What is a Bubble?

I’m dreaming dreams,
I’m scheming schemes, I’m building castles high.
They’re born anew, their days are few,
Just like a sweet butterfly.
And as the daylight is dawning,
They come again in the morning!

I’m forever blowing bubbles,
Pretty bubbles in the air,
They fly so high,
Nearly reach the sky,
Then like my dreams
They fade and die.
Fortune’s always hiding,
I’ve looked everywhere,
I’m forever blowing bubbles,
Pretty bubbles in the air.
When shadows creep,
When I’m asleep,
To lands of hope I stray!

I’m Forever Blowing Bubbles — Jaan Kenbrovin


What is a Bubble?

A financial bubble is a temporary situation where asset prices become elevated beyond any realistic fundamental valuations because the general public believes future price increases justifies current pricing. If this belief is widespread enough to cause significant numbers of people to purchase the asset at inflated prices, then prices will continue to rise. This will convince even more people prices will continue to rise facilitating even more buying. Once begun, this reaction is self-sustaining, and the phenomenon is entirely psychological. Once the pool of buyers is exhausted and the volume of buying declines, prices stop rising, and the belief in future price increases diminishes. When the remaining potential buyers no longer believe in future price increases, the primary motivating factor to purchase is eliminated; Prices fall. The temporary rise and fall of asset prices is the defining characteristic of a bubble.

The bubble mentality is summed up in three typical beliefs:

1. The expectation of future price increases.

2. The belief that prices cannot fall.

3. The worry that failure to buy now will result in permanent inability to obtain the asset.

The Great Housing Bubble was characterized by the acceptance of these beliefs by the general public, and the exploitation of these beliefs by the entire real estate industrial complex, particularly the sales mechanism of the National Association of Realtors.

Robert Shiller, in his book Irrational Exuberance, argues that speculative bubbles are caused by “precipitating factors.” Like a spark ignites a flame, a precipitating factor serves as a catalyst to begin the initial price increases that change the psychology of market participants and activate the beliefs listed above. There is usually no single factor but rather a combination of factors that stimulates prices to begin a speculative mania. The Great Housing Bubble was precipitated by innovation in structured finance and the expansion of the secondary mortgage market, the lowering of lending standards and the growth of subprime lending, and to a lesser degree the lowering of the FED funds rate.

Real Estate Only Goes Up

The mantra of the National Association of Realtors is “real estate only goes up.” This economic fallacy fosters the belief in future price increases and the limited risk of buying real estate. In general real estate prices do increase because salaries across the country do tend to increase with the general level of inflation, and it is through wages that people make payments for real estate assets. When the economy is strong and unemployment is low, prices for residential real estate tend to rise. Therefore, the fundamental valuation of real estate does go up most of the time. However, prices can, and often do, rise faster than the fundamental valuation of real estate, and it is in these instances when there is a price bubble.

Greed is a powerful motivating factor for the purchase of assets. It is a natural response for people to desire to make money by doing nothing more than owning an asset. The only counterbalance to greed is fear. However, if a potential buyer believes the asset cannot decline in value, or if it does, it will only be by a small amount for a very short period of time, there is little fear generated to temper their greed. The belief that real estate only goes up has the effect of activating greed and diminishing fear. It is the perfect mantra for creating a price bubble.

Buy Now or Be Priced Out Forever

When prices rise faster than their wages, people can obtain less real estate with their income. The natural fear under these circumstances is to buy whatever is available before there is nothing desirable available in a particular price range. This fear of being priced out causes even more buying which drives prices higher. It becomes a self-fulfilling prophecy. Of course, the National Association of Realtors, the agents of sellers, is keen to exploit this fear to increase transaction volume and increase their own incomes. If empirical evidence of the recent past is confirming the idea that real estate only goes up, the fear of being priced out forever provides added impetus and urgency to the motivation to buy.

The fallacy in this reasoning is easy to identify: who exactly is pricing out whom? When a housing unit becomes available for sale, it must be purchased by someone. The potential pool of buyers will put in competing bids to obtain the property. Unless very wealthy people start wanting to live in small condominiums, there will always be a housing unit available for someone willing to put in a competitive bid. At some point, the available housing stock gets bid up so high that people choose to rent rather than own. When the quality of units available for rent at a given monthly payment far exceeds the quality of those available for sale at the same monthly payment level, people chose not to bid on the property and chose to rent instead. One sign of a housing bubble is a wide disparity between the quality of rentals and the quality of for-sale houses at a given price point.

Confirming fallacies

There are a number of fallacies also believed by the general public with respect to residential real estate that either affirm the belief in perpetually rising prices or minimize the fears of a price decline. These fallacies generally revolve around a perceived shortage of housing or a belief that the higher prices are justified by current or future economic conditions. These beliefs are not the core mechanism of an asset price bubble, but they serve to affirm the core beliefs and perpetuate the price rally.

They Aren’t Making Any More Land

All market pricing is a function of supply and demand. One of the reasons many house price bubbles get started is due to a temporary shortage of housing units. This is a particular problem in California because the entitlement process is slow and cumbersome. Supply shortages can become acute, and prices can rise very quickly. In most areas of the country, when prices rise, new supply is quickly brought to the market to meet this demand, and price increases are blunted by the rebalancing of supply and demand. Since supply is slow to the market in California, these temporary shortages can create the conditions necessary to facilitate a price bubble.

The fallacy of running-out-of-land plays on this temporary condition to convince market participants that the shortage is permanent. The idea that all land for residential development can be consumed ignores one obvious fact: people don’t live on land, they live in houses, and land can always be redeveloped to increase the number of housing units. If running-out-of-land were actually a cause of a permanent shortage of housing units, Japan and many European countries where there is very little raw land available for development would have housing prices beyond the reach of the entire population. Since this is not the case, it becomes obvious that the amount of land available for development does not create a permanent shortage of dwelling units.

Over the long term, rent, income and house prices must come into balance. If rents and house prices become very high relative to incomes, businesses find it difficult to expand because they cannot attract personnel to the area. In this circumstance one of two things will happen: businesses will be forced to raise wages to attract new hires, or business will stagnate and rents and house prices will decline to match the prevailing wage levels. During the Great Housing Bubble, many businesses in the most inflated markets experienced this phenomenon. The effect is a net outmigration of population to other areas.

Everyone Wants To Live Here

Everyone believes they live in a very desirable location, after all, they choose to live there. People who make this argument fail to understand that the place they live was just as desirable before the bubble when prices were much lower. What is it about their area that made it two or more times as desirable during the bubble? Of course, nothing did, but that doesn’t stop people from making the argument. There is a certain emotional appeal to believing the place you chose to call home is so desirable that people were willing to pay ridiculous prices to live there. The reality is prices went up because people desired to own an asset that was increasing in price. People motivated by increasing prices do not care where they live as long as prices there are going up.

Prices Are Supported By Fundamentals

In every asset bubble people will claim the prices are supported by fundamentals even at the peak of the mania. Stock analysts were issuing buy recommendations on tech stocks in March of 2000 when valuations were so extreme that the semiconductor index fell 85% over the next 3 years, and many tech companies saw their stock drop to zero as they went out of business. Analysts even invented new valuation techniques to justify market prices. One of the most absurd was the “burn rate” valuation method applied to internet stocks. Rather than value a company based on its income, analysts were valuing the company based on how fast it was spending their investor’s money. When losing is winning, something is profoundly wrong with the arguments of fundamental support. The same nonsense becomes apparent in the housing market when one sees rental rates covering less than half the cost of ownership as was common during the peak of the bubble in severely inflated markets. Of course, since housing markets are dominated by amateurs, a robust price analysis is unnecessary. Even a ridiculous analysis, like the ones produced by Gary Watts, if aggressively promoted by the self-serving real estate community provides enough emotional support to prompt the general public into buying. There is no real fundamental analysis done by the average homebuyer because so few understand the fundamental valuation of real property. Even simple concepts like comparative rental rates are ignored by bubble buyers, particularly when prices are rising dramatically and such valuation techniques look out-of-touch with the market.

When rental cashflow models fail, which they do during the rally of a housing bubble, the arguments justifying prices turn to an owner’s ability to make payments. The argument is that everyone is rich, and everyone is making enough money to support current prices. It seems people began believing the contents of their “liar loan” applications during the bubble, or perhaps they counted on the home-equity-line-of-credit spending to come from the inevitable appreciation. Even when confronted with hard data showing the everyone-is-rich argument to be fallacious, people still claim it is true. One of the unique phenomenons of the Great Housing Bubble was the exotic financing which allowed owners the temporary luxury of financing very large sums of money with small payments. There was some truth to the argument that people could afford the payments. Unfortunately, this was completely dependent upon unstable financing terms, and when these terms were eliminated, so were any reasonable arguments about affordability and sustainable fundamental valuations.

It Is Different This Time

Each time the general public creates an asset bubble, they believe the rally in prices is justifiable by fundamentals. When proven methods of valuation demonstrate otherwise, people invent new ones with the caveat, “it is different this time.” It never is. The stock market bubble had its own unique valuation methods as described above. The Great Housing Bubble had proponents of the financial innovation model. Rather than viewing the unstable loan programs of the bubbles with suspicion, most bubble participants eagerly embraced the new financing methods as a long-overdue advance in the lending industry. Of course, it is easy to ignore potential problems when everyone involved is making large amounts of money and the government regulators are encouraging the activity. Alan Greenspan, FED chairman during the bubble, endorsed the use of adjustable rate mortgages in certain circumstances, and official public policy under the last several presidential administrations was the expansion of home ownership. When everyone involved is saying things are different and when the activity is profitable to everyone involved, it is not surprising events got out of control.

Who Cares?

Why should anyone care about financial bubbles? The first and most obvious reason is the financial fallout is stressful. People buying into a financial mania too late, particularly in a residential housing market, will end up in foreclosure and most likely in a bankruptcy court. Stock market bubbles will only cause people to lose their investment. It may bruise their ego or delay their retirement, but these losses generally do not cause one to lose their home or declare bankruptcy like a housing market bubble does. In a stock market collapse, a broker will close out positions and close an account before the account goes negative. There is a safety net in the system. In a residential housing market, there is no safety net. If house prices decline, a homeowner can easily have negative equity and no ability to exit the transaction. In a housing market decline, properties become very illiquid as there simply are not enough buyers to absorb the available inventory. A property owner can quickly fall so far into negative territory that it would take a lifetime to pay back the debt. In these circumstances bankruptcy is not just preferable; it is the only realistic course of action. It is better to have credit issues for a few years than to have insurmountable debt.

The real problems for individuals and families come after the bankruptcy and foreclosure. The debt addicted will suddenly find the tools they used to maintain their artificially inflated lifestyles are no longer available. The stress of adjusting to a sustainable, cash-basis lifestyle can lead to divorces, depression and a host of related personal and family problems. One can argue this is in their best interest long-term, but that will be little comfort to these people during the transition. The problems for the market linger as well. Those who lost homes during the decline are no longer potential buyers due to their credit problems. It will take time for this group to repair their credit and become buyers again. The reduction in the size of the buyer pool keeps demand in check and limits the rate of price recovery.


The Great Housing Bubble, like all asset bubbles, was driven by the belief in permanent house price appreciation, an unrealistic perception of the risk involved, and the fear that waiting to buy would cause market participants to miss their opportunity to own a house. These erroneous beliefs were supported by a host of fallacious beliefs embraced by everyone involved. As with any mass delusion, it is difficult to see beyond the fallacies to the deeper truth; however, it is essential to do so because the cost in emotional and financial terms of getting caught up in the mania is very high. Foreclosure and bankruptcy are never positive outcomes.

60 thoughts on “What is a Bubble?

  1. irvinesinglemom

    This post ought to be required reading for every lawmaker in the country. And every presidential candidate. Excellent job, IR. Thank you for another wonderful example of an articulate, fact-based, rational examination of the current credit disaster.

  2. Live And Work In Irvine

    As someone who was obliterated in the dot-bomb era, I can tell you your “Who Cares” section is dead on.

    The marketplace will be punishing them for many, many years in ways you can’t imagine.

  3. AZDavidPhx

    This post was almost “boring” (which I mean as a compliment) as it is so common sense and obvious. Yet, so many foolish people flat-out stuck their heads in the sand.

    Many highly educated people and those whom most would consider to be above average intelligence were all parroting these fallacies.

    IrvineRenter – another one that I would add to the list is:

    “If you are renting then you are throwing your money away”.

    When I opted to sell my home and start renting, I had to listen to all this garbage about how I am just “throwing money away” and not “building equity”.

    When I moved into an apartment, I would get solicitors leaving flyers on my door on an almost weekly basis that said things like “Are you ready for the NEXT STEP” (Home Ownership) as though I was some lower class citizen for not being an “owner”.

    Looks like I had the last laugh on that one. I don’t get those flyers anymore either.

  4. SGK 7761

    Can this logic be applied to cars? I have heard people say the same thing about cars (why would you lease it…, you are just throwing money away. Better to buy it, and at least retain some equity). But cars lose equity literally the second you purchase it, and drive it off the lot. Houses don’t do this, raw land doesn’t do this.

    Great post IR. I’m a longtime reader, but changed my name because of some undue harrassment.

  5. MalibuRenter

    For the “Who Cares?” section, don’t forget that knowledge of a bubble can be a very big help to noninvestors. In 1999 there were many colleges and grad schools where 1/3 of their graduates were going to internet and new media companies. The majority of those companies weren’t making profits. The exit strategy was to go public.

    Both the dot com bubble and the housing bubble had a lot of people make career choices assuming the bubble would go on for a long time. From late 2000 through about 2003, I saw huge numbers of people trying to switch careers out of dot com-related jobs. The same is now happening for real estate agents, mortgage brokers, and construction workers.

    The dot com bubble caused tremendous problems with state and local budgets. On the way up, revenue collections grew very strongly. More govt employees were hired. Large raises were given out. Nonessential projects were started. Then it went bust, and the State and local governments had a real budget crisis.

    Here is a real gem of an explanation of Santa Clara County’s finances in 2002, when the dot com bubble was deflating and jobs were leaving the County in droves:

    “The various economic data points we have seen and reviewed over the past two months have not been positive. As most people are well aware, the financial markets have experienced a precipitous decline due to a variety of corporate accounting scandals and misappropriation of funds by corporate executive officers to the detriment of investors. The technology and telecommunication sectors have been particularly hard hit with significant layoffs continuing to occure in these industries. Unfortunately, this has affected the Santa Clara Valley. The first quarter sales tax collections for
    Santa Clara County fell by 21% when compared to the prior year. This is the second consecutive quarter of dismal results in this area. This result could have a negative impact on our public safety sales tax collections in FY 2003 if Santa Clara County continues to contribute less to the statewide sales tax totals.

    Other economic trends have also lagged expectations as consumer confidence has dropped substantially over the past month. Economists are concerned that if consumers stop spending the meager recovery we are now experiencing could be reversed and we could see additional economic reverals.

    On the positive side of the ledger, the housing markets continue to do well. The Assessor’s affidavit, released on July 1, 2002, confirms that Santa Clara County is still enjoying moderate growth in assessed value with secured values increasing by 6.68 percent.” http://www.sccgov.org/SCC/docs/SCC%20Public%20Portal/attachments/keyboard/535272KeyboardTransmittal-0031613.PDF

    Translation: “Our dot com bubble is ripping apart. Companies are vanishing. Sales tax revenue is dropping like a rock because fewer people live here and have less to spend.

    However, on a positive note, despite some of the worst job market changes you could imagine from last year, housing prices and number of home sales are going up!”

  6. CapitalismWorks

    I appreciate the time you spent on authoring this piece. Unfortunately, I must differ with you on both the concept and support for several of your key points. I have done so below organized using the topic heading from your essay. I look forward to your responses.

    Real Estate Only Goes Up/Buy Now or Be Priced Out Forever…

    Housing prices rise with inflation. Inflation is rampant (though not fully reflected in CPI). Using hedged finance over a sufficiently long period of time with ALWAYS provide a lower aggregate cost of housing. Prop 13 tax rules only serve to enhance this aspect. I have reminded you of the 70’s several times where housing cost increased 6x to 8x over an decade… I know you don’t think it can happen again, but you are wrong. It has happened, it will happen again, and when it does anyone who has owned for a sufficient time-period using a fixed rate mortgage will be sitting pretty.

    The Fed is going to continue to stimulate the economy through aggressive rate easing combined with injections of liquidity. Ultimately these policy actions will have a firming effect on the overall economy and stave off the full brunt of this mess. Ahem, IR, we disagreed on recent Fed actions and you were wrong wrong wrong. You have a blindspot when it come to macro-related policy and the overall effect on the economy. Ceteris Peribus – your forecast would be accurate, however as the macro-related variables change you MUST account for them in you predictions.

    THEY AREN’T BUILDING ANYMORE LAND! It kills me that you would use a “strawman” argument to diffuse one of the central drivers of SC property. In summation your argument is that there is no shortage of land because “people don’t live on land, they live in houses, and land can always be redeveloped to increase the number of housing units.” Now you are assuming that houses and MDUs (or worse yet HDMDUs) are perfect substitutes. They are not. Most people would much rather have as much land as they can get, and prefer a detached SFR from a condo or and apartment. All available price data supports this claim. Yes when prices get high enough people begin to sacrifice space in order to stay close to something (e.g. Manahattan: Work), this is a sacrifice. There may be a lot of land in California, Hell, all you have to do is get on plane to see that. But there are number of factors that support higher priced areas (Anyone drive on the 91 anytime in the past decade?)

    Everyone Wants to Live Here. Ah, yes, the desireability of land and real estate changes over time. How do you think a place like Vegas works? Infrastructure is created, supported by local business, jobs combine with recreation, and voila, land prices go up. I guess everyone forgot that this was just desert and the land should be FREE!?! No, failing to recognize that land value do change over time is among your weakest claims yet IR. You know better.

    Its Different this Time. I agree with the sentiment, no it is never different.

  7. NanoWest

    For cars and homes…it is the cost of ownership that matters. In the end we will have a car and a place to live from the time we are young adults until the time when we die. The question is: what is the “cost” for having these assets? Sometimes it costs less to rent and sometimes it costs less to own?

  8. Purplehaze

    I appreciate this article. However we must all keep an open mind to the developing situation and not live the same ‘we know all’ fallacy that people lived during the ‘bubble years’. There is no anti-dote to ‘due diligence’ and making ‘informed’ decisions based off developing situations. In fact this is what saved me from buying a home during the bubble.

  9. IrvineRenter

    I gather from your response you believe in most of the above fallacies. I suggest you read Robert Shiller’s Irrational Exhuberance. It will provide the detailed research studies backing up the claims made in this post.

    As for inflation, I don’t disagree with any of the points you raised. If nominal prices are saved by sacrificing real prices, I don’t see how homeowners benefit from this.

    “Ahem, IR, we disagreed on recent Fed actions and you were wrong wrong wrong.”

    Was that really necessary?

    “You have a blindspot when it come to macro-related policy and the overall effect on the economy.”

    If you say so…

    The FED policy was wrong, and it continues to be wrong. You may perceive a benefit from inflation as it may serve to prop up the nominal price of your depreciating asset, but that does not make it sound policy. Perhaps you are too young to remember the problems of inflation in the 70’s, but there was a reason we plunged the country into a severe recession in the early 1980s to stamp out inflation. I never thought I would see that genie let out of the bottle again in my lifetime, and I wish I hadn’t.

    “THEY AREN’T BUILDING ANYMORE LAND! It kills me that you would use a “strawman” argument to diffuse one of the central drivers of SC property.”

    This isn’t a strawman argument. It is made by ignorant homedebtors all the time. The argument made is that there is a permanent shortage of dwelling units. This is not true, and it never is true. Your argument about substitutions and quality is a different argument entirely. Your points are correct, but they do not address the fallacious argument made by many.

    “I guess everyone forgot that this was just desert and the land should be FREE!?!”

    How can you make a silly statement like this after accusing me of strawman arguments?

    Are you actually going to make the argument that land prices in OC went up 150% during the real estate bubble because OC became that much more desirable during that timeframe?

    Improvements to land over time do add to the desirability of a location. It does not do so at the rate of appreciation we witnessed during the bubble.

  10. 7

    FWIW, I agree with CW’s argument. There is a price that one pays to have land, and it is the weakest point in IR’s article.

    The premium one pays is due to the limited land, and the housing shortage in Japan and parts of Europe is reflected in the lifestyle they have. Unlike Japan and Europe, they don’t have high birth rate, and uncontrolled illegal immigration. This helped them a lot.

    In a way, the Mello Roos in newer community is also a premium that ones pay due to the limited land. Land is relatively cheap, but it cost money if you want to have city sewer/DSL/phone/electrity and close to walking distance from school/shopping ctr./beach/ski/work.

  11. IrvineRenter

    I suggest you read:


    Land is a commodity subject to the laws of supply and demand like any other traded commodity.

    If you think we are running out of land, and thereby running out of housing units, where did the 5000 new units on Jamboree come from? Redevelopment projects which increase housing densities are normal in environments where there is no raw land.

  12. MalibuRenter

    I’m not sure if any of the posters are missing a particular point about land.

    There is definitely plenty of land that is not developed. However, one of the prime causes of the perceived shortage of land is development regulation. This makes land which could have been developed, or developed at a higher intensity, have little or no housing on it.

    This is also another major contributor to bubbles in CA: long, expensive, and uncertain timelines for approval. In a rising market, the value of entitled land goes up more rapidly in highly regulated areas. Because of the long timeline for approval, the perceived high-value entitlement loses value quickly.

    Because many such entitlements require construction within a particular timeframe (usually something like commenced in 6 months, finished in 2 years), this encourages builders to finish projects for which there is no longer demand. Sitting on empty entitled land doesn’t help much either. Perhaps IR can add comments on this part of the discussion.

    For more background on this, try “The The Impact of Building
    Restrictions on Housing Affordability” http://www.newyorkfed.org/research/epr/03v09n2/0306glae.pdf

  13. IrvineRenter

    The cumbersome nature of the entitlement process certainly does create short-term shortages of dwelling units. This is one of the precipitating factors that provides bubbles with the initial price velocity to generate the “buzz” which takes over to inflate the bubble. This supply will make its way to the market eventually. At the end of every bubble, there is a massive inventory overhang just like we are witnessing now. When a perceived shortage suddenly becomes a massive inventory overhang, what does that say about the perception of scarcity?

  14. tonye

    As a matter of fact, housing in Western Europe and Japan is actually out of reach for the middle class. Unless, of course, you want to move out to the sticks, which in those places usually means more than 20 miles from work!!

    Most folks in Western Europe and Japan rent, do not own. Only folks with money buy and the flats tend to stay in the family, handed down from parents to the oldest son.

  15. IrvineRenter

    Japan “running out of land” did not stop their real estate market from dropping 64% over 15 years.

  16. SoCalWatcher

    CapitalismWorks, you are forgetting something. When an area becomes very popular and there is little or no more room to build outward, they then start to build UPWARDS. This is one of the reasons for San Francisco’s seriously expensive home prices because they will not allow this. Notice all the freshly completed high-rise condo buildings that went up in the last 5 years and now many sit empty or 1/3 or less occupancy.

    Interesting article, IR. You need to add a paragragh titled “Common sense isn’t so common”. Amazing how a mentality fueled by intense competition to keep up with the Joneses when the Joneses don’t have any money to float the facade either! The “everyone is rich” thing is interesting in psychological
    sense because people just ignore the hard data that belies their belief. They lie to themselves in order to justify paying $800/sq ft because they think that someone else will and therefor they bite the bullett and start digging their own financial grave.

    California and it’s economic-psychological attitudes and idealisms are fascinating from chilly Chicago!

  17. Smurf

    Excellent article IR!

    BTW some economists have studied how much housing goes up on real terms over 100s of years (since the mid 1800s, links in the Marin house bubble blog) and after adjusting for inflation it was less than 0.5% per year.
    The analyses of those economist indicated that in real terms houses do not increase in value in a significant way and excessive house prices eventually even out to be around 3.5x median incomes, whether that happens over a short period because prices crash (when people are forced to sell, foreclosures etc) or because real value drops as inflation eats on the value of stagnant house prices.

    Thanks for the great blog and the intelligent arguments you put forth.

  18. lawyerliz

    California is fascinating to this Floridian because California is in housing Florida doubled.

    Of course, in other types of weirdness, we are no. one.

    The running out of land thing is actually sorta true in Miami-Dade
    County. However, as IR points out, when you can’t expand horizontally, you expand vertically, and we have been doing that.
    Boy, have we been doing that. We have been building highrises past the point of no return. Will these things rot away before they’re sold? Trouble is, what people really want is a house with land all the way around it.

    If these highrises were built to sell in the 250-300 range, all, if not well, would become well rather quickly. But they were built to sell for twice that. Here in the land of Low Salaries, there are no customers for the product, and I don’t know what the contruction lenders were thinking.

    Or the county. (Except that perhaps, it could be that money changed hands. . . )

  19. Smurf

    where in Europe?
    In certain cities in Italy where the property prices have been increasing consistently over the past 10 years (after the last price crash) the % of vacant homes is >%20 because people invest in “bricks & mortar”. All this while development of new houses goes on and on.

    And Europe is not immune to housing bubbles, case in point the UK, Ireland and Spain. Prices are currently falling in these three nations. In Spain oversupply is the number 1 culprit though of course lax lending standards and all the rest has played a major role there as well.

  20. lawyerliz

    I’ll eat my hat if more than a handful of people respond to those letters warning of resets a few months before the resets hit.

    They will be thrown away as junk mail I betcha.

  21. Purplehaze

    A “responsible-looking” government should “show” that it is doing “damage control”. Like any other government reform trickle down to the bottom is going to be hard and most people afflicted by the housing crash may not be able to hold their breath under water that long.

    This is just going to be something for the National Assciation of Realtors to pitch to gullibe buyers.

    Now I don’t blame the government for doing what it is doing. But like any epic battle of good v/s evil, this makes the evil side look even more tainted and likely to fail in stopping a market correction. Go Market forces! Go!

  22. janet

    While I agree there are still a lot of land available in OC, but basically there are all be terminated. Guess who is the biggest fund donator for govern Arnold Schwarzenegger.
    That right it is the owner of TIC. If you are ever working for TIC you know even the coffee is limited to one cup a day, then you will start wondering the reason behind of the donation.
    I always think this is a invisible hand behind the land restrictions in OC.

  23. buster

    Great and well reasoned. And every bit true, although I would add a couple of modifiers. Of course So. Cal. will be far more expensive than Iowa. The weather is better and the jobs more plentiful. But will it be 1.5x, 2.0x or 5.0x for the same or similar property? Right now a $200,000 property in middle America is $1,000,000 here in So.Cal. They’re not making any more land, but there’s plenty of developable land in the USA. And at 5x the average, plenty of people will pick up and move to Idaho or Colorado or even Ohio rather than become serfs to their mortgage company.

  24. MalibuRenter

    Am I the only one here who is surprised that government entities aren’t buying up lots of land to use for schools and parks? It could actually be a good opportunity for them. A builder could make a graceful exit, get some cashflow.

    I am unsure of the tax implications, but I’m guessing you can’t take tax credit for the higher of cost or market for a donation of land by builders. Otherwise, I suspect we would have seen large-scale donations by builders.

  25. uto

    I don’t believe that all families want house with land around it. For example in Singapore, Hong Kong there are very nice, family oriented high rise condo towers in so called suburbs (not in city business district but 30-40 min away by subway). Going price around $300-$400USD per sq ft. Now I lived in SF Bay Area so I think I can do comparison however subjective it is and if I could get my Singapore accommodation in CA, I’ll swap typical suburban stucco box for it in heart beat. It goes without saying that crime rate, accessibility to amenities, transportation cost and convenience are the factors in deciding where to live. Right now in CA and almost everywhere in US except perhaps Manhattan all those factors favor SFH. However I observed first hand when these factors can favor high rise condos.

  26. DMA

    Excellent piece of work, and so right on.

    If only homedebtors would have followed the fundamentals of buying real estate – 20% down, 3-4 times annual income, we would have avoided this whole mess.

    I agree with you on the Fed. Ben Bernanke hates the middle class and will always choose Wall Street over us. He and Greenie have destroyed the dollar, and we are all paying for it.

    The devaluaiton of the dollar = the invisible tax that we all pay.

  27. No_Such_Reality

    Doubtful, first nobody knows how they’ll actually do it. Second, they instantly grind to a halt with lawsuits. Third, the last talking head, I think a BofA analyst, said with swift action they could probably “save” 1/3rd of the foreclosures.

    Let’s face it, 2/3rds of the foreclosures will still crush the market.

    All that will happen is people locked into debt-servitude fora few more years before they give up or bust out. Much like many that get saddled with a payment restructuring trying to work out a deal to avoid bankruptcy, it grinds them, grinds them, grinds them, and eventually, they all still give up the ghost.

  28. yaka56

    It is very good and important that there are multiple views on this post. Overall, we tend to all and too often agree with IR, but universal consensus doesn’t lead to reality nor truth. (and we-the Irvine renters- are biased !)
    So we have to be careful …

    – One comment about:
    “Ahem, IR, we disagreed on recent Fed actions and you were wrong wrong wrong.”
    Yes, little too tough, but indeed, I was surprised IR was expecting Ben to increase rates short term:
    a) over all history, when US had to choose between risk of growth vs risk of inflation, they have always taken inflation path, whatever Greensman was saying. And this time is no different (…), if not stronger in favor of inflation.
    But I don’t believe it’ll for for ever. So IR, soon (Q109 at latest) you’ll be “right right right”. Indeed, our friend Ben has another fear than Inflation. He’s also scare about deflation:
    This is VERY good news, because if you look at today’s situation with this fallen assets (=houses) that IR perfectly describes in today’s post, and also looking at other economical dynamics like fear about financial companies exposure, we share some of the conditions which lead Japan to deflation in the 90′.
    If you think about it: house pirce will continue to go down, but up to a certain limit anyway. What’s guaranteed is lots and lots of people in the US will try to pay back their mortgage, devoting more and more of their revenue to this mortgage rather than consumming other goods. And they won’t be able too, ’cause credit conditions will get very tide.
    So when people are busy paying back their debt, this is close to deflation circle.
    You can of course argue with that because as the USD will be so weak, imported goods prices will increase, so not really in favor of deflation. But this will prevent people to consume even stronger, so if TIMING is aligned, situation can be very nasty.
    So Ben and the Fed will try to avoid this because these guys are old enough to know the dramatic effect of such a deflation loop.
    And to some extend, I trust them. We’ll have tough time, and house bubble will deflate. Prices will definitely go down, maybe not as much (unfortunatly) as what IR is projecting (I believe because rent will increase more than inflation in coming months/years) , and for sure not as fast (because not everyone will reach foreclosure in OC, and people are not eager to give away their home with a couple of hundreds thousands loss).
    I also do believe SoCal is a place where people (still) want to move in. To argue with this, you need to spend some time in Seoul, Taipei, Beijing, Shanghai, and other places (including Europe) where quality of life is terrible. Not that it justifies a bubble, and beyond the fact Californian indeeds tend to smoke crack too much and be so naive about where world reality is (there I’m 100% aligned with the post). But still, it does justifies a little premium (like maybe a 18-20 Price/Rent(year)) and not back to 13-14.

    Good to see that this post sometimes moves from local house market trend to ecomony chat. Probably good as I think debating about the fundamentals of the house prices has become less meaningfull now that everyone is aligned with at least this one. Even no real estage agent has tried to argue in there. Have you noticed !?
    (We need to remember that “economists have been invented so that astrologists looks serious” though ).

  29. lawyerliz

    When I was much much younger, and dinosaurs ruled the earth and there was no internet at all, even with the military, the rule of thumb was 2 1/2 times income.

  30. yaka56

    From National Economist club, Nov 21, 2002:
    Ben Bernanke: ” Deflation: Making sure IT doesn’t happen Here”

  31. IrvineRenter


    Bernanke is a believer in currency devaluation and inflation to stimulate demand. It will be interesting to see how he reacts when the inflation data starts to show the inevitable results of currency devaluation on our import consumer society.

    I vividly remember the problems with inflation and the pain of the early 80s recession. There was a collective sense of relief and accomplishment when we did what was necessary to slay that dragon. I do not want to see that Phoenix rise from the ashes.

  32. No_Such_Reality

    Our government is reactionary.

    Their view is that we must maintain our asset prices. Any price drop is viewed as deflation and bad. Frankly, I’d rather oil be at $40/barrel than $90/barrel, even though $90 better for the environment.

    So we will inflate the currency to maintain prices until we all capitulate and scream about the inflation. Gas at $4/gallon next spring for Memorial day will be a big test heading into the election. Maybe it’ll take $5/gas and a $6 gallon of milk, maybe more, maybe less.

    Part of this will be mitigated by the neutered CPI data. CPI has little left in it that reacts. Housing is out, gas is out, fuel is out, energy is out, food…

    Made up numbers to maintain lower mandatory increases in welfare state payments.

  33. IrvineRenter

    “Made up numbers to maintain lower mandatory increases in welfare state payments.”

    That is exactly what it is.

  34. tonye

    The major metropolitan centers. This, of course, ignores most of the countryside farther than 20 miles from the center.

    However, note that I did not say that Japan and Western Europe are immune to bubbles and speculation. Only that what is their “normal” price is relatively much higher than in US.

    And, if you want land in Pamplona or someplace in the middle of France, Sicily or Wales, well you can buy it… but just like you can cheaply buy land in Palmdale, good luck getting to work in the city.

  35. rastaman

    I believe in capitalism as well, it is a fine system. But look at the NY Times article today about the national debt: 9.13 trillion. That is such a gargantuan number it boggles the mind. And so much of that debt directly benefited SoCal through massive defense spending. So again I stand my ground that what “capitalism works” thinks is normal: watching homes quintuple or whatever in value is due to unsustainable policies. You can only live on credit card (whether as a consumer or as Uncle Sam) for so long before you can’t even meet your minimums. Then the game stops. This bubble is not just about real estate — it is the way we keep our economy humming: we borrow money and call that prosperity. But don’t let me rain on your parade: buy OC real estate, you can’t go wrong, or so you think.

  36. cadaigo

    Well, if one wanted to know what land is worth, Lennar is finding out. 40 cents on the dollar. Ouch!
    IHB, how does that price translate into finished homes?
    And does anyone know how much of this land is in SoCal?

    “MIAMI – Home builder Lennar Corp. formed a land investment venture with Morgan Stanley Real Estate to acquire, develop, manage and sell residential real estate, with Lennar selling properties valued at US$1.3 billion to the venture for $525 million.

    The acquired properties include about 11,000 homesites in 32 communities throughout the United States, consisting of raw land as well as partially and fully developed homesites in California, Colorado, Florida, Illinois, Maryland, Massachusetts, Nevada and New Jersey.

    As of Sept. 30, the acquired properties had a book value of about $1.3 billion for one of the country’s largest home builders.”

  37. doug r

    $16,000/160=$100. Does your lease cost more than $100 a month? I know the math ain’t the same, but it seems that almost everybody has “high mileage” and “excessive wear and tear”. If leasing wasn’t more profitable, car dealers wouldn’t push it so hard.
    I am sure there are cases where leasing makes more sense. From what I can tell, leasing costs almost as much as buying and you don’t have a car at the end of it.

  38. WaitingToBuyByandBy

    IR: Another landmark post. I enjoyed it all the more knowing that, unlike earlier posts made when bulls roamed the Earth, these same ideas you have brought up before are now irrefutable in the light of recent data. There really was a housing bubble and it really popped.

    So, moving forward, what can this bubble and the “early fallout” tell us about the future?

    Unlike foreign investors, corporate executives and wall street bankers, you and I have seen the enemy face to face (our neighbors) and I have to tell you, if the economy is dependent upon Americans continuing to pay a mortgage in the face of declining home values, we are all in for some serious hurt.

    These are the same people who bought houses because it was the thing to do. Are we expecting them to stay in their houses when everyone else is skipping out on paying the bill? Oh, that America had such responsible citizens.

    No, with 100% financing, a consumer lifestyle based upon borrowed income, and no shame about walking away from responsibility, I think we can safely assume (as you do) foreclosures will soon be off the chart.

    Normally, I would consider the following comments to be better suited to the CR website (to which I confess I am now addicted). However, seeing as you put up that video contrasting the housing bubbles quotes to famous quotes from The Great Depression, I think it is fair to ask if The Great (U.S.) Housing Bubble is the precursor to TGD II?

    I don’t mean people jumping out of windows and runs on the banks (we have FDIC now, right?). I mean economic downturn that puts people on the streets. After all, when was the last time the country averaged a negative savings rate? How much wealth does the average American have in the bank? (IHB participants excluded, since you must by definition be financially responsible or you would have been sucked in by TGHB).

    If the economy has been driven by the consumer and the consumer has been driven by borrowed money, and the money tree has been driven by mortgage backed securities driven by house appreciation, what must take place for that unsustainable cycle to unwind?

    Has Lansner taken a poll yet on how many underwater buyers plan to stay and pay off their mortgages? How many would try to hang on to the house if they suddenly become unemployed?

    I am reminded of a friend who claimed to know “how to handle the credit card companies”. He had racked up $15,000 in bills. “Just don’t pay them,” he said. “They’ll call, and call and call. Just get a different phone line or ignore them. Eventually somebody offers you to only pay half the bill. That’s when you should take action. I went without paying anything for about two years before it got to that point, and I got rid of half my debt with that one phone call.”

    Apparently, he didn’t remember I was the same guy he talked to when they originally called him. He wasn’t sure at the time if he should make such a deal. He also to this day probably does not realize his FICO is worthless. He now only pays with cash (he has no choice) yet doesn’t save at all (and so is simply awaiting disaster).

    The point is, when I look around, especially in the light of the recent housing madness, I don’t see people like me (the guy who reads the fine print on the back of the credit card application and breaks into laughter as though there were actually a joke somewhere in there, or shrieks as if there were something unearthly in there, or yells in outrage as if there were something ungodly in there).

    No, instead I see thousands and thousands of people like this guy. People who have no understanding of the agreements they signed, no feeling of responsibility beyond keeping out of jail, and no willingness to do what is right.

    To be fair, I feel I must mention this guy was renting (like me, he couldn’t afford to buy reasonable housing). And I have to admit I don’t know your friends or your neighbors. Still, if there are others like him who bought, what does the future hold?

    Is it perhaps fair to say The Great (U.S.) Housing Bubble is but a symptom of the cultural mindset you have described and attributed to Southern California? What if this mindset exists across the country?

    Beyond the flood of foreclosures and accompanying price declines, what can the bubble (and early indicators of the fallout) tell us about the future of the US economy?

    My wife and I are intent on saving up that 20% down payment, but now I’m wondering if we won’t need that money as an emergency fund when the full magnitude of this fallout is felt.

  39. mmg

    unless you buy :mrgreen:

    I agree it costs about the same.

    so I have learned to get a good deal on the lease, then at the end of three years(like stupid suggested above) I buy the car in excellent condition, drive till death do us apart (the car of course) 😆

  40. woodbury house renter

    If the market participants in the run-up were not rational what is going to make them rational now? Uh – oh the streets of Woodbury were packed with families being lead around by realtors this past Sunday. Bargain hunting fools? Of course we’ll see if this increased activity leads to an increase in sales – and at what price. I’ll be watching the 92620 data while I keep renting. Should I hand out copies of today’s deeply insightful IHB to save them from themselves? Maybe if someone could translate it into Korean…

  41. graphrix

    The no more land line is the same lame line used in the 90s, and every time I read it, I roll my eyes. Funny, they kept building houses after they said that then and they keep building houses now. I personally know of over 60k units in the pipeline for OC, and I know there are more that I don’t know of. The OCBC did a study, that shows that there is enough infill land for 70k units. If people had the ability to pay any price for a home with land, then why are those homes not selling and the homebuilders dropping the prices faster than Wal-Mart? Seriously, get a new line that isn’t nearly 20 years old. It wasn’t true then and it isn’t true today. Look what happened to those who believed that BS then?

    I am sure everyone in Ohio etc. wants to live here. One problem… Jobs! According to Chapman’s financial executive survey the number one barrier to do business in OC is… you got it, housing. On a scale of 1-5 it was a 4.6. This is despite the fact that OC is a “desirable place to live” as the most significant reason for doing business in OC. Now, when for the last 15+ years OC has had a net-migration of 25-35 year olds, and year over year the employment has decreased, means there is a problem. So, if you like living in a place where all you have are a bunch of retired baby boomers driving their Buick’s, and spiked haired kids driving their Civic’s, then we should just rename OC; Maricopa County.

    Lets do the math… A possible 130k homes, an optimistic job growth of 10% in 10 years, 60% of those jobs being dual income households. That is around 150k jobs, 60% would be 90k households, and an oversupply of 40k homes. Yup, not a problem, because all the foreigners will come and buy these homes. My other favorite BS myth.

    So, you are right, it really isn’t all that different this time. Hopefully we don’t see the job losses like the 90s. But, if we do, then hold on tight, because this will be a housing crash that will make the 90s crash look pleasant.

    BTW, if you bought at the peak in 91, in what year would it be before you recovered the loss in SoCal inflation rate adjusted terms?

  42. Laura Louzader

    lawyerliz, I remember when 2.5X your income was the rule.

    Actually, most people without too much cc debt or car debt could go little or no-down at this multiple of their incomes and easily pay for their places.

    With a 10% down and 2.5X your income and little other debt, you are mostly in good shape.

    Loans of 3 and 4X your income did not become prevalent until the 80s, and I remember that it was during this period that people began to carry much more debt, and that foreclosures and bankruptcies became more common than previously.

    This bailout, or freeze of interest on adjustable loans, will do incredible harm, for , as one famous blogger pointed out elsewhere, it means that contracts are meaningless, that you cannot make a contract without fear that government action will render it worthless.

    My guess is that if this proposal becomes law, that credit will become incredibly tight, permanently, as the risk of lending money on any terms will be vastly increased in a climate where obligations can be cancelled en masse by legislation. This is much different than granting people bankruptcy protection on an individual basis. Bankruptcy law recognizes the legitimacy of the contract, but this proposal makes contracts meaningless.

    All around, this bailout proposal is one of the most destructive pieces of legislation ever proposed.

  43. Keith

    IMHO, the Bernanke and AG’s interest rate’s decision always a political and not an economic decision. AG creates housing bubble to exchange one more term as Fed chairman.
    Next year this time around, Bernanke will make interest rates stay around 3.25% to3.5%, so the economic not too good and no to bad but leave enough room for more rate cut so the next President can save the economic and hence he can be re-nominated.

  44. johnny

    Get a good deal on a new car that doesn’t depreciate and you’ll be better off buying. I have a civic i bought new in 03. In 4 years it has depreciated $4k from the selling price. Not bad cost of ownership, eh? It helped to get $2.2k off the sticker, but still…

  45. k.o.

    Good points; El Toro has a large amount of land there, and there is still plenty of land in Irvine. The Irvine Co holds onto the land and then will piece it out over long periods of time in order to develop slowly and hopefully get more demand. But trust me, I’ve lived in Irvine for 22 years and seen it get very developed, but (unfortunately) there is still plenty of room for more development. (I say ‘unfortunately’ because the traffic is horrible, people aren’t as nice, and honestly, I feel like I’m in Beverly Hills with all the pretentious luxury cars around)

  46. lawyerliz

    There is an appraiser down the hall, a young guy, who between his mortgage and his maxed out credit cards, owes about half a million dollars. He is walking away from his 100% mortgage on his Fla home. he feels no guilt or shame. I tried to guilt him out, and succeeded only a tiny bit. Yes, he should be ashamed. But wtf was anyone doing, loaning him that much money in the first place. He still has a business, by the way. He’s learning FHA and REO appraisals.

    He’s squatting in his house, until he gets foreclosed out. He has a nice place picked out to rent, and doesn’t feel that qualifying for renting will be a problem.

    by the way, he can’t file bankrupcy, because he filed once already a couple of years ago. So he accumulated his debt AFTER the bankruptcy. He’s 27 years old. Altho I believe people should pay their debts, I have a hard time feeling any sympathy towards the people who lent him money. They are getting what they deserve.

  47. CapitalismWorks

    Single-family new house construction building permits:
    1996: 205 buildings, average cost: $254,700
    1997: 242 buildings, average cost: $305,400
    1998: 425 buildings, average cost: $312,800
    1999: 326 buildings, average cost: $320,400
    2000: 161 buildings, average cost: $353,800
    2001: 163 buildings, average cost: $347,900
    2002: 129 buildings, average cost: $500,400
    2003: 140 buildings, average cost: $458,500
    2004: 112 buildings, average cost: $538,100
    2005: 111 buildings, average cost: $616,200
    2006: 103 buildings, average cost: $705,900

    These are the land development statistics for Newport Beach over the past decade.
    Here is the link: http://www.city-data.com/city/Newport-Beach-California.html

    If builders were making so much money over the past several years, why were so few houses being built, in this highly desireable area?

    My guess is that they started RUNNING OUT OF LAND! Hello?

  48. IrvineRenter

    It could also be that there were running out of buildable lots, or that they began running out of buyers at those price points.

    When prices continue to drop and inventories continue to surge, you will see that running out of land did not create a shortage of dwelling units available for sale.

  49. CapitalismWorks

    Here are the Irvine numbers.
    Single-family new house construction building permits:
    1996: 773 buildings, average cost: $143,800
    1997: 986 buildings, average cost: $186,700
    1998: 1247 buildings, average cost: $173,900
    1999: 1276 buildings, average cost: $167,700
    2000: 1138 buildings, average cost: $167,600
    2001: 1338 buildings, average cost: $167,600
    2002: 1006 buildings, average cost: $174,400
    2003: 1062 buildings, average cost: $197,700
    2004: 943 buildings, average cost: $215,900
    2005: 1164 buildings, average cost: $215,400
    2006: 600 buildings, average cost: $269,700

    Notice the difference between he and MB in both scale and trend? Irvine is huge, but just like NB,LB(hell any B) the land is filling up. Prime land, with ocean views, short commutes, no traffic noise, close shopping, top quality recreation, etc. etc. is of LIMITED supply.

    P.S. You asked the question what happened to those people who bought at the peak 20 years ago? If they purchased something they liked and could afford and kept it, they KILLED IT. They now have one of two things (1) Super low housing costs relative to the current market, including ridiculously low property tax, (2) a rental property that generates huge positive cash flow.

  50. CapitalismWorks

    Real Estate is a local market. How does that .5% real growth figure match up against SF, LA, NY, and Chicago. My bet is not even close. Secondly using 100 year figures may be wholly useless considering changes over time (see conditional heterokedasticity for further explanation).

    One thing that had occurred to me the impact of traffic congestion on housing prices as function of distance to employment centers. I have found little in the way of research, however it is certainly an important driver of overall prices. It may also help to explain why prices rise, even if there is and endless supply of land, because the cost of time spent commuting.

    I suspect, though have no data to back it up, that price impact on housing of increasing congestion is geometric over time with respect to proximity to employment centers. Read: since everyone works in Irvine, Irvine R/E will do a whole hell of a lot better over time than any city south of the Y.

  51. IrvineRenter

    Robert Shiller’s study of appreciation nationally and in major metropolitan centers shows the 0.7% real growth was consistent for over 100 years — that is prior to the bubble. The reason is simple: you pay for housing from income, and incomes tend to rise with inflation (in fact, rising income tends to lead to inflation.) When housing prices rise without a commensurate rise in incomes, as was the case over the last several years, then the rise in prices must be attributable to something else — in this case expansion of credit. The only way for prices to sustain themselves is for lenders to continue loaning out money to people at double the historic price-to-income ratio as they did during the bubble. Since this is obviously not happening (per the credit crunch), prices will fall to the new level of lending. The only real question is, “how tight will credit get?” IMO, the answer is 28% DTI and 20% down on 30-year mortgages. It is the only form of lending proven to be stable.

  52. Laura Louzader

    Uh…. he filed only two years ago and he’s racked up $500K debt that he is now delinquent on?

    Does he know that he could be nailed for fraud for doing that?

    You had better be a very good little doobee after you file BK, especially now that BK laws have been tightened. If you file and then run up unpayable bills immediately after being cleared, you could be looking at jail time, from what I’ve been told.

    But perhaps he figures that there are so many people just like him out here, that the authorities are overwhelmed and he’ll get lost in the shuffle.

  53. Atlanta New Homes

    I agree with irvinesinglemom. Such a post is with so much real world information is a must read for everyone!

    Great job as always!

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