Thursday, January 05, 2006

Is the Sky Falling?

The real estate cycle is turning. How bad will the bust be?

Busts are always a function of the excess that precedes them. The greater the excess, the greater the bust. The classic example is the Great Depression which followed the roaring twenties. In the 1920s we had wild speculation in stocks. The resulting bust was deep.

While the Great Depression was terrible, it need not have ever been so bad. The Fed followed a severely restrictive monetary policy in response to the stock market bubble in order to “squeeze the excess” out of the economy. Unfortunately, they turned a serious downturn into a supreme disaster.

In the 1990s we had a similarly risky scenario in the wake of the housing bubble of the 1980s. In response the US implemented stimulative policies and we averted the disaster. At the same time Japan followed the restrictive policies of the same type that we had foolishly used during the 1930s, and they have suffered a similarly disastrous result.

Such severity will not happen here again unless we restrict the money supply too severely. So far the Fed has avoided that blunder, at the expense of some overheating.

The prolonged real estate bust of the 1990s followed upon extreme excesses in the 1980s, the worst of which we have not yet seen this time. Remember that the Savings and Loan Crisis of the 1980s started about four years before the real estate market peaked. We had many savings banks already going insolvent at least three years before the real estate market peaked. The market was so bad in the 1980s that the Federal S&L Insurance Corp. was also declared insolvent – TWO YEARS BEFORE the real estate market peaked. And the bubble marched on.

After four years of financial collapses by banks, builders and property owners, the Federal government created the Resolution Trust Corporation to engage in an orderly disposition of all the troubled assets. That was during the very same year that the last of the major bubble markets peaked (1989).

We have not seen any of these severe symptoms in this cycle. If we do it will take several more years of such continued excess to get just as bad. Pray that it never happens. Fortunately, it looks like this cycle will end before any of these really severe excesses occur.


At January 27, 2006 5:08 AM, Anonymous Anonymous said...


Your assertion that "We have not seen any of these severe symptoms in this cycle with regard to the real estate bubble" is highly presumptuous and very misleading. Are the "symptoms" you mentioned the only warning signs possible? And since when does history exactly repeat itself?

What about the fact that most of the exotic mortgage RISK has now been transferred from those S&Ls and banks to Mortgage-Backed Securites holders and the GSEs? If the S&Ls, banks and other lenders these days hold very little of the paper they originate, then of course there will be no preceding bank failures. They are simply not assuming most of the risk this time around.

You have also selectively chosen to ignore the massive scale of real estate speculation currently acknowledged BY THE NAR ITSELF, as well as the historically massive levels of mortgage & HELOC debt consumers have piled on in recent years. You have presented little in the way of compelling factual evidence that the real estate bubble implosion will not as severe as the previous cycle, and instead rely upon such false causality as, "massive bank/S&L failures haven't yet happened, ergo, no bubble".

Next time, I recommend perfoming a little more research before presenting an ill-informed opinion. I recommend perusing the following sites:

At January 28, 2006 12:58 AM, Blogger zephyr said...


I have reviewed those sites and many many other sources. The sites you list are interesting discussion forums for the average person. is more diverse and very casual in its discussions. Thehousingbubble2 is a news aggregator and discussion board on the RE bubble – no professional analysis there, and the information is filtered to only present the negative view. Piggington’s is written by a computer guy who has decided to claim expertise in real estate and economics. He is getting better with time, making fewer fundamental economics errors than before... but his lack of expertise shows to the trained eye. Themessthatgreenspanmade is nicely done especially considering the writer is a computer guy and not a finance or economics expert. CalculatedRisk is the only one that you listed that has real economic analysis by someone with actual expertise in the subject. It appears that his background is similar to mine. I enjoy reading CalculatedRisk and many other similar sites and other sources every day.

As for my analysis, I have not ignored the speculation or lending abuses taking place today. These factors will be important in the cycle dynamics. However, during the last cycle these excesses were also present and were already causing rampant bankruptcies well before the cycle peaked. Such financial system distress might happen in this cycle as well – but it has not happened yet.

The last cycle got as bad as things are today several years before the peak. This cycle could become comparably severe if it runs hot for a few more years.

At January 29, 2006 7:15 PM, Anonymous Anonymous said...

Hello Zephyr,

I tracked you down. Thanks for posting your link in the other website so I could find you here.

Impressive track record on investing, I've been actively investing for the past 3 years and I haven't been able to beat 20%.

This year I am making out very well based on investments made last year, well over 25% in dollar terms. In gold terms, I'm actually losing. But I'm losing less that others, so I guess that is gaining. I hate calculating value in a FIAT currency regime.

In the other blog (I think, you posted that gold is a bad investment. I wholeheartly agree. Gold is an investment when you fear total colapse. A rise in gold is either speculation, or a sign that everything is losing value. I suggest you plot the price of gold over the last 35 years. You can calculate the statistics between gold bulls due to speculators, predicting recessions/colapses, and both. What you will find will scare the crap out of you when modelled on todays gold prices versus other market indicators.

I use a Baysean approach at investing. I've tried to remove emotion from the equation, but it is quite difficult. I know that markets are corrupt, imperfect, but Baysean reasoning works even under very poor assumptions.

Recently, though, things are very out of whack on several levels. Which is why I have decided to take my money off the table.

Where do you find your source of optimism on todays market? Do you look to your own historical models of markets during crashes based on experience?

One more question. How do you currently model "Value". Is it purely intuitive, or do you have a base measure to a collection of weighted assets (Do you use the goverments CPI index for example?).


bio -- I'm currently in my early 30's. I pursue investment as a hobby. My current job is research.

At January 31, 2006 12:32 AM, Blogger zephyr said...


I am optimistic for the longer term, but I expect asset value declines in the near future.

Things are not as out of whack as they will soon become. I have not taken any money off the table yet.

I have looked at the long term charts for gold. With the exception of a few good years, gold has been a loser for decades. The current recovery is small compared to the value lost over the last 25 years.

While I do have investment models and standards that I follow, I do not use sophisticated investment strategies. I look for value and buy for the long run. I rarely trade and have only exited markets at selected key times.

I do not try to search the universe for investments. Instead I take a focused approach and work within areas where I have depth of knowledge. Real estate has been the best performing sector for me.

I tend to agree with the advice of Andrew Carnegie:

“The way to become rich is to put all your eggs in one basket, and then watch that basket.”
-- Andrew Carnegie 1835-1919, American Industrialist, Philanthropist

At February 01, 2006 1:35 PM, Anonymous Doctorwho said...

All of those blogs mentioned in the first post are daycare level food fighting and faux analysis, save calculated risk.

I agree with the Carnegie quote, but only because that has been how I have accumulated wealth, so I am biased. Others have done well through diversification.

For anyone looking for job security these days, I agree good luck, but I do believe there still is the old fashioned way of generating revenue for your employer - be a money maker. Not too many of those drawing UI bennies.


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