I can remember fondly the days when the word “bubble” was rarely used in reference to anything but chewing gum and soap. My husband and I had a sizeable chunk of money in tech stocks and we were raking it in without lifting a finger. It was the “new economy” where tech stocks were going to moon – no matter that the underlying businesses weren’t even making profits in some cases.
(Anyone recall Pets.com by chance?)
But in early 2000, I started to feel a bit uneasy about the stock market, though the “talking heads” on television couldn’t have been more positive. Just a little research convinced me that we were in some kind of an investing bubble and it looked liked it was close to popping.
We had already lost a few hundred dollars as the pendulum started to swing in the other direction for our investments when we took a deep breath and made the hard decision to liquidate all our stocks in the summer of 2000. We took out every single penny despite the curious looks from family and friends. My husband’s co-workers shook off their comparatively small losses and laughed at our “paranoia” chanting mindlessly, “it will bounce back,” as their investments dropped down, down, down… well, you know the rest of the sad story.
Though we managed to escape the dot.com bubble in the nick of time, many were not so lucky and our economy was hit hard. Fast forward to today and it seems we’re in the same mess we were before, except now with real estate. Hadn’t we learned our lessons about bubbles already? Why didn’t the government do something to stop this? Why didn’t anyone warn us?
You may have missed this particular warning from The Economist Magazine in a 2005 article:
“Never before have real house prices risen so fast, for so long, in so many countries. Property markets have been frothing from America, Britain and Australia to France, Spain and China. Rising property prices helped to prop up the world economy after the stock market bubble burst in 2000. What if the housing boom now turns to bust?
“According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries’ combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America’s stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.
“The global boom in house prices has been driven by two common factors: historically low interest rates have encouraged home buyers to borrow more money; and households have lost faith in equities after stockmarkets plunged, making property look attractive. Will prices now fall, or simply flatten off? And in either case, what will be the consequences for economies around the globe? The likely answers to all these questions are not comforting.
“The increasing importance of house prices in the world economy prompted The Economist to start publishing a set of global house-price indices in 2002. These now cover 20 countries, using data from lending institutions, estate agents and national statistics. Our latest quarterly update shows that home prices continue to rise by 10% or more in half of the countries (see table). America has seen one of the biggest increases in house-price inflation over the past year, with the average price of homes jumping by 12.5% in the year to the first quarter. In California, Florida, Nevada. Hawaii, Maryland and Washington, DC, they soared by more than 20%.”
As The Economist points out, the government actually created the perfect environment for a real estate bubble. Their response to a slowing economy, hit hard by the dot.com bubble, was to loosen lending as much as possible and this, my friends, created yet another asset bubble as a result. Except our houses became the new dot.coms, the new “fail-safe” make-oodles-of-money-hand-over-fist-guaranteed scheme. And it worked for a lot of people who got in and got out. But many of you got in too late and too deep. And some of you who bought prior to the explosion are now wondering – just like my husband and I did back in 2000 – should I take the money and run before – poof! – it’s gone as quickly as it came?
Last year, the PBS television news show, NOW, interviewed UCLA Senior Economist Christopher Thornberg, who described in simple terms just how an investing bubble occurs by using the .dom crash as an example:
“A real estate bubble, or any asset bubble is not a situation where you hear a pop. Everyone always associates bubble with a pop. They think, gee, if there’s a bubble, there must be a pop! coming at the end. That’s not what a bubble is. A bubble is when the price of an asset becomes misaligned with the fundamentals that truly determine the price of that asset.
“Let me give you an example of what I’m talking about here. Amazon dot-com — let’s go back to the NASDAQ days. At one point in time, Amazon was worth $180, $190 a share. The big question is: was that stock worth $180, $190 a share? Well, what determines the price of a stock? It’s the net present value of the profits that accrue to that stock in the future. That’s what we teach our MBA students. When they buy that stock, you’re buying a share of the profit stream that comes from that company today and in the future. Some bright economist at one point in time, sat down and said, “Well, gee. What if Amazon dot-com captured 100 percent of the DVD, book and CD market in the U.S.? Would they ever make enough profits today or in the future to justify a share price or the market capitalization implied by the share price of $180, $190 a share?” And the answer was no way.
We’ve all witnessed the housing buying frenzy during the past several years. During that time, an unprecedented number of Americans became homeowners and second homeowners. Almost a third of all loans were variable interest rate loans and a sizable chunk required no money down. Hundreds of thousands of Americans jumped in thinking the housing boom was going to last forever. But what we’re learning, the hard way, is that it can’t last forever because it was a boom built on loose lending, easy credit, and a psychological fervor that is unsupported by the true fundamentals, as Mr. Thornberg reiterates.
Homes typically don’t make you rich; they usually just keep up with inflation over time while putting roof over your head and nice place to relax after work or have dinner or display your Star Trek memorabilia, or whatever suits your fancy.
Remember the tech crash; you’ve seen the psychology of a popping investment bubble play out before. As more and more people catch on, more cash out, until momentum grows and everything crashes almost all at once.
I’m just glad that I’m watching the crash as a renter.
Best,
Mels
