The Real State of Real Estate
By Susan Barretta Elliott Wave International
The housing boom-gone-bust in Naples, FL was the lead article in the nation's leading financial daily, recently. The concluding quote was, "This market downturn came out of nowhere… It surprised everybody, especially the people making mortgage payments."
"Out of nowhere"…? All I can say is, Wow.
Bob Prechter’s Conquer the Crash bemoaned the fact that homeowners were $7.6 trillion deep in mortgage debt, with two-thirds of them owing more than two-thirds of the value of their homes, plus interest, and that increasingly people were buying with little or no down payment. To compound the financial recklessness, banks started accepting super-sized appraisals so that homeowners could get super-sized loans.
And to think that was written back in 2002.
Back then we were still reeling from the dot-com crash, which was the financial equivalent to hitting that iceberg the first time. The time bombs, poison pills, landmines and weapons of mass destruction that now pervade the housing market in the form of cheap credit and ever more “innovative” loan packages with cash back options have brought us to the brink.
If you're a regular reader, you understand something about social mood and mass psychology. Bob Prechter isn't the first person to recognize the psychological pattern of an asset mania, yet he has endeavored to describe a mania as a technical pattern; he also used technical and mathematical tools to predict manias. We know that a mania leaves a recognizable footprint, and we have the tools to anticipate what is coming. We don’t know the exact what or the exact when, but we know the pattern. And we know the algorithm – the steps a boom takes to become bubble.
That's what I’d like to talk about here and in a series of future articles -- how the housing market has progressed over the last several years to its current state. Amazingly, many major economists, financial analysts and journalists today still refuse to recognize the housing market for what it is. In an environment like this, an alternative framework to interpret what you hear and read can literally mean the difference between financial salvation and disaster.
In the meantime, I leave you with two graphs depicting the state of the housing market today. The first is a longer-term at median U.S. home prices from 1990. The recession in the early 90’s shows up as a dip, but nothing in the past 16 years compares to the plunge in 2006.
The second picture is a housing starts and permits: the trend speaks for itself.
Technical Characteristics of the Real Estate Mania
A look back at the May 1997 Elliott Wave Theorist essay “Bulls, Bears, and Manias” reminds us that normal markets propel themselves via a chaotic feedback system. Price movements are driven by behavior which in turn drives behavior. The market inhales and exhales, moves up, then moves down, retracing part of its gain. We see this in the progress and regress of Elliott Waves. Yet this price “respiration” vanishes when markets are not normal, as is clear from a study the chart of asset manias. You notice fewer and briefer setbacks. The usual tools of analysis don't work -- in a stock market mania, for instance, prices blow through calculated levels of resistance that the former bull market would have respected. In some markets, technicians might characterize the final move of a mania as parabolic -- a period when the price graph becomes considerably steeper toward the peak. Technically, a mania arises out of a long-term bull market that once exhibited the normal pattern of ebb and flow, but changes into virtually a non-stop rise that appears as a steep line on a graph.
Manias have duration. Some famous manias that “Bulls, Bears, and Manias” cites lasted two years, the 1920’s run-up was about eight years, the Japanese market experience was 15 years, and the U.S. stock market’s mania covered 1982-2000, about 18 years.
Manias have extent. Manias raise asset prices by multiples. From its low in 1982 until its 2000 high, the Dow's price multiplied by 15x. The multiple for tulip bulbs in the 1630’s was considerably more.
U.S. house prices have been ascending at least since the start of this data series in 1963. Are any of the technical characteristics of a mania evident in this chart?
Figure 1. Median U.S. House Price, 1963-2006.
The national housing market has certainly been in a long bull run. The arrows point to the most protracted flat-to-down periods of the long-term upward trend. Some regions of the country endured substantially longer and more painful housing bear markets during the time range in this graph, thus contributing amplitude to these national-scale corrections. But on that national level, the recovery times from these corrections have been relatively quick. There are a few down times in very recent years, but the dips are brief.
Note the three red trend lines. Prices broke away from the first trend line in 1992. The second trend line highlights the slightly steeper slope that started around 1994 and terminated in 2002. Finally, the third even steeper trend line started in 2002 and lasts until it was decisively broken in the first half of 2006. Thus another of the technical conditions that characterize this market as a mania is clear, namely increasingly steeper trends. Manias accelerate in arithmetic terms.
The graph shows duration. If one counts the start of the mania from 1982, it includes 25 years; from 1971 includes 36 years. When we examine the behavioral aspects of a mania and the steps that turn a bull market into a mania, we could make a case that some aspects go back to the Great Depression -- over 70 years -- and even longer than that.
And then there is extent. In nominal terms, the median house price was $25,000 in 1971, and poked through $250,000 in 2006, a 10-fold multiple.
Figure 2. Existing Home Sales, 2004-2006.
“Bulls, Bears, and Manias” notes that it is practically impossible to call the top of a mania, but other measures of the asset market potentially flag when a decline is imminent. With stocks, for example, the Advance/Decline line typically falls, so the final advance rests on fewer and fewer stocks. In the housing market, existing home sales seasonally adjusted topped out June 2005, and inventory, described in terms of the number of months it takes to sell it, has been climbing since January 2005.
Figure 3. Housing Market Months Supply, 2004-2006.
So by some other measures of housing market strength, the jig is up. These weakening indicators do not guarantee a decline of course, but these indicators would need to weaken before a price decline develops.
Relatively quick recovery from setbacks, shallow quick dips in very recent years; increasingly steeper trend lines; duration; extent, other measures that have warned of a weakening trend -- it looks like our national housing market has been in a mania from a technical perspective, and that the mania is in the process of unwinding.
In the next article, we’ll talk about the psychological pattern in the progression from a bull market to a mania.
Steps from Boom to Mania, Part I
Charles Kindleberger, Donald Christensen and other noted economic writers have described the progression of a mania in great detail. An investment mania exploits a good financial strategy, progresses into overuse, and eventually abuses the strategy to death.
I've drawn on various sources to construct a general timeline for the behavioral steps in a mania. These steps are not linear; they can include plenty of reordering and overlap. This Market Watch looks at the steps going from good strategy through overuse; next week considers abuse to death and its aftermath.
“What’s a safe place for my money?” A financial displacement event happens that moves investors to seek new solutions to their financial problems.
The displacement, or dislocation, need not be a crisis or collapse. It could be a change in law that makes a particular investment vehicle unfavorable or favorable. But sometimes a collapse in one market can drive investors into another market, or into speculative asset.
“We got through the last crisis, so we’ll get through the next one.” After a financial shock or economic downturn, investor confidence starts to build.
U.S. investors have endured many financial shocks and crises over the past several decades; most of these are wedged between the permanent severing of the dollar from gold in 1971 to the stock market crashes of 2000-2002. Many of these events produced a coordinated "authoritative" response, which coached investors into thinking that the authorities would take care of things. Speculators concluded it was safe to go back in the water, and assumed the authorities would act again when necessary.
“The future is assured and looks bright. I feel so much better now!” A positive event sparks confidence in the future.
At this stage, something positive happens that reinforces a growing sense of invincibility in the public mood. Psychologically, we are soaring. We’re starting to feel pretty good! Arguably, the most recent large degree event to have such an effect on us was the arrival of January 1, 2000 -- the passing of the Y2K milestone.
From Boom to Mania
“It’s a new era. It’s different this time.” Investment rules get rewritten. Proven measures of value and risk are cast aside. We experience cognitive dissonance, and rationalize away awkward financial truths.
The rationalizations come dressed up in "new" economic models, which justify asset prices and forecast trends. Yet, they typically forecast more of what just happened. As markets get bubbly authorities may issue warnings, but those warnings are criticized. Few act on them. The crowd has been hearing about a new era, which is all it wants to hear so it can justify absurd asset valuations.
If you don't support the notion of a new era -- and won't embrace the new measures of valuation -- you are deemed obsolete. There is intense social pressure to conform to the crowd. If you try to persuade speculators of the dangers, you may be accused of trying to profit from their potential misfortunes.
“It’s easy to invest in X.” The surge of incoming money from the initial financial displacement has dried up, so to keep the money coming, agents of the financial strategy lower or even eliminate admission fees, commissions, or other investment costs.
The rails are greased for easier participation. This may include what Bob Prechter's Bulls, Bears, and Manias called official sanction -- the government actions encourage participation. These can range from credit and monetary expansion to short term interest rate adjustments to lending regulations and margin requirements.
If government helped trigger the wave of speculation, it will deny the existence of any ensuing problem -- until it is painfully and embarrassingly obvious.
“I doubled my money in X. If I can do it, you can too!” Participation in the financial idea looks like a fun activity and a sure win.
By this time there is probably a blizzard of advertising illustrating successful investors making what appears to be easy money and living their dream lives.
Anyone not participating in the mania by this time will probably know people in his social network who are, and appear to be doing well.
“I am going to quit my job and just deal in X.” This is the point in the mania where people seek deeper involvement with the object of their financial affection.
Some speculators mistake their success for genius or aptitude. They quit their jobs to trade full-time. They go to school or get licensing to enter related careers.
To some outsiders, these mania-related occupations look easy, since so many willing and eager participants have lined up to buy. Other outsiders perceive brokers and advisors as little more than order-takers who don't add value. And all the while, insiders feel the pressure to outperform the other pros and keep the money rolling in. These combined pressures can make it a most unhappy time for the pros.
“Everybody ought to be rich. Everybody ought to have their piece of the American dream. This is a great time to buy X.” The flip side of this is the reluctant holdout who thinks, “Why is everybody getting rich but me? If I don’t get in now, I may get shut out forever!”
Steps from Boom to Mania, Part II
In the last article, we looked at the "The Steps From Boom to Mania" part one, namely the steps from good strategy through overuse. This article looks at the steps from Abused to Death to the Aftermath.
Abused to death
Participation in the mania broadens to the point of exhaustion. Agents have to keep that money flowing in, so they cast their nets over an ever-wider area to pull in every last widow, orphan, overlooked ethnic group, income level, gender, and age group (yes, children get pulled in). Up to this point, speculators were propelled along by excitement, euphoria, and greed, but there is now an undercurrent of fear of being left behind and losing the chance for easy riches. Promoters push that emotional button for all it is worth.
Those who recognize the mania and take bearish positions risk financial suicide. Bulls, Bears, and Manias mentions that the bears are typically the first victims.
The number of professionals in professions related to the traded asset approaches a peak.
“Hey did you hear the joke about X?” Participation in the financial idea becomes the topic of movies, TV commercials and shows, books, magazine and newspaper articles, poems and jingles, and songs, eventually working its way into humor.
At this point in the mania, comedians can now talk about it because enough people are involved that they will get the joke.
The end is nigh.
The Bust and Aftermath
The emotional evolution of the crowd on the way up becomes a devolution during the unwinding. Ann Crittenden’s essay The Stock Market Scene Today: A Jungian Perspective suggests that a good guide during the unwinding is to expect the opposite of what was in the public consciousness during the boom; Christensen also says to expect everything to play out in reverse. So we can expect euphoria and high expectations to be replaced by fatigue, disillusionment, and disappointment. Confidence and greed are replaced by self-doubt and fear. Invincibility becomes vulnerability.
“It’s time to get out.” In Mania, Crashes, and Panics, Charles Kindleberger suggested that an acute crisis (causa proxima) may trigger an abrupt change in confidence and spark a desire to sell.
An alternative explanation is that the participants reach the realization that the mania itself has reached the point of exhaustion, and they are looking for an excuse -- any excuse -- to start unloading the asset.
If valuations change rapidly enough to constitute a market crash, the fear of being left out (which propelled the mania to its final peak) is replaced by fear of not getting out on time, which pushes valuations down.
“You mean it was a lie?!?” A downturn exposes fraud, embezzlement and deception in the asset markets. Revelations of fraud can serve as the excuse speculators needed to dump the asset.
The fraud has been there for some time, but until the right moment speculators have looked the other way. Now the psychological climate has changed enough so that the public mood favors harshly punitive measures to address the problem. The relaxed trust in social mood on the way up is replaced by suspicion and distrust.
“The fundamentals are sound. Prices just got a little ahead of themselves. This is just a healthy correction.”
The authorities assure us that the conditions are merely temporary and the good times will return shortly.
“It’s company/market/region/agency specific.”
Market declines are explained away. This excuse actually acknowledges a problematic decline, but claims the damage is contained and implies that it probably won’t affect the speculator who happens to be listening.
A large degree mania takes a while to defuse. The rationalizations continue on the way down. There may be recurrences of that old good-time mania behavior, though at a smaller scale. Any temporary pause or rebound as the market works its way down is heralded as the bottom, with a recovery just around the corner.
During the trip upwards, we felt we were invincible, we thought that our scientific and technological know-how put us in control. We were proud of our achievements. But on the way down, we become painfully aware of our vulnerability, and come to realize that we aren’t in control of things, and we appeal to higher authorities for help.
“Will we ever see a bottom?”
When the popular press stops talking about the bottom and starts asking about a bottom, when we keep seeing words like agony and depression in the papers, and when all the concomitant hard-luck stories are old news, perhaps enough sense has been knocked back in to the crowd that people are psychologically ready to begin anew.
Estate: "Insidiously Worked Their Way..."
When the November 2006 Elliott Wave Theorist mentioned that we had few charts to go on to analyze our real estate market, it also suggested that they weren't needed, because the psychological pattern of the real estate market was alerting us to the existence of a mania.
Parts three and four of this series described the general steps from boom to mania, and the subsequent unwinding. Now that we know the steps of a mania, parts five and six will look at how some or all of them insidiously worked their way into our attitudes toward real estate.
Home ownership is deeply entrenched in America's psyche. It is regarded as a sacred right, the American dream, and the most assured way to prosperity. Owning real property was a chief aspiration of our forefathers who settled in the original colonies and founded this country -- there was a time when if you didn't own real property you didn't have the right to vote. Stock speculation was not what the colonists had in mind.
One might therefore make a case that the seeds of the boom and ensuing mania were planted centuries ago, when immigrants colonized this country. But since this article is limited in scope to a few pages, we'll look at what has happened relatively recently.
"What's a safe place for my money?"
Real estate became a refuge after the stock market crashes of 2000-2002; the rapid lowering of short term interest rates at that time only increased the perception of a "safe haven." That perception explains why homeowners today still believe a decline in real estate market values is outside the realm of possibility.
"We got through the last real estate downturn, so we'll get through the next one. Besides, real estate markets are only local, and real estate always goes up."
Today's investors think that maybe Mom or Dad saw some temporary real estate problems in the 80's or 90's, but at worst prices just flatten -- they don't go down!
"The future is assured and it looks bright. I feel so much better now!"
One could argue that the U.S. military's relatively rapid capture of Baghdad in 2003 was the spark that lit the fuse on the final leg of our housing consumption frenzy, but this is debatable.
"It's a new era. Today's markets are different."
A home was once considered affordable if the 30-year, fixed rate mortgage was between 2 and 3 times the borrower's annual salary. Mortgage lenders typically required a 20% down payment. Lenders also looked at the borrower's income tax records to establish veracity. In those days, a house worth buying was the cheapest one (relatively speaking) in the best neighborhood the borrower could afford.
But when the boom gun goes off, measures of affordability are reengineered, and all birds can fly -- even the turkeys. The experts disavow the existence of a bubble. Or, they quantify the bubble in such a way that it becomes meaningless.
"The ongoing strength in the housing market has raised concerns about the possible emergence of a bubble in home prices...the turnover of home ownership is less than 10 percent annually -- scarcely tinder for speculative conflagration." - Fed Chairman Alan Greenspan, before Joint Economic Committee, April 17, 2002
"The time has come to put this issue to rest...the nation's home builders have said it, the Realtors have said it, and now Alan Greenspan has said it once again, in no uncertain terms: there is no such thing as a current or impending house price bubble." - David Seiders, National Association of Home Builders (NAHB), July 2002
"A bubble exists when the ratio of the median existing house price to per capita personal income exceeds 6.8 times." - Michael Youngblood, Friedman Billing Ramsey, Business Week, May 15, 2006
In their August 2006 news release, the California Association of Realtors (CAR) reported that it had developed a first-time buyers housing affordability index (FTB-HAI) and recalculated this statistic back to 2003. In 1984, when CAR developed its first HAI, affordability calculations used conservative guidelines. Now, the HAI calculations assume a 10% down payment and an adjustable interest rate. CAR said the index was developed to reflect the "realities of today's markets", but the truth is that by the old standards, almost nobody can afford a house in California.
"It's easy to buy a home"
When a boom gets what Bob Prechter's "Bulls, Bears, and Manias" essay called official government sanction, look out. The monetary and credit rails are now greased for easy acquisition.
After the post-WWII real estate boom came the mortgage securitization trend in the 1970's and 1980's. Lenders could sell their mortgages and acquire capital to make more loans. After banks and S&Ls crumbled under the weight of bad loans in the late 80's, securitization became the way for lenders to transfer the risk of bad loans to the investors who held these securities. A mortgage default in California can effect the income fund of an investor in Kansas. It became a lot easier to lend, but this is one way the housing mania has now become a national problem.
"Part of the [homeownership] gains have also come about because innovative lenders...have created a far broader spectrum of mortgage products and have increased the efficiency of loan originations and underwriting." - Fed Chairman Alan Greenspan, America's Community Bankers, November 2, 1999
The loans that these "innovative" lenders provide assume that the borrower's income and the property's value will continue both continue to rise -- in other words, that inflation rescues the borrower. The trick may even work for a while. Zero-down, no-documentation, interest only, negative amortization, and adjustable rate loans have gotten lots of press. It's amazing that these poison pills are legal.
"I'm going to retire, move to Florida, and become a real estate agent." The demand for real estate has become so intense that housing becomes overtraded, and even the associated professions become glutted.
Speculators, like the ones who attended those real estate seminars, are now crawling all over markets like termites in an attic. Markets see frenzied bidding wars. Potential buyers line up to bid on a property. Some bidders pay other bidders to go away. At this stage, some properties in hot markets get over two dozen bids, and frustrated buyers may submit bids for as many as 40 or 50 properties without luck. A serious buyer has to write a letter to the seller and include a photo of his pets and children and "articulate positive feelings" about the property.
Those who recognize an unsustainable trend and sell their homes to cash out now feel like fools for selling too early. Some are tempted to jump back in; some are under intense pressure from their spouses to reenter the market.
Those who cannot or will not participate in the market may still suffer financial consequences, as they are forced out of their homes due to steep rent increases or rental conversions.
Some who have sell their homes in the hottest markets and monetize their gains opt to leave those areas and move the proceeds into other, less inflated markets. This distorts real demand, misallocates resources, and aggravates conditions to where some housing markets become overbuilt almost overnight. The credit bubble from one market inflates into another. This is another mechanism by how the housing bubble has become national in scope.
In the meantime, outsiders continue to flow into the profession. According to the California Department of Real Estate (DRE), the number of licensees in the state stood at an all-time high 514,000 in September 2006, well past the peak of 371,000 reached in 1993. DRE notes that historically there has been a multi-year lag between a market price extreme and an extreme in the number of licensees, so the number may continue to climb.
"I took $3000 and turned it into $80,000 in two months! Anybody can do it!" At this point, real estate investment is starting to look easy and we are encouraged to overtrade it.
Estate for Dummies
The publication of Real Estate for Dummies in November 2004 indicated that real estate has "arrived" in the public consciousness. The complete idiot’s guide to success as a real estate agent followed in 2006.
It was no longer a matter of buying a house to shelter yourself and your loved ones -- instead, it was about putting your money to work in "hard assets" by buying second and vacation homes, creating streams of income in rental properties, and fixing up properties for a quick flip.
The mania even reaches a point where speculators do not even have to put any elbow grease into a fixer-upper; they merely buy under-construction properties from a builder and sell 'em once they're built.
"Everybody should have the opportunity to own their piece of the American dream, no matter their income level, race, religion, or gender." On the other side of this is the haunting thought, "If I don’t get in now, I may never be able to afford it!"
"You’ve got to live someplace. They aren’t making more land!"
"[Comparable] houses have gone up…Now I feel like we will never be able to afford a house."
Thwarted home buyer, Los Angeles Times, August 4, 2002
"We've got -- home ownership rate is at an all-time high. And a particularly important part of that statistic is minority home ownership rates are at an all-time high…When I'm talking about ownership, I'm talking about ownership for all people, not just -- not just a certain type of person. We want ownership to be a part of every neighborhood."
President George W. Bush, July 2, 2004
The real surge in home ownership came in the post war years. Between 1960 and 1990 ownership rates were between 60% and 65%. Even with the push to improve home ownership rates for even the most disadvantaged groups, one would think that the rates would have surged past 75% by now. In 2004, when President Bush made those remarks, the home ownership rate stood at 69%. It declined slightly in 2005 to 68.9%. Perhaps slick lending tricks have been run to exhaustion.
Even children are part of the audience in the real estate sales pitch. Some realty agencies have sponsored school essay contests for students to write about what the word "home" means. One national home builder offered coloring books to the kids while the parents were in the sales gallery of the latest condo development. The subject of the coloring book? Moving into a new house, of course.
"Did you see the movie about those crazy home buyers?" Not content to just live in a house, we experience real estate through games, books, comics, TV shows, and movies.
Monopoly, the classic real estate game first released by Parker Brothers in 1935, is still the most popular board game on the planet. In the United States, city specific editions started appearing around 1994. A Mega edition, released in 2006, takes players back to the game’s origin (Atlantic City, NJ) and now has players erecting skyscrapers. The properties in the United States Here and Now edition, also released in 2006, cover the entire United States, ranging from Jacobs Field in Cleveland to Times Square in New York.
For Sale signs resembling Monopoly game boards have been spotted. The California Department of Real Estate has a link on its website directing children to a Monopoly page, to teach children about real estate.
In the amazon.com book listings, not only are there scores of published books on real estate speculation, but the number of books scheduled for future publication is climbing.
In 2006, David Lereah, chief economist of the National Association of Realtors (NAR), released Why the real estate boom will not bust – and how you can profit from it. Other books published in 2006 are:
- Wise women invest in real estate
- The insider’s guide to tax-free real estate: retire rich using your IRA
- Weekend warrior’s guide to real estate
Titles due out in 2007 include:
- All real estate is local: why understanding the housing trends in your area is essential to building wealth (also by NAR’s economist)
- Successful real estate investing in a boom or bust market
- Nothing down for women: the smart woman’s quick-start guide to real estate investing An insider’s guide to real estate hot spots
- Rent to own: use your rent money to get started owning real estate
- The real estate entrepreneur
- Be a real estate millionaire: secret strategies to lifetime wealth today
If residential housing is not your cup of tea, you can always wait until 2008 for the release of How to retire fast investing in commercial real estate.
In June 2005, the nationally syndicated cartoon Cathy ran a humorous but truthful story arc in which the characters got hit with "sticker shock" while looking for a new home, and then went through the stressful process of buying a house.
Characters in the role of real estate professionals have appeared in movies and television series since these entertainment genres have come into existence. But few television programs or movies have focused on the buying, improving, and selling real estate as its central theme. Until recently, that is. There is a real estate glut on the airwaves and in film.
Among the crop of reality TV shows are The Apprentice (2004), in which contestants seek the opportunity to work for real estate icon Donald Trump; Extreme Makeover, Home Edition (2003), in which volunteers remodel or rebuild the house of a family facing hardship; The Adam Carolla Project (2005), in which the comedian fills in as contractor and carpenter on a housing project; Flip This House (2005), in which real estate developers rapidly turn eyesores into "profitable beauties"; House Hunters International (2006), in which buyers and their agents try buying real estate overseas; and one show not yet aired as of this writing but in the works is Real Estate Confidential (2007), which presents stories on successfully buying or selling a house.
Some recent documentaries and movies on the subject include House Hunters (1999), which "focuses on the emotional experience" of buying a home; Crazy Like a Fox (2004), in which victims wage war against evil real estate speculators; and Closing Escrow (2006), a comedy about real estate in which different couples try outbidding each other for the same property. If one wants to go back far enough, Glengarry Glen Ross (1992) is about the lives of high-pressure of real estate salesmen.
An acquaintance from a family of realtors recently joked that he was hoping this market bubble would pop, "so these TV shows will go away."
"I guess it's going pretty good…I love California."
Homeowner whose house value has tripled since 1997, L.A. Times, November 12, 2006
It's time for a trend change.
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