Financial Bubbles: Common Sense or Sophisticated Concept

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IrvineRenter_IHB

IrvineRenter_IHB

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On several of the other blogs, late buyers (many of whom are getting burned) are ridiculed as lacking in common sense. There is condescension among the bears that anyone should be able to see a financial bubble for what it is. I am not so sure. These things are always easy to see in hindsight, but they are difficult for most to see while they are happening. Does it take a fair degree of sophistication in one's understanding of financial markets to see financial bubbles, or is it just common sense?
 
<p>Irvine Renter:</p>

<p>The answer depends on what you mean by "common sense". If you go by the standard dictionary definition found on <a href="http://dictionary.reference.com/browse/common%20sense">Dictionary.com</a>, you could say that yes, people should have enough "native intelligence" to make a sound judgement on this issue of being able to spot a financial bubble from afar.</p>

<p>But common folk these days are barraged by sound bites, hearsay, advertisements and subliminal messages hiding beneath cleverly disguised statistics, "expert" opinions and public statements by major luminaries (including by our current <a href="http://www.whitehouse.gov/infocus/homeownership/">commander-in-chief</a>, and his equally clueless but paradoxically pragmatic <a href="http://www.presidency.ucsb.edu/ws/index.php?pid=51447">predecessor</a>, not to mention the much-maligned <a href="http://davidlereahwatch.blogspot.com/">NAR chief economist</a>). So it is not surprising that common sense among the public-at-large becomes clouded and manias and bubbles form as a result. We have been reduced to "<a href="http://www.bls.gov/cex/csxgloss.htm">consumer units</a>" by the government, corporations, and the media, and are easily manipulated into doing the wrong thing.</p>

<p>i.e., common sense, as we know it - is dead. Long live manias!</p>
 
<p>Inre common sense among the populace... I gave up all hope after the last presidential election. Before then, I was thinking "that was a mistake, but we will recover from it and heal soon enough."</p>

<p>Now I'm thinking "my countrymen have changed and I want the old ones back."</p>

<p>With this New Paradigm in Joe Sixpacks, anything is possible.</p>
 
<p>I vote for sophisticated concept. When it comes to the housing bubble, it's pretty hard to tell the difference between the good arguments and the bad ones if you don't have at least some training in economics.</p>

<p>"Why should rents and prices have anything to do with each other, I am not buying my home to rent it out! It's where I am going to raise my kids someday."</p>

<p>"Of course houses are getting more expensive in So-Cal. Look at how crowded it is. Supply and demand, right?"</p>

<p>"Even if they stop the exotic loans, most people can afford their mortgage. Since most people won't have to sell at a loss, prices won't fall much."</p>

<p>We all have heard real people we know say stuff like that. I gave a lot of pop econ books as stocking stuffer presents last month. Sure, you can understand the bubble without knowing economics, but it's much harder, and it's not that suprising that few have bothered.</p>
 
Maybe it takes some uncommon sense. Or maybe the memory of what it felt like to be upside down on a mortgage in '95 after putting 20% down at the top.



Markets function such that they make the most people wrong at the worst time. Or as Warren Buffett says, "Buy when others are fearful, and sell when others are greedy."



I can't tell you how many folks either told me I was nuts or would just give me a condescending look when we sold in Aug of '05. We will buy when there is blood in the streets.
 
<p>Disclaimer: I am not a "housing bull." Please don't yell at me.</p>

<p>One man's bubble is another man's trough. That's why it's not easy to see. Take the stock market. At any particular moment in time, there are bulls and there are bears. Some people were calling a tech bubble in 1995. They missed out on a lot of gains. In early 2000, there were others saying the market would double or triple. They suffered tremendous losses.</p>

<p>Right now, I think the stock market is overpriced. But am I going to sell everything and sit on the sidelines? Of course not. Why not? Because, over time, the best way to make money in the stock market is to stay in it. Market timing is incredibly difficult, if not impossible (see Warren Buffett and his teachings, often cited by bears as their mantra).</p>

<p>Same goes for other asset classes, like housing. I think a lot of the condescension towards housing bulls stems from the fact that the housing market has done so much better for so much longer than most bears predicted. If you are truly content with your belief that we are in a bubble that is bound to come crashing back to earth, then why get angry at people hyping it? I think the reason is that behind the anger lies frustration. Maybe not frustration at having "missed out," but perhaps frustration that the market is not completely rational and you cannot predict what it will do (or when it will do it).</p>

<p>Are houses overpriced right now? Probably. But I can't say for certain whether prices will come down (the housing bears all know with a certainty that prices are coming down, which I find disingenuous -- the market can stay irrational longer than you can stay solvent), and if so, when they will come down, and how far they will fall. That's why I think the best play in housing is -- assuming you can afford it and you're ready to live in the same place for the foreseeable future -- buy a house, and continue to own it for a very, very long time. Twenty years from now, the fact that the market went up or down 20 percent in a given year isn't going to make all that much difference.</p>
 
<p>"I think a lot of the condescension towards housing bulls stems from the fact that the housing market has done so much better for so much longer than most bears predicted."</p>

<p>There is probably some truth in that statement. As a bear myself I am willing to admit that the extreme irrationality of the market over the last few years has indeed frustrated and pissed me off a fair amount. This, along with the gnawing fear that my bearish position might be wrong, has pushed me to study the housing market and the current bubble very intensely. However now that I have studied it so much and pretty well understand what is going on I am no longer frustrated. Even though the exact timing is indeed nearly impossible to work out, I think it's become clear that the end result no longer admits to much serious doubt.</p>
 
Marty Mcfly - Yes the stock market is overpriced, and am I out? Of course I am. Except those times when I am short, and hopefully that will be when the market is trending down. I don't care how much money I supposedly don't make or miss out on. There is too much risk.





bigmoneysalsa - It is my opinion that you do not need exact timing to time the market. You have to able to identify an overall trend. For example; right now, is the housing market trending up or down?
 
awgee,





Hasn't this recent bull run in stocks been strange? The RSI reading for the DIA (Dow tracking stock) has been overbought for almost 3 straight weeks. I have never seen that before. Even in the strongest bull runs, prices take a breather. It particularly makes no sense given the slowdown in the economy. I would like to see some data on foreign money inflows. I suspect the deteriorating dollar is attracting capital from overseas.





I don't even attempt to forecast the overall direction of the stock market. There are too many variables and wildcards; besides, you don't have to to trade it profitably. I am like you in that I like to trade short. You make money faster that way.
 
Hi IrvineRenter - Will others get upset if financial bubbles from the title includes stock or other asset class markets? I am a newbie here and am feeling my way around.<p>

Agreed DIA is extremely overbought and I had to sell some DIA puts for a slight loss; part of being a short seller I guess. Even it if takes a breather, it could take off again. The liquidity is coming from Treasury Dept t-bill sales and Fed repos and yen carry trade and Swiss Franc carry trade. And the second tier borrowers are using these funds to leverage up on "investments". The second tier looks to me to be hedge funds, those labeled as private equity, and some of the larger banks, even though they are also first tier. I see no reason for the yen carry trade to stop as the Japanese central bank is giving no signs of seriously increasing their interest rates. The biggest chink I see is the Shanghai stock market. The Chinese central bank is concerned and they may put a kibash on the outrageous speculation there or the Shanghai market could just exhaust itself. If either happens, my short orders will be in before US markets open that day. Actually, I see the exhaustion of the Shanghai market as inevitable, but there is no way that I know of to know when that will be. If the world markets crumble as a result of Shanghai, which I see as entirely possible and maybe even likely, the de-leveraging of the derivatives and stock markets and the unwinding of the yen carry trade will create a rush for cash that I think none of us can comprehend. The highly leveraged over the counter derivatives market is three times the size of the US GDP and as large as the world GDP; something like 400 trillion dollars. There is no way to know what effect a meltdown of this size could have. Buffett refers to over the counter derivatives as financial WMD. And for some Irvine housing blog pertinent info, the present mortgage market was built from the supposed risk reduction provided by the derivatives market. I say supposed, because at $400 trillion dollars, it seems logical to me that if anything, another layer of risk has been added instead of subtracted. I speculate that if the holders of CDSs and everything else written against the CDOs and MBSs cannot fulfill their obligations, which to my thinking is very probable because the holders used their payments as capital to leverage, the derivatives market will meltdown, and the mortgage market will literally dissappear. Yeah, it all sounds a bit nutty, but when I say dissappear, I mean dissappear. There will be no money to lend. How long would it take the Fed to get liquidity pumped into the financial system? I have not a clue. Normal channels, lending to member banks, might not work because they might not want to lend and there may be no takers of loans if they did. Wow! I just went back and read this, and it seems like a nut job wrote this, but oh well, it is really what I think.
 
<p>Been there, done that, with short/long stock. It's no different than gambling. Eventually, you end up in the poor house!</p>

<p>I am seeing foreign money going straight to real estate purchase of high-end homes. Mostly in the form of parents/grandparents purchasing homes for their children. The thinking here is why not give while you are alive.</p>

<p>We really need to think globally and understand where buyers are coming from. I am frustrated as you bears as well as I would like to increase my real estate holding; however, properties I like to own are not even dropping in price yet.</p>
 
Sophistication? Common sense?





I put my money on good parenting. "Huh?!" you say.





Some parents are very clear about religious beliefs. Even fewer are clear on what a penis and a vagina is for. Even more fewer (correct grammatically?!) sit their child or a community child down and say, "This is a checkbook, this is how you balance it. This is a good way to value a stock, this is an A share, a B share. This is when you should buy a home, this is when it is too expensive" and so on. I find this ironic as many more divorces end over more than sex and religion combined. 4/3 of the world sucks at math. =) I wouldn't expect half of all homebuyers to have any idea what a P/E ratio is, let alone know what it means, where to find it, how to compare. Maybe half is too high. That being said, yes, I think it requires a bit of sophistication. Yes, I think there is condescension, and rightfully so for the other sophisticated people who can't see it the crater among the hole in the ground. For those not so sophisticated, I think that it important to be clear without flamboozling them with math or prognostication. People are smart, their parents just didn't sit them down.
 
Foreign money is not going straight to real estate purchase of high end homes. Foreign money is not stupid and foreign money knows that US re is depreciating the the dollar is tanking.<p>



All properties at every price point are dropping in price. Every time you say they aren't, you lose credibility. The folks in here aren't stupid. They can read the news and so can foreign money.
 
"Does it take a fair degree of sophistication in one's understanding of financial markets to see financial bubbles, or is it just common sense?"





Much as it would like to be otherwise, economics is a social science, not a science, because it deals with less than rational actors. I probably should not have bought when I did (in 2002), but my income, home prices and interest rates all jived at that point in time to make it work - and it put me much closer to work (sadly, only temporarily).





Sometime in 2004, I started to realize that there was a liquidity bubble and that it was driving the rapidly increasing prices. I don't know how I came to that realization, but I did.





I also know people who bought last year because mentally, they were just ready. They were either newly married or tired of being in an apartment and ready to move into a space of their own. Not everyone always of thinks of money first. Heck, we were ready to put a low ball bid on a place last November - and we knew better! That said, we were in for the long haul. Whatever we buy next, will, absent a radical change of circumstance, will be our last place ever.





That doesn't really answer your "this or that" question, but at least provides you a data point.
 
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