Psychological Stages of a Bubble

Once a bubble starts to form, it will go through several identifiable stages: enthusiasm, greed, denial, fear, capitulation, and despair. Each of these stages is characterized by different speculator emotional states and different resulting behaviors. There are outside forces that also act on the market in predictable ways in each one of these stages. Most often, these outside factors serve to reinforce the market’s herd behavior and exacerbate changes in price.

Precipitating Factor

There is often a precipitating factor causing the initial price rally that pushes prices above their supported fundamental values. A bubble rally is usually kicked off by some exogenous event, but it may occur simply because prices have been rising and investors take notice, or it can be merely the result of a lack of investor fear and the widespread belief prices cannot go down. [1] In a typical market, there is a significant selloff when prices exceed fundamental valuations. This selloff is a natural reaction to inflated prices as a decline to fundamental valuations is normal and expected. Many seasoned market observers will “sell short” here to profit from the initially inflated values caused during the take-off stage. However, in a financial mania, this sell off is short-lived, and it traps many who are bearish on asset pricing on the wrong side of the trade. This “short squeeze” may prompt a feverish activity of buying as short sellers cover their positions before their losses get too great. A short squeeze may act as a precipitating factor. In a securities market, a precipitating factor may be a very large order hitting the trading floor, and in a real estate market it may be a dramatic lowering of interest rates as it was in the Great Housing Bubble. Regardless of its cause, the initial price rise has the potential to spark sufficient interest to prompt further buying and set a series of events in motion which repeat with a remarkable consistency. Market bubbles can be found in all financial markets and on multiple timeframes.

Figure 35: Psychological Stages of a Bubble Market

Enthusiasm Stage

At the beginning of the enthusiasm stage, prices are already inflated, so there is cautious buying from traders looking for trends and momentum. If prices fail to drop to fundamental valuations and instead push higher, media attention is often drawn to the speculative market. The general public starts to take notice of the money being made by people who have bought the featured asset and they begin to participate in larger numbers. Of course, this stimulates more buying and prices continue to climb. The market sentiment turns very bullish. Buyers are everywhere and sellers are scarce. At this point, prices are completely detached from fundamental valuations, but people are not buying because of the underlying value, they are buying because prices are going up.

In residential real estate markets, the enthusiasm stage is often greeted by lenders with open arms. With prices rising, there is little risk of loss from default. If a borrower gets in trouble, they can simply sell into rising prices, and neither party takes a loss. With neither party fearing loss, and since lenders make most of their money on the transaction itself through origination fees, there is an inevitable lowering of standards to meet market demand. This in turn creates more market demand leading to further lowering of standards. The credit cycle reinforces the bullish psychology in the market and helps push prices even higher.

Greed Stage

In the greed stage, the bullish sentiment reaches a feverish pitch and prices rise very rapidly. Every owner in the market is making money and most believe it will go on forever. As prices continue to climb, buyers become very enthusiastic about owning the asset, and they tell all their friends about their great investment. The word-of-mouth awareness and increased media coverage bring even more buyers to the market. Egomania sets in as everyone thinks she is a financial genius. Any intellectual analysis at this stage is merely a cover for emotional buying and greed. During the Great Housing Bubble, there were many instances of properties receiving a dozen or more offers the day they were listed, with many in excess of the asking price. Encouraged by realtors, some buyers wrote emotional letters to sellers to convince them why they should be bestowed with the honor of home ownership. [ii]

Most people who are bullish already own the asset, but for prices to continue to rise there must be more buying. For buying to occur, someone who was either bearish or ignorant of the rally must be convinced to buy. In other words, a greater fool must be found. Once everyone is made aware of the market rally and is convinced to buy, you simply run out of new buyers. Once there is a shortage of potential buyers, prices can only go down.

Denial Stage

When the limit of affordability is reached and the pool of available buyers is exhausted, prices start to decline. At first market participants are still overwhelmed by greed, and they choose to ignore the signs that the party might be over. In 2007 most real estate markets were in the denial stage as prices had not dropped enough to cause real fear. Denial is apparent in polls in mid-2007 where 85 percent believed their home would rise in value during the next five years, and 63 percent believe a house is a good investment. That is denial. It is also apparent in the number of homes purchased during the greed stage that are held for sale at breakeven prices–even if this is above market. When the inventory is large, and houses stay on the market for a long time, prices are too high. Sellers who refuse to lower their prices to take a small loss are in denial about the state of the market. They believe bids will increase and some buyer will come along and pay their price–after all, that is the way it was just a couple of years prior. Buyers who bought in the enthusiasm stage are still ahead, so they feel no urgency to sell. They have made good money already and they will hold on with hopes of making a little more. Since they believe the asset will appreciate again (and they have no exit strategy), this group of buyers does not sell. [iii] In contrast, the few traders who still hold positions liquidate and go back into cash. Successful traders recognize the emotion of denial as a signal to exit their positions to lock in profits or prevent further damage.

In the denial stage of a residential real estate market, many speculators are unable to obtain the sale price they desire. [iv] The accumulation of unrealistically priced houses starts to build a large inventory of homes “hanging” over the market. Overhead supply is a condition in a financial market when many units are held for sale at prices above current market prices. Generally there will be a minor rally after the first price decline as those who missed the big rally but still believe prices will only go up enter the market and cause a short-term increase in prices. This is a bear rally. It is aptly named as those bullish on the market buy right before the bear market reverses and quickly declines. For prices to resume a sustained rally, the overhead supply must be absorbed by the market. Once prices stopped going up and actually began to fall, demand is lessened by diminished buyer enthusiasm and the contraction of credit caused by mounting lender losses. With increasing supply and diminished demand prices cannot rally to absorb the overhead supply. The overall bullish bias to market psychology has not changed much at this point, because owners are in denial about the new reality of the bear market; however, the insufficient quantity of buyers and the beginnings of a credit crunch signal the rally is over and the bubble has popped.

Fear Stage

In the grieving process there is a shift from denial to fear when the reality being denied becomes too obvious to be ignored or pushed out of awareness. There is no acceptance of reality, just the idea that reality might be fact. The fact that an investment might turn out to be a very poor financial decision with long-term repercussions to the speculator’s financial life is generally very difficult to accept. The imaginings of a horrifying future creates fear, and this fear causes people to make decisions regarding their investments.

The most important change in the market in the fear stage is caused by the belief that the rally is over. Price rallies are a self-sustaining price-to-price feedback loop: prices go up because rising prices induces people to buy which in turn drives prices even higher. Once it is widely believed that the rally is over, it is over. Market participants who once only cared about rising prices suddenly become concerned about valuations. Since prices are far above fundamental values and prices are not rising, there is little incentive to buy. The rally is dead.

Another major psychological change occurs in this stage after people accept the rally is dead: people reassess and change their relationship to debt. During the rally, debt becomes a means to take a position in the housing commodity market. Nobody cares how much they are borrowing because they never intend to pay off the loan through payments from their wage income. Most believe they will pay off whatever they borrow in the future when they sell the house for more than they paid. Once prices stop going up, people realize they are simply renting from the bank, and the only way to get ahead and build equity is to pay off a mortgage. The desire to borrow 8 to 10 times income diminishes rapidly as people realize they could never pay off such a large sum. What started in the denial stage as an involuntary contraction of credit, in the fear stage becomes a voluntary contraction of credit as people simply do not want to borrow such large amounts of money.

In August of 2007, a more serious credit crunch gripped financial markets, and during the times that followed there was increased liquidation of bank held inventory. Banks tried to get their wishing prices through the prime selling season, but by the end of the year, there was pressure to get these non-performing assets off their books. The sales of bank foreclosures and the ongoing tightening of credit drove prices down an additional 5% to 10%. This caused some major problems for owners of residential real estate. Fear began to grip the market.

By the time a financial market enters the fear stage, greed stage buyers are seriously underwater. Comparable properties may be selling for 10% less than their breakeven price, and there is little hope that prices will rally. Some sell at this point and take a loss, but most do not. People who bought in the enthusiasm stage come up to their breakeven price and face the same decision the greed stage buyers faced earlier: sell now or hold out for a rally. Even though there is good reason to fear, most do not sell here. They regret it later, but they hold on. Speculators generally only sell an asset when the pain of loss becomes acute. The pain threshold is different for each individual, but there is no real pain until the investment is worth less than the purchase price, so few sell for a profit or at breakeven. Inventories grow in the fear stage because many would like to sell, but sales volumes are light because few are willing to sell at prices buyers are willing to pay.

Prices do not rally here because there are even fewer buyers in the market and a reduced appetite for debt due to the change in market psychology. There are more and more sellers either choosing to sell or being forced to sell, and since there are more sellers than buyers, prices continue to drop. During the fear stage, a majority of buyers during the rally go underwater on their mortgages and endure the associated pain and stress. In the past, since the bubbles of the 80s and 90s were largely built on conventional mortgages, people just held on. During the Great Housing Bubble, people used exotic loan financing terms, and they simply could not afford to make their payments. They borrowed from other sources until their credit lines were exhausted and they imploded in foreclosure and bankruptcy. During this stage many renters who would otherwise have purchased a home put off their purchase and save more money because they correctly see the decline in prices has momentum and prices should continue to drop further.

Capitulation Stage

The transition from the fear stage to the capitulation stage is caused by the infectious belief that the rally is over. There is a tipping point where a critical mass of market participants either decide to sell or are forced to sell. In residential real estate, people are compelled to sell by anxiety, and the mechanism for force is foreclosure. Once a critical mass of selling is reached, the selling causes prices to decline further which in turn causes more selling. This convinces even more people the rally is over yielding even more selling: a downward spiral. The same price-to-price feedback mechanism that served to drive prices up during the rally works to drive prices down during the crash. Collectively, everyone in the market accepts prices are going to drop further, and they need to get out: Now! Of course when everyone knows prices are going to drop, and everyone is trying to sell, there are very few buyers. Each market participant has a different threshold for pain. Some give up early; some give up later; some stubbornly try to hold on, but in the end, by choice or by force, everyone who cannot afford their home sells out and capitulates to the forces of the market. Each seller accepts the market rally was a bubble, and the frenzy of selling activity clears out the overhead supply. The capitulation stage is the counterpart of the greed stage. Sellers are everywhere and buyers are scarce. This puts prices into free-fall until a critical mass of buyers is ready to buy again.

Since buyers in the aftermath of a bubble tend to be the risk averse who did not participate in it, they will make cautiously low offers on properties. Buyer caution is reinforced by lender caution. In stark contrast to the days of bubble lending, large downpayments are suddenly required, appraisals are carefully reviewed, eligibility is tighter, and most exotic loan programs are gone. This cautious buying together with desperate sellers causes the market to drop below normal valuation standards. The market enters the despair stage. Here the market participants think nobody wants the asset, and nobody ever will again. Of course, nothing could be farther from the truth as those who recognize the fundamental value of the asset are buying it in preparation for the next cycle.

Despair Stage

From a perspective of market psychology, it is difficult to tell when the capitulation stage ends and the despair stage begins. Both stages have an extremely negative bearish sentiment. It is called the despair stage because most who own the asset are in despair and wish they did not own it, and the general public is still selling. Most who still own their homes are able to afford the monthly payments, but realize they will face a large loss if they sell their house anytime soon. They feel like prisoners in their own homes because they are unable to relocate for a better job or any other reason. One distinguishing feature of the despair stage is the increased buying activity of investors–true investors, not the speculators who were wiped out during the price decline. Investors are not in despair during this stage. This is the time they were anticipating to make their purchases.

There is an extreme emotional toll paid by those who participated in the mania. Losing a home to foreclosure is devastating. The emotional ties to a home go beyond seeing it as an investment. A home is supposed to be a safe haven where people raise a family. It is a unique reflection of the family, adorned with mementos and family photographs. Being forced to leave the family home is difficult for reasons that have nothing to do with money. Unfortunately, this is often followed by personal bankruptcy, and the difficulties in bankruptcy have everything to do with money.

In some ways, those who endure foreclosure may be the lucky ones as they get to leave their debtor’s prison and go find an affordable rental. The income that used to go toward housing is now freed up to go toward living a life. Those homeowners who hang on, who are desperately underwater, and who are putting 50% or more of their income toward a house worth less than they owe on it, their circumstances are arguably even more dire. There is no light at the end of their tunnel; they must live with their pain every day.

The despair stage is not desperate for everyone. What makes the despair stage different from the capitulation stage is that buyers who focus on fundamentals like rental savings or positive cashflow return to the market and begin buying. Affordability has returned to the housing market, and those who did not participate in the mania finally get their chance to become homeowners–at reasonable prices. These buyers are not concerned with appreciation; they simply want an asset which provides a savings or a cash return on their investment. They are not frightened by falling prices because their financial returns are independent of the asset’s market valuation. It is the return of these people to the market that creates a bottom.

Bubbles as Cultural Pathology

What is a Cultural Pathology? There are certain beliefs if widely held and acted upon by a group of people leads inevitably to collective suffering and personal destruction. One example of a cultural pathology is demonstrated by the American auto industry. Before the age of imported cars, the American auto industry believed the quality of their product did not matter; people bought their product irrespective of quality. For many years, the industry was successful despite this pathology. This belief allowed offshore competitors to enter the market, build market share, and finally take over the industry. The American auto industry’s belief system had had a pathologic effect on their business which caused much suffering in Detroit. This commitment to quality in the industry is still suspect, and it may lead to the bankruptcy and destruction of our major automakers.

The best treatise on the pathology of cultural beliefs was George Orwell’s novel, 1984. [v] In Orwell’s vision, a totalitarian State had convinced the populace of the following:

• WAR IS PEACE
• FREEDOM IS SLAVERY

• IGNORANCE IS STRENGTH

Although these statements are clearly contradictory, in the story the slogans do make sense to the State. For example, through constant “war”, the State can keep domestic peace; when the people obtain freedom, they become enslaved to it, and the ignorance of the populace is the strength of the State. Just as Orwell’s Big Brother convinced the populace the above contradictions were true, Californians and other bubble participants have convinced themselves of the following:

• APPRECIATION IS INCOME
• CREDIT IS SAVINGS

• DEBT IS WEALTH

Just as these statements are contradictory and ridiculous, the proof that these statements are believed is that they are reflected in the actions of many homeowners during the Great Housing Bubble. For example, through borrowing against increasing home values, appreciation is turned to income; when people obtain more credit, they spend it like available savings, and a large amount of debt used to finance a large, opulent home makes one wealthy. To many buyers and homeowners during the Great Housing Bubble this made perfect sense.

The problem is rooted in a basic misunderstanding of what separates the rich from the poor: the habit of saving. There is an old expression, “the rich get richer and the poor get poorer.” It is more accurate to say the rich save money and the poor spend it: in the end, the rich will have money, and the poor will have none. [vi] This is not one of life’s inequities, but rather one of life’s simple truths. When the average Joe says he wants to be rich, what he is really saying is he wants unlimited spending power. He wants the ability to spend like the rich people he sees wearing Rolexes and driving BMWs to their mansions. This is why, when given the chance, poor people will emulate the rich by spending beyond their means in order to be rich. Of course, in the process, they spend themselves poor.

Appreciation is Income

There is a noticeable difference between the behavior of rich and poor when it comes to home price appreciation. The rich view home price appreciation as adding to their net worth. If lower interest rates allow them to refinance, they will restructure their debt to pay off the loan more quickly in order to increase their wealth. Poor people view home price appreciation as income; free money for them to spend. If lower interest rates allow them to refinance, they will restructure their loan to pull as much home equity as possible and reduce their payment as much as possible so they can spend more. If any net worth happens to accumulate, they obtain a home equity line of credit and spend the appreciation as quickly as possible–it makes them feel rich even though it really makes them poor.

Credit is Savings

So how do the rich and poor deal with credit? The rich do not carry consumer debt. Why would they pay interest on a credit balance when it almost always costs more than the income they earn on their savings? The rich will use credit sparingly and most often pay off any credit balances each month as the bill comes due. In contrast, the poor carry as much consumer debt as they can afford to service. Whenever they receive an increase in a credit line, they believe they have more money to spend, just like it was savings. In a strange way, a credit account is like a savings account, only it has a negative balance. In a savings account, the saver earns money; in a credit account, the spender pays money. Again, the rich have savings, and the poor have credit.

Debt is Wealth

There are a great many homeowners who live in big houses, and they believe that makes them rich. To them, the possession and use of an expensive house makes them wealthy even if they have no equity in the property. The rich buy less home than they can afford and work to pay off the debt in order to maximize their net worth. The poor stretch their finances to possess more home than they can afford with loan terms which never retire the debt, or in the case of negative amortization loans, actually increases their debt held against the property. This ensures they never gain any equity or only gain it by appreciation, and as mentioned previously, if prices appreciate they quickly withdraw the gain to fuel more consumer spending.

It’s a California Thing

So what happens when you give poor people money? They spend it. The stories of people who won the lottery and managed to spend themselves into bankruptcy a few years later are classic examples of the pathology of the beliefs of spenders. [vii] A great many Californians are spenders. This is why California has a strong cultural pathology. The main psychological reason house prices in California were bid up to such dizzying heights during the Great Housing Bubble was because there was a high percentage of the population in California that subscribed to the spending habits just described. They went out and borrowed as much money as they could with exotic loans, bought up all the real estate they could get their hands on, and in the process drove real estate prices into the stratosphere. In other areas of the country, reckless spending was not so trendy, and home prices were not bid up so high.

Pretentious displays of conspicuous consumption are less common in the Midwest, and consumerism is often viewed with contempt rather than envy. In short, there is a smaller percentage of the general population in the Midwest with the aforementioned pathologic beliefs. [viii] To substantiate this claim, observe the profile of Minnetonka, Minnesota, a suburb of Minneapolis with very similar income and demographics to Irvine, California. The median income in Minnetonka, Minnesota in 2006 was $84,024, and the median income in Irvine, California, in 2006 was $84,253. [ix] This is close enough to be a good comparison. The median home price in Minnetonka in 2006 was $305,600, and the median home price in Irvine in 2006 was $722,928. [x]^,[xi] If the thesis is correct, one would expect to find a much higher percentage of home loans utilizing exotic loan terms in Irvine as compared to Minnetonka. In 2006 the Minneapolis area had 8.7% of its loan originations were negative amortization, while Orange County had 32%.[xii] In all of California more than 80% of loan originations in 2006 were either Option ARM or interest-only. Here are two groups of people with the same median income, and with the same access to credit making very different choices. Potential homebuyers in Minnetonka and Irvine faced the same decision on taking out an exotic loan and buying more house than they can afford or choosing to live within their means. Very few in Minnetonka chose to overextend themselves, so they did not bid up the values of their houses. Residents of Irvine (and the rest of California) chose to utilize exotic financing and thereby real estate prices were bid much, much higher. The high utilization of exotic financing was the cause of the price increase, not the result of it. Nobody was forced to buy.

Perhaps Californians were just more financially sophisticated than the rubes back on the farm in the Midwest? If many in California were spending freely, feeling rich, and enjoying life, where is the pathology? The beliefs and resulting behavior is pathological because it is not sustainable. There is an inevitable Day of Reckoning when all debts must be paid. Charles Ponzi was the most excessive example of this pathology. So extreme were his activities, that the term Ponzi Scheme has become synonymous with the use of ever increasing amounts of investment or debt. [xiii] This scheme is also encapsulated in the expression “robbing Peter to pay Paul.” The twentieth century economist Hyman Minsky wrote about the “Minsky Moment” when borrowers must liquidate assets to pay off debts which in turn lowers asset prices and creates more margin calls and even more asset liquidation. [xiv] At some point, the debt becomes so large that no lender is willing to loan more money, no greater fool can be found to bail them out, and the whole system comes crashing down. However, while the debt was building, the debtor becomes accustomed to a certain lifestyle and level of spending. When the credit is cut off, the debtor can no longer spend, and a great deal of suffering ensues. This is Armageddon for debtors: the spending stops, they lose their homes and with it their illusion of wealth, and they definitely are not enjoying life. The cause of all the weeping and gnashing of teeth is not an exogenous event, but rather a direct result of the circumstances they themselves created.

The California Social Contract

Satire is often more revealing than detailed explanations. The pathology of a collection of beliefs becomes apparent when the natural end result of a group of people acting on those beliefs is an absurd contradiction and an obviously unsustainable state. The following is a satirical essay written from the point of view of a desperate homeowner trying to sustain the Ponzi Scheme of the Great Housing Bubble:

You fence-sitters are failing to fulfill your part of the California Social Contract. Your failure to continue buying homes is disrupting the social order, and it is causing those of us who bought before you psychological, emotional and financial damage. It is time for you to get off the fence and buy–NOW!!!

In any social contract, you give up something personally for the greater good. When those of us who bought before you purchased our homes, we had to commit unrealistic percentages of our income to housing, lie on mortgage applications, and take out financing on unstable mortgage terms in order to do our part for the continuing social good. We made these sacrifices willingly because the benefits of maintaining the social contract are worth the price we paid. Look what those who bought before us received in return:

1. Dramatic increases in wealth through home equity. I think we can all agree this is desirable. You want to be rich, right?
2. The ability to spend more than what is earned through productive activities like work. Think of all the BMWs, Mercedes, vacations to Maui, Coach Bags, designer jeans, Rolex watches and other items purchased with home equity lines of credit. You want to double your spending power, right?
3. The ability to buy furniture and home improvements without saving or spending income. Your house should be a self-sustaining asset which provides the ability to maintain itself with perpetual appreciation. Who would not want that?

We provided all of this to the buyers who came before us, and all we ask is that you do the same for us. Is not this a fair bargain? You want the same for yourself, right? If you do this, the next generation of buyers will learn from your example, and they will be willing to do the same.

Some have argued it is our fault that the social contract is falling apart. If we recent homebuyers had simply made our payments, the contract would not have been broken. This is rubbish. The lenders failed us. They knew we could not make those payments when we took out the loans. They knew we were not truthful on our loan applications. They knew they were going to have to provide opportunities for serial refinancing of ever increasing amounts of debt. They failed us. They are the ones who broke the social contract, not us.

The tightening of credit just means you will have to make more significant sacrifices to keep the social contract. You may need to borrow money from family members or solicit larger gifts. You may need to become more creative in your attempts to inflate your income or assets. All we had to do was sign some fraudulent paperwork, but you may have to forge some documents or buy a seasoned credit line or find a hard-money lender who does not record the debt (loan sharks). It is going to be tough, but look at the benefits listed above. Is it not worth the sacrifice?

It is time for you to buy now. Trees really can grow to the sky; prices really can go up forever–if you hold up your end of the California Social Contract. To paraphrase Winston Churchill,

Let us therefore brace ourselves to our duties, and so bear ourselves that if the {California Social Contract} last for a thousand years, men will still say, ‘This was their finest hour.’

This is your chance to stand up for what is right and perpetuate a system that is beneficial to our society. History will remember what you do. Will you be the generation that lived up to its duties, or will this be the end of the world as we know it? You decide.

[1] In Risk and Return in the U.S. Housing Market: A Cross-Sectional Asset-Pricing Approach (Cannon, Miller, & Pandher, 2006), the authors noted a 10% increase in volatility with each 2.48% increase in annual returns. This strongly suggests bubble volatility occurs just because prices are rising.

[ii] An article in Real Estate Journal.com (http://www.realestatejournal.com/buysell/markettrends/20050106-capell.html) from the Greed stage in the bubble anecdotally documents properties selling for over list and realtors telling clients to write emotional letters to sellers (Capell, 2004).

[iii] Karl Case and Robert Shiller noted (Case & Shiller, The Behavior of Home Buyers in Boom and Post-Boom Markets, 1988) that prices in the early 80s leveled off, but they did not decline at the conclusion of the first California housing bubble of the late 1970s. This convinced people that prices could not decline and that if they just waited long enough prices would come back. This belief caused people to bid up prices even higher in the coastal bubble of the late 1980s. When the decline of that bubble (25%) was forgotten, market participants inflated the Great Housing Bubble.

[iv] In Robert Shiller’s studies, very few market participants said they would lower their prices until they found a buyer (Case & Shiller, The Behavior of Home Buyers in Boom and Post-Boom Markets, 1988).

[v] (Orwell, 1950)

[vi] Vernon L. Smith noted in Human Nature: An Economic Perspective that “We should all love rich people, because they consume such a small percentage of their accumulation, leaving almost all of it to work in the economy and make the rest of us better off.” (Smith, Human Nature: An Economic Perspective, 2004)

[vii] Newspapers frequently print stories of lottery winners who spent all their winnings or were unhappy after the windfall (Geary, 2002) (Sullivan, 2006).

[viii] Karl Case and Robert Shiller noted (Case & Shiller, Is There a Bubble in the Housing Market, 2004) that Wisconsin had almost no volatility in the ratio of house price to income whereas the coastal bubble markets have price volatility where income only explains about half of the movement in price seen over longer terms.

[ix] Median income information is available from the US Census Bureau:

http://www.census.gov/hhes/www/income/income.html

[x] Median home sales price from US Census Bureau.

[xi] Data for the California market is from DataQuick Information Systems and the California Association of Realtors.

[xii] BusinessWeek wrote one of the finest articles on the mortgage problem in 2006. In it they reference the now infamous Map of Misery showing the distribution of Option ARMs throughout the United States. The source of their data is not given. The data presented in this work on the loans in Minnetonka, MN and Orange County, California, come from this map. Two of the most moronic lender statements of the housing bubble are in the article’s final paragraph, “Analyst Frederick Cannon of Keefe Bruyette & Woods says most banks don't apologize for their option ARM businesses. ’Almost without exception everyone says [the option ARM] is a great loan, it's plenty regulated, and don't bug us,’ he says. In an April letter to regulators, Cindy Manzettie, chief credit officer for Fifth Third Bank in Cincinnati, said it's not the ‘lender's responsibility to help the consumer determine the appropriate payment option each month…. Paternalistic regulations that underestimate the intelligence of the American public do not work.’” Those statements are wrong on every point, but they do serve to illustrate the mindset of lenders during the bubble.

[xiii] Charles Ponzi was an Italian immigrant who arrived in the United States in 1903. He was a consummate schemer and tried numerous get-rich-quick schemes. He hit the con-man’s jackpot in 1920 with a scheme involving international postal reply coupons. When the structure collapsed, Ponzi paid out all his gains and ended up penniless. He was sentenced to prison in 1921 for mail fraud. (Zuckoff, 2005)

[xiv] Hyman Minsky was a controversial economist of the late 20^th century. He wrote extensively as a professor of economics at Washington University in St. Louis. (Minsky, Can "It" Happen Again? Essays on Instability and Finance, 1982) (Minsky, Stablizing an Unstable Economy, 2008) As the Great Housing Bubble began to deflate, the causes were readily identified in Minsky’s work from decades earlier. His writings rose from obscurity and attained a new prominence due to his prescience.

This weekend's property is an REO priced near rental parity.

Irvine Home Address … 13 COLUMBUS Irvine, CA 92620

Resale Home Price …… $745,000

{book1}

Regrets I've had a few

But then again too few to mention

I did what I had to do

And saw it through without exemption

I planned each charted course

Each careful step along the byway

And more, much more than this

I did it my way

Frank Sinatra — My Way

IHB News

This was an eventful week with several national blogs picking up on Monday's story that Bank of America to Increase Foreclosure Rate by 600% in 2010. We were picked up again by Patrick.net with Loan Modifications Succeed by Increasing Borrower Entitlements. We had over 30,000 visitors for the week.

Housing Bubble News from Patrick.net

Writer's Corner

I have decided to take a small piece on the weekend open thread for me. I have always tried to keep my personal interests unrelated to real estate out of my posts. I am not very interesting, and people come here for news and analysis rather than because I am interesting. I recognize that, so I keep myself out of it — mostly.

If you have no interest in anything outside of my views on real estate, you may skip the writer's corner, and you will not miss a thing.

My beliefs and character come through in my daily real estate commentary, so you already know me in ways that matter, but I want a place where I can share off-the-wall things that catch my eye during the week, a place I can talk about my interests an hobbies: writing, blogging, video games, science, astronomy, biology, history, local destinations, the Green Bay Packers, golf course design, whether or not Tiger Woods will win the Masters, anything I am focused on at the moment.

Saturn's Hexagon Cloud

For Christmas I bought my two pre-teen cousins the Universe series on DVD. I thought it was so cool I bought a copy for myself, and I either watch it or Star Wars: The Clone Wars with my morning breakfast all this year… Yes, I am a total nerd.

I was watching Universe's discussion about new images from the Cassini spacecraft of a strange but persistent cloud formation on Saturn that forms a nearly perfect hexagon. How does that happen? I was floored when I saw this. I thought it was made up.

Scientists don't have a clue how such a formation can exist. From Wikipedia: "The straight sides of the northern polar hexagon are each about 13 800 km long. The entire structure rotates with a period of 10h 39 m 24s, the same period as that of the planet's radio emissions, which is assumed to be equal to the period of rotation of Saturn's interior. The hexagonal feature does not shift in longitude like the other clouds in the visible atmosphere."

Featured property

This REO is priced near rental parity. With no HOA or Mello Roos, the cost of ownership is under $3,000 per month.

Irvine Home Address … 13 COLUMBUS Irvine, CA 92620

Resale Home Price … $745,000

Home Purchase Price … $644,739

Home Purchase Date …. 1/19/2010

Net Gain (Loss) ………. $55,561

Percent Change ………. 15.6%

Annual Appreciation … 59.2%

Cost of Ownership

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$745,000 ………. Asking Price

$149,000 ………. 20% Down Conventional

5.11% …………… Mortgage Interest Rate

$596,000 ………. 30-Year Mortgage

$156,197 ………. Income Requirement

$3,240 ………. Monthly Mortgage Payment

$646 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$62 ………. Homeowners Insurance

$0 ………. Homeowners Association Fees

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$3,947 ………. Monthly Cash Outlays

-$796 ………. Tax Savings (% of Interest and Property Tax)

-$702 ………. Equity Hidden in Payment

$299 ………. Lost Income to Down Payment (net of taxes)

$93 ………. Maintenance and Replacement Reserves

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$2,842 ………. Monthly Cost of Ownership

Cash Acquisition Demands

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$7,450 ………. Furnishing and Move In @1%

$7,450 ………. Closing Costs @1%

$5,960 ………… Interest Points @1% of Loan

$149,000 ………. Down Payment

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$169,860 ………. Total Cash Costs

$43,500 ………… Emergency Cash Reserves

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$213,360 ………. Total Savings Needed

Property Details for 13 COLUMBUS Irvine, CA 92620

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Beds: 4

Baths: 2 full 1 part baths

Home size: 2,508 sq ft

($297 / sq ft)

Lot Size: 5,250 sq ft

Year Built: 1980

Days on Market: 3

MLS Number: S611281

Property Type: Single Family, Residential

Community: Northwood

Tract: Pl

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According to the listing agent, this listing is a bank owned (foreclosed) property.

4 bedroom, 3 bathroom pool home located in charming neighborhood. Bonus room can easily be 5th bedroom as well. Entertainer's kitchen offers granite counters and cherrywood cabinets and built-in cabinet lights. Cherrywood Staircase and built-ins in living room. Fabulous backyard with pool. Upstairs Loft and much more. Hurry! this home will not be around long!

Happy Easter