Tag Archives: Real estate bubble




I’ve often compared Japan’s two decade malaise to the current recession occurring in the USA.  I’ve pointed out a few distinct differences though.  First, this is a household balance sheet recession in the USA whereas Japan suffered from a business balance sheet recession.  Second, the USA has been much faster to respond to the crisis.  And finally, the USA is not suffering from the double whammy that is an equity bubble AND a real estate bubble on top of one another.  Instead, the USA has had their dual bubbles spread out over an entire decade.  For these reasons, I think it’s reasonable to argue that the aftermath in the USA is not only likely to be shorter, but less severe.

In a recent story, FT Alphaville cited a Nomura research report which elaborates on this thinking.  Remember, the balance sheet recession in the USA is largely a real estate phenomenon – not entirely, but largely.  So, it’s no longer “so goes GM, so goes the USA”.  It’s “so goes housing, so goes the USA” (generally speaking).   Nomura points out a very important distinction between Japan and the USA:

“In the second half of the 1980s, land price fever gripped the Japanese archipelago: residential land prices in the six major urban areas rose by 169% in the five years before they peaked in Q3 1990 and fell by 66.5% before bottoming in Q3 2005; commercial land prices in the six major urban areas rose by 275% in the five years before they peaked in Q3 1990 and fell by 87.2% before bottoming in Q3 2004. In contrast, the Case-Shiller Composite-20 home price index rose by “only” 78% in the five years before it peaked in April 2006 and fell by “only” 31.8% before bottoming five years later.”

So, in terms of the ways we like to think about bubbles, I would argue that the disequilibrium in the US housing bubble was less extreme, therefore, the aftermath should be expected to be less extreme.  I guess that’s some consolation in this horrid economic environment.  Less bad is good, right?

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Can the United States thrive with another decade long decline in home values?

The impending slow motion doom for housing – can the United States thrive with another decade long decline in home values?.

The real estate market is destined for a slow and painful adjustment for the upcoming decade.  Thedemographic shift and also the reality that the current generation will be poorer than the baby boomers will make it difficult to sustain home values even at current levels.  Our economy is largely driven by the financial sector and their asset of choice is real estate.  Yet we are running out of options when it comes to keeping real estate values inflated.  We’ve tried artificially low interest rates with the Federal Reserve buying up mortgage backed securities with no natural market demand.  We’ve tried tax credits.  We’ve even tried ignoring homeowners who miss mortgage payments as a method of artificially keeping supply low.  Yet home prices continue to move lower in tandem with lower household incomes.  Home prices in the U.S. are now back to 2003 levels painfully retracing a decade long boom.  But as we are now realizing, no amount of financial engineering can come up with a free lunch.

Where the bubble lives

It is hard to believe that many large metro areas in the U.S. still sustain incredible housing bubbles:

price to income ratios metros

Source:  Department of Numbers

I think one of the largest conscious mistakes committed during the housing bubble was that of decoupling home price gains from real household income gains.  Everything was focused on the supply side.  If you built enough homes and you provided enough credit people would be willing to buy.  This of course played out but was absolutely unsustainable and once the psychological mania ran out of fumes, the market came crumbling down.  As the above chart highlights many areas have price-to-income ratios that are much higher than five.  Three of the top four most overpriced metro areas are in California.

Just because people continue to buy does not mean there is no bubble.  Bubbles pop in uncontrollable paths.  As we are seeing, Greece is merely the first domino to fall in the perpetual debt machine of modern society.  Yet Greece is not alone.  Ironically countries that have defaulted on their debt (i.e., strategically default) have seen growth only a few years later:


Take a look at Argentina that defaulted on its commitments at the same time we jumped into our housing bubble.  Greece might want to look at South America before making a large commitment to the banks just like Ireland did.  The only reason I show the chart of Argentina is that Greece’s best bet may be to default and get their house back in financial order instead of saddling a generation with debts that will only go to payoff large banks.  If they get their act together money will flow back in (just look at Iceland as well).  The Federal Reserve is ultimately trying to keep housing prices inflated not because of good will to the people but because the banking system would be insolvent if we had to use a basic accounting rule of mark-to-market.

So far the Fed has gotten its way and this is the outcome:


Home prices across the nation are back to 2003 levels.  As painful as this is, household incomes are stuck in the late 1990s so why should home prices be any higher?  Ultimately people pay for their monthly expenses from a paycheck.  To think that the world facing dramatic challenges like European debt issues or a real estate bubble in China that access to capital will remain cheap is somewhat naïve.  It is only a matter of time that things adjust.  Keep in mind that the only reason mortgage rates are at this level is because the Fed has purchased over one trillion dollars in mortgage backed securities.

People have a hard time visualizing two lost decades in housing values but Japan has been living in this scenario:

japan real estate

Run a quick check list between the two asset bubbles:

-Real estate prices outpacing income gains (check)

-Stock market bubble in connection with housing bubble (check)

-Central bank bailing out too big to fail banks (check)

-Bailouts only create zombie institutions yet prices continue to fall (check)

-Interest rates remain artificially low (check)

-Squeeze on most household incomes (check)

-Quantitative easing (check)

There are a lot of similarities and the paths we are following are similar.  Some will point to low interest rates in Japan as a sign that we will have low interest rates moving forward.  Not necessarily.  The U.S. dollar is the dominant reserve currency.  Have you seen what is going on in Washington about the debt ceiling?  Both political parties are out to lunch so how does this instill faith around the world?  It really doesn’t and our central bank is being looked at more closely by more and more people.

Preconceived notions can and do fall hard.  Some of you may know the story of the Salton Sea here in Southern California:

salton sea

The creation of the Salton Sea as we know it today was created in 1905 when heavy rains and overrun from the Colorado River poured into the Alamo Canal.  The sudden influx of water and the inability to drain water caused the sea to form.  In the 1950s, there was an attempt to make this area into a resort town and it actually enjoyed relative success during this time.  Real estate speculators rushed in.  Of course none of this materialized and it largely became an environmental challenge.

On the surface, success did seem possible.  After all, Los Angeles and Orange County were being built out so why not go out a few hours more?  It made sense on paper but of course that isn’t always how things play out.  We are experiencing this with our housing market.  An entire generation has never seen year-over-year nationwide home price declines outside of this housing bubble.  The mantra “real estate never goes down” did hold some truth before this crisis in the minds of many.

If we look at housing starts, we are still scratching the bottom of the barrel:

housing starts

Those that are most sensitive to market changes in terms of building houses are seeing no need to build more homes.  Given demographic shifts and the 6 million homes in the shadow inventory we are assured plenty of supply for years to come.  But the real question centers on the ability of households to increase income which we have no evidence for because this comes from a large growth in good paying jobs and not burger flipping service sector work.  We are seeing price increases in food, energy, and other items that have a global market.  But real estate has to be consumed locally.  When Japan was booming in the 1980s many thought that all of Hawaii and California would end up in the hands of Japanese investors.  How did that turn out?  Many were only interested in tiny boutique areas and not mid-tier areas like Culver City or Pasadena.  Today memory has forgotten that time just like many speculators in the 1950s thought the Salton Sea would be a boom like Palm Springs.

Get comfortable for the next decade because home values will not be going up.

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