbles are born when there is an unexpected spike in demand causing a dramatic increase in prices in a relatively short period of time. Greed kicks in to push prices higher if credit is made available to the masses.
 
Most bubbles die a very painful death, particularly in real estate. When the stock market bubble popped in 2000-2002, many people lost their entire investment, sometimes their entire life savings, but few people were pushed into bankruptcy. If you are about to go negative in your brokerage account, your broker will sell all your positions and close you out. You generally don’t go negative in a brokerage account.
 
There are no stoplosses in real estate. When the market takes your house values below what you owe on it, there is no getting out. Houses are very illiquid. It takes time to sell, and the transaction costs are very high; therefore, the risks are much, much higher. When a housing market crashes, there are lots of foreclosures and bankruptcies. This is very emotionally upsetting, far more so than losing money in your brokerage account.
 
One more note about the death of bubbles: People are greedy, and right now they still believe in house price appreciation. At market bottoms, they don’t.
Between 1995 and 1998 when the market was bouncing along at the bottom, people had just witnessed 5 or more consecutive years of declining real estate prices. Nobody thought prices would go up again. The only reason they didn’t continue to drop was because rents finally caught up with payments, and it made sense to buy. The fundamentals aligned with prices again. This happens at every market bottom.
Last time it took 5 years of declining prices to defeat the belief in continual appreciation. How long will it take this time? I don’t know, but I suspect with the pain that is coming, people will be much more cautious and be much more suspect of claims of perpetual appreciation in the future.

9) Why do people get so fired up about the concept of a housing bubble?
Owners get fired up because they don’t want to see their fantasy wealth evaporate.  Everyone got greedy and bought with the notion they were going to become instant millionaires. You could make $100,000 a year or more just for owning real estate during the rally. It was free money. That kind of fantasy dies hard. 

10) Will there ever be an explanation for bubbles that we can all agree upon?
See above, and consult the book "Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay.
 
11) Will there ever be a time when the discussion about bubbles goes away? Is this just a passing fancy?
I’m sure it will reach a crescendo over the next 2 years. Once the debate is over and the bears are proven correct, there will be some gloating by the bears, and there will be some who continue to go to the boards to get updates on the market train wreck, but once there is no real debate, interest will flag. 
 
12) What has motivated you to participate in the bubble discussion and what have you learned? What is your background in real estate/economics?
I don’t want to see more people lose money. It really bothers me when I see shills in the real estate industry, thinking only of their own financial gain, encourage people to commit financial suicide. 
 
I have a masters degree in land development, and I have worked for 20 years in the land development field. I see the market on the wholesale level very intimately. I observe the retail market as an interested outsider and sometimes participant. I have been a student of financial markets generally for about 10 years and real estate markets in particular for 20.
 
 
Let me know if you can talk by phone today (Thursday) or I’m happy to work by e-mail.
 
Thanks for your time.
 
Sincerely,
 
-Glenn

this is my new best friend.
-bix

Great job IrvineRenter. Way to represent!

IrvineRenter - Good writing, but I disagree with some of the points. For one, I dont think there will be panic selling as most people DONT have to sell their homes. Only the subprime buyers with risky loan will have to sell, most homeowners can just simply stay put. And when forclosures start to become a bigger national issue, the rate might go actually down pushing affordability/demand back up. Thus we might have a balance of supply and demand. This is very likely in a more affluent and desirable area with pent-up demand.

Also I know you speculated that after forclosure people can actually spend more because huge mortgage burden have been lifted and thus economy should be all good. This logic is flawed as these people already have extremely LOW mortgage payment to begin with. Now they have to find rental which probably costs more, and they dont have equity to spend. So I think there’s a good chance of Fed lowering the rate when things get a little uggly.

Red,

"For one, I dont think there will be panic selling as most people DONT have to sell their homes."

This is where we will all have to wait and see. The large number of negative amortization loans in California (over 500,000) portends of an apocalypse. Combine this with the huge number of Interest-only loans with resets on the way, and the potential for foreclosure meltdown is very real.

"This logic is flawed as these people already have extremely LOW mortgage payment to begin with."

People don’t have low mortgage payments. Statistics show people are putting a higher percentage of income toward housing than ever before despite the drop in interest rates. (From Piggington’s site).

This is trees trying to grow to the sky. It is not sustainable. Eventually people will have no more money to spend as 100% of their income will be required to make their housing payment. As you can see from the graph above, even if the FED lowered rates, I doubt it would make much difference.

Red, you mentioned in a previous post that you have reasons that will probably compel you to purchase this year. I can only speculate on what these reasons might be, but based on what I am seeing happen in the market, the longer you can hold off before buying, the better off you will be. If you can wait out the spring/summer buying season, you should be able to see if these trends are continuing or if there is a housing rebound.

If you haven’t checked it out yet, you should go read the following two articles at Piggington’s site. They are very well researched and well written:

  Evidence of a California Housing Bubble
  Risks of a Serious Home Price Decline
>

BTW, None of my thoughts are original.

Irvinerenter - That was a very well thought out and to the point of what we believe. I wonder if Inman will use your opinions?
Red - Keep in mind that the Fed has 1. said that it is highly unlikely that they will lower rates to help the housing market. 2. The Fed is still concerned with inflation and every statement that I have read shows they will not lower rates. Take a look at the Fed futures market for the rest of the year they are predicting no change. 3. The Fed doesn’t not set mortgage rates. Since most are traded as MBS they are a security just like a stock which has a supply demand price factor. If the Fed were to lower rates to 0% and if investors felt there was risk to MBS then they would want a premium to cover for the risk or higher rate. 4. If you buy now and prices only drop a little or stay flat for a few years then you are throwing money out the window to inflation. Keep in mind that if you bought at peak 1991 it took ten years before you could break even due to inflation. Even if you bought in 1995 it would be five years before you would break even. This doesn’t include cost to carry or any maintainace or repairs you would have to factor in. OC home prices typically appreciate at an annual rate of 8% and when you factor in inflation, cost to carry and maintainance/repair that really isn’t a great return even with the tax break.
Do research the last bubble and look at the similarities from blaming the media to the political landscape. The main factor that was affordabilty and the economy came after. Then decide for yourself and weigh how much risk you think is involved and make decision from there. If you do buy could your decision be a good one? Yes. If you buy could your decision be a bad one? Yes. Does the stock market go up and down? Yes. Does the housing market go up and down? Yes. Take our opinions for what they are worth and they are just that opinions. Would I buy right now? No. I want to see what happens this spring and summer to see how the rest of the economy goes as well as housing.
 

Irvine Renter
Thanks for the well stated responses.  Hope you get published, although it seems that you may be anonymous.  Maybe you can use your pen name Irvine Renter.
I was just wondering about your comment:
"The event which triggered the spike in demand this time was the entry on the scene of sub-prime lending. Suddenly a whole group of people who were previously excluded from the housing market now had the ability to buy. Downpayments were eliminated, lending standards were lowered, and demand increased dramatically."
Do you really think that it is this single factor that caused the housing bubble?    It seems that the US had been going through a long period of sustained economic growth prior to the bubble which gave many people enough assets to purchase homes and on top of that with the burst of the dot.com bubble a lot of investors lost confidence in the stock market an started investing in real estate.  Then with the addition of sub-prime lending, there was just an influx of demand all around to create the bubble.  It seems that there may have been a lot of contributing factors to the bubble and perhaps this is why there isn’t a consensus on what caused it.  So perhaps, we shouldn’t be searching for that one reason that caused the housing bubble because like most things, it is a culmination of many factors working together to create a certain event in time.

Irvine Wanna Be,

Your correct that there is not one cause of the bubble; however, I would argue that the bubble prices would not have risen so steeply, and the bubble would not have gotten so large or gone on so long if sub-prime had not made credit so widely available. Every statement about a financial market is an oversimplification.

graphix,

Doesn’t Fed rate decide short-term (ARM) rate? Some experts actually predict Fed might lower the rate so we’ll just have to see.

I am just pointing out that if ARM rate is lower then it helps affordability and demand. Also help people who need to refinance for the next few years. This supports the soft-landing scenario.

5/1 ARM is very popular in Southern California. I know some of you think it would be crazy to get an ARM right now but for many buyers/homeowners that is the popular option. It is only crazy if housing do crash and if rate keeps on increasing.

Like I said before, if this was for investment, I probably wouldn’t buy now. But as a place to live, financial risk isn’t the only determining factor for us. But after reading this blog, I admit I have become curious to what will happen in the spring and summer this year. That’s why we decided to purchase a new home with longer escrow window (6 months).

Red - In general the Fed sets the Fed Funds rate which would be the short term rate. This would in most circumstances have an affect on short term interest rates when it comes to mortgages such as a 5/1 arm because the loan is based off either the 1 year treasury or the 6 month libor plus a margin. In the old days banks would lend their own money and would have a specific amount of money they could lend known as their warehouse line. Once that line is full then they can no longer lend any money. So what they do now is they sell the loans in the open market as mortgage backed securities (MBS) freeing up their warehouse line to lend more money. Rinse and repeat. Here is where it becomes a problem and this is a very simple break down of it and honestly is more complex but this will show how it works. Lets say currently 6% is worth $100 or what would be considered par and six months from now and rates haven’t changed 6% is worth $95 now the bank doesn’t make a profit they actually lose money when they sell it. So the bank has two choices they can keep the loan and tie up their warehouse line or they can raise the rate to say 6.5% for $100 and now they would make money.  The reason this happens is either the investor found a greater return elsewhere or they believe that MBS has more of a risk so they need an incentive or greater return to compensate for the extra risk. Also demand could be a factor if there are few buyers the bank will be happy to sell it at whatever price they can get.
I hope that mess above made sense as it seems you are coming here for more information. Now you have more info than most mortgage guys and you should ask them what are MBS trading at today? Personally I have nothing against a 5/1 arm or even interest only. I have a 7/1 I/O but that is because I am on commission and the good months I pay extra and for the bad months I pay I/O. That is what they are designed for and if I had to pay the full amount every month I would. I would suggest you look into a 7/1 or 10/1 vs. the 5/1 the rate difference shouldn’t be that much if you plan on being there for the long haul it will be worth it. If values do go down it will be more difficult to refinance and this is where another problem that comes in that irvinerenter has pointed out.  
As for the experts that say they might lower the rate I wouldn’t bet on it and neither are the traders that do bet on it. Even if they do then see above it may not make a difference.

"That’s why we decided to purchase a new home with longer escrow window (6 months)."

red:  an offer to purchase is a binding contract, and always with a minimum of $35,000 good faith deposit.  If prices should plummet, you are still locked in the price you agreed to six months ago and must go forward.  That is why you see people willing to risk losing their deposits than losing sleep over the possibility of what some bloggers have coined "equity evaporation."

red:  what do you do for a living and how are you knowledgeable?  Just curious

correction:  graphrix:  what do you do for a living and how are you so knowledgeable?  just curious

IIIrvine, I am talking about a new home purchase. Most builders are willing to adjust the price before close of escrow now, some in writing although most still arent. It takes them apprx 6 months to build the new home thus the longer escrow.

For us personally unless there are obvious sign that price is about to plummer 40% or more, we are going forward with the purchase. We will enjoy the new home, move on with our life and hope for the best. In general we are very conservative with money, and yes we do have enough savings for 20% downpayment + more for rainy days, and probably even enough to buy one or two investment properties in case price drops significantly enough after our home purchase. So maybe that’s part of the reason we downplay the financial risk when purchasing a place to live and would rather time it with our personal needs. I dont recommend anyone buying now without doing their homework. But for some, it may make sense especially if renting and timing for a bottom means scarificing your personal life.

IIIrvine - I don’t mind you asking what I do for a living. I am in the financial services industry and I do investments/retirement, insurance, estate planning, etc. I have only been in the industry for about a year now but I am doing pretty well considering it is a tough business that has many choices.
Now where I get my knowledge of the mortgage business is that I was a loan officer for a major homebuilder for five years and small broker shop before that. For the most part I took pride in what I did and knew that knowledge was an important key to being professional. I took the time to learn how MBS worked, economic news and other various technical factors to help me have an advantage over other people in the industry since I had better knowledge of where rates were going. Learning how to read the technical signals of MBS and knowing what economic news that was coming made me the interest rate guru of the office. I would say that and not to brag but 4 out of 5 times I was correct in which way rates were going. All this has probably helped me greatly in the business I am in now. I left the business for several reasons in which we could have a whole seperate topic on but I would much rather help people make money and wise financial decisions.
This week should be choppy for rates as I stated in the post with article from NAR that a lot of high impact economic data is coming out this week. So I guess I have to disclose now since you know what industry I am in that these are my opinions and should not be considered as investment advice. If you are crazy enough to invest in MBS you are on your own.