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February 7, 2008 by Gary North, Ph.D.
Why do buyers do this? Because they have missed out again and again by offering less than the listed price. The buyers who offered the listed price bought the house.
Then the panic escalates. Those offering the listed price get left behind. They wait too long. "Too long" means more than one day after the house comes on the market. They hesitate. He who hesitates is lost in a seller's market.
Then panic appears. A group of buyers will line up in front of a property before it officially goes on sale. The list price is merely the minimum bid in what soon becomes an auction. In an auction, buyers overpay. They become frantic that they will miss out again. The presence of other bidders makes them desperate. They think: "This is the last time I will be able to buy. It's now or never." This is always wrong. They are in fact buying at the peak. This happened in Southern California in 2005. It happened to town houses in the Washington, D.C. area in 2006. In March, 2006, this story ran in the Washington Post: "Median Price Breaks $400,000 Barrier."
That was the end. Toward the end of the article, the report offered this bit of information.
It was not a statistical artifact. It was the end of the bubble. In late September, 2007, the Post reported on a very different market. Sellers were not lowering prices, buyers were biding their time, and homes were not selling. In that region of the country, income comes from American taxpayers. The flow of funds into the region rarely slows. Federal hiring never ceases to grow. So, sellers are not desperate to sell. But they are stuck inside their houses. Buyers are not being stampeded. This has not been the case in California, Florida, and Las Vegas. There, foreclosures are steadily motivating sellers to come to terms emotionally with the new conditions. When a home owner is forced to move, he leaves his home empty. That is a tip-off: "Motivated seller." Then more For Sale signs appear. The motivation increases. Sellers rarely admit to themselves that they made a mistake, that they should have sold in 2005 and rented. They pretend that their home is different. Why? Because they own it. They think this makes a difference. But the home isn't different. What varies is the degree of desperation of the sellers. In some regions, home ownership is still sound policy. But that policy is going to be less and less sound, depending on the size of the house and the demographics of the neighborhood. If jobs in a recession dry up, real estate will fall. A WORLDWIDE MANIA IS ENDING It was not just Greenspan's Federal Reserve that pumped new money into the housing market. All over the industrial West, central banks inflated. The commercial banks then imitated the United States and extended credit to real estate buyers. The whole world became subject to the carry trade: creditors who borrowed short to lend long at higher interest rates. Residential real estate has for a century been the carry trade of preference for lenders. In the United States, this has been especially true because of subsidized FDIC and FSLIC insurance programs that guarantee depositors' accounts. Now the real estate carry trade is unwinding. It has a great deal of capital to unwind. Trillions of dollars and other currencies have been funneled into residential real estate. New credit extended to this market is going to decline. There will be fewer buyers making offers. Housing prices, as with all other prices, are set at the margin: the latest exchange between buyer and seller. What conceals this is the difference in markets: locations, income levels, and expected opportunities. It is not like the commodity futures market, where the products are tightly defined and interchangeable. In Amsterdam, Prof. Piet Eichholtz, a real estate professor at Maastricht University, has been using records of house prices on the canal to trace the rise and fall of booms and busts. He has traced this back 350 years. There are few time series more comprehensive in the literature of economic history. Professor Eichholtz has come up with a non-spectacular thesis: bubbles always burst. He has studied more than just the price moves on the Amsterdam canal. He has been following world real estate price movements in recent years. He concludes that we have been in the midst of a worldwide bubble. It has now reversed. We should prepare ourselves for double-digit price declines in housing. These declines will be even greater in countries with falling populations. This includes South Korea, Japan and Eastern Europe. America's professors Shiller and Case take Prof. Eichholtz's studies seriously. In 2005, in his book, Irrational Exuberance, Prof. Shiller cited Eichholtz's work and warned that the real estate bubble was close to the end. It was. Prof. Eichholtz's assessment is today very grim.
When someone has the bulk of his capital tied up in his home -- a consumer good, not an investment asset -- and he finds that he has suffered a 30% loss, this will affect his plans. His confidence about the future will decline. His plan to live inside his capital base until his death, with his widow inheriting it and living there until going off to a retirement facility, is called into question by a 30% fall. Because this mania has spread to many nations, the slowdown will hit them all. This is going to hit with varying intensity, nation by nation. The home-owning public will react differently. Where the recession is most likely, such as in the United States, the decline will be sharper and sooner. It has already begun. Where there has been less speculation and homes are owner-occupied, the decline will be more gradual. WHEN REALITY INTRUDES Reality is what happens whether you believe it or not. Reality is now intruding into the housing markets. People had better re-think their plans. A change is coming to the American political scene. In my April 4, 2002 issue of Reality Check, I wrote:
The future is now. The presidential administration is now on its way out. It is under a cloud economically. Bernanke's FED gave us tight money policies. It looks as though the FED has now reversed. But this is too late to avoid the recession that almost everyone denied last December. It is going to hit the economy before the voters go to the polls. They will vote their pocketbooks. They will demand change, meaning economic recovery, meaning higher price inflation. If their homes are falling in price, their ability to refinance will be limited if they refinanced within the last three years. Their equity is lower today: falling prices, more debt. The use of home equity as a credit line is still possible for people with good jobs, high credit ratings, and lots of home equity. But this is not the average American's position. In August of 2003, I reported on the warnings of Richard Benson regarding the coming crisis of the real estate industry. His warning concerned the inability of the government-sponsored enterprises Fannie Mae and Freddy Mac to sustain the bubble they had jointly created. His warning was too early. So was mine. But the scenario he described then has now surfaced. The accounting scandals at Fannie Mae and Freddy Mac erupted in 2004. Here is what Benson wrote in 2003.
He cited a report from Franklin Raines, head of Fannie Mae, on the rotten accounting procedures of Freddy Mac. But it was Raines who got the axe. He announced his retirement in December, 2004, under the cloud a suspicion regarding accounting practices. In 2006, he was sued by the Office of Federal Housing Enterprise Oversite, which regulates Fannie Mae. Why? The OFHEO said he had been given payments of $84.6 million on the basis of vastly overstated profits. He had previously served as the head of Clinton's Office of Management and Budget. The leverage problem is still there. This is being threatened by the defaults in the subprime mortgage market. The equity of both organizations is declining. HOW CAN YOU PROFIT? In May, 2004, I presented my case for avoiding a major loss. I also described how to profit. I wrote:
I was a year early. But, generally speaking, the person in Los Angeles or Boston who did what I said is ahead of the game today. If he has equity money in reserve, he is going to be able to buy at substantial discount before this cycle is over. CONCLUSION Optimists think this housing market is going to reverse in 2009. I am not among them. This is an international phenomenon. The decline in on-paper wealth is going to shake the confidence of hundreds of millions of home owners. I suggest that you prepare for an international economic slowdown. The people who thought they were real estate rich are going to face a new reality: rising property taxes, rising expenses, rising utility bills, and declining equity. This is not the scenario for bull market investing. Dr. Gary North earned a Ph.D. in history and is one of America's keenest economic analysts and commentators. He supports the Austrian school of economics and is a previous assistant to libertarian congressman Dr. Ron Paul. Visit his website at http://garynorth.com. To subscribe to Gary North's Reality Check go to http://www.dailyreckoning.com/sub/GetReality.cfm If you enjoyed this essay and would like to read more of Gary's writing please visit his website at http://www.garynorth.com or http://www.freebooks.com
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In
the midst of local house-buying manias, the classic
mark of the end is when buyers line up to buy a
house and bid against each other. This is the best
way to sell a house and the worst way to buy
one.
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