The Cause of All Busts

Submitted by Rich Toscano on November 20, 2006 - 4:25pm

Last week we determined that San Diego's early-90s housing downturn was not caused by unemployment, as it is ubiquitously believed, nor by interest rates.

Yet the price of a typical single family home price fell by 17 percent between 1990 and 1996. A price decline of that magnitude and duration must have had its cause in something. And it did -- but that primary cause was not external to the market itself, and it wasn't anything that took place during the downturn.

The housing bust was the inevitable result of the housing boom that preceded it.

A speculative bubble took place in the late-1980s San Diego real estate market. For a brief peak at some evidence, consider the accompanying chart of San Diego home prices and rents in the half-decade leading up to 1990.

read more at voiceofsandiego.org

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Submitted by MonkeyInChief on November 20, 2006 - 5:10pm.

This post would benefit from adding a companion graph (or perhaps just extending the time scale on the main graph) showign the gap between rents and prices narrowing in 1990's.

While I agree with the argument that fundamental reason that of the early 1990s was that prices were too high (relative to rents and other factors), events like interest rate jumps or unemployment increases are often the catalyst that causes prices to start to fall.

Submitted by sdcellar on November 20, 2006 - 6:48pm.

MonkeyInChief-- As Rich's earlier posts show, neither interest rates nor unemployment appear to be the catalyst for the 90's decline.

Perhaps it's easier to think of in the context that nothing goes up forever. Eventually, things come down for no other reason besides gravity and the way the world seems to work.

It can happen all by itself one day when a guy says "how would you like to buy this super swell condo for $600K?" and the other guy says "are you out of your frickin' mind?"

Nobody needs to lose a job or have interest rates to go up in order for this to start happening with regularity.

Submitted by MonkeyInChief on November 20, 2006 - 6:58pm.

There's a half point jump of Rich's interest rate graph for 1990 right as the market peaks. There' a likely a bit of lag to the jump in interest rates to the effect on sales prices due to rate locks in advance of closing. Rich also says "Unemployment appears to have been a contributing factor but not the primary one."

I don't think the explanation that buyers suddenly woke up and decided housing was over priced is 1990 is either very satisfying to most people or entirely correct. There was definately going to be a bust because the real was over valued. The exact timing of bust is likely due to secondary factors: unemployment, interest rates, drop in consumer confidence, etc.

Submitted by sdcellar on November 21, 2006 - 12:52am.

It can (and has) been argued that a short term rise in rates can increase buyer urgency. Regardless, the rates go right back down and either way, I see no real effect on prices (at least not that I can see) as they just keep going down.

As far as the particular comment regarding unemployment being a contributing factor, I believe Rich might have meant over time and not as the actual event causing the downturn. The graph certainly doesn't point to unemployment being the trigger.

I'm not sure why you find it hard to believe or unsatisfying that a downturn can be caused soley by the boom that precedes it. All things being equal a boom will bust if the fundamentals aren't there to support it (in this case, exceeding income and other housing choices).

I'm not saying secondary factors can't influence these things or timing, just that they are entirely unneccesary.

Sorry, but some people do just wake up one day and say "I'm mad as hell, and I'm not going to take it any more." Oh wait, I'm mixing metaphors or movies or something...

Submitted by powayseller on November 21, 2006 - 6:39am.

MonkeyInChief, I think there was likely a catalyst, but we just don't have the data, or Rich would have shown it. There aren't any ways to measure buyer exhaustion and negative psychology.

If it happened like this time, it would go like this: Buyers were exhausted from high prices so they either stopped buying or started leaving San Diego. By 1991, 6600 people left San Diego, and by 1993 it was 50,000. When people leave, prices drop. (Don't have population exodus data prior to 1991.) Of course, that population decline was probably due to the military layoffs, but some could be due to people looking for cheaper places to live.

With the first time buyers priced out, and the move-up buyer leaving town, we broke the chain of sales. In every real estate transaction, there is a chain of people involved. I sell my starter house for a bigger house, and that person buys a bigger house and the next person downsizes to a condo, and that person buys another house, etc. When people in the chain move out of town and are not replaced, they break the chain.

With population declines, real estate goes down in a hurry. It's all about supply and demand.

A year or two after prices fell (median fell 1-2 quarters before job losses began but median is lagging, so prices were most likely falling several quarters earlier), San Diego experienced military and defense job losses, causing higher unemployment and more population decline. This further skewed the supply/demand imbalance.

Once inventory rises, buyer psychology shifts. People become reluctant to buy, as they notice others are having a harder time selling. Foreclosures just make it worse.

Submitted by no_such_reality on November 21, 2006 - 10:35am.

I'd have to agree with MiC, extending the graph through the 90s would be highly enlightening for the price apologists.

If you add the hypthetical 30 yr mortgage payment to the chart compared to the hypothetical rent, I suspect you'll see the lines cross in the '93'94 range and remain that way until 97'98.

If someone points me to a decent source of the data, I'll gladly build the charts.

Submitted by analysisguy on November 21, 2006 - 11:49am.

Today’s report on San Diego has been released!
Local Home Price Analysis

Submitted by no_such_reality on November 21, 2006 - 12:19pm.

Now that I've seen SD, I would like to see OC and Riverside/SB.

LA looks more tempered than SD so I wonder if that is just size or income distribution.

I wonder how much of SD/OC/Ventura is tail of the dog being wagged.

Submitted by guy1 on November 21, 2006 - 3:48pm.

If I may jump in here, I have to question the 17% drop from 1990 to 1996. Prices degraded significantly more than that. I can name specific properties in Newport that were cut in half. I am no statistical expert, but I am quite suprised to see only 17% decline on the typical home. Confusing. Second, I would add, that a great deal of the price fall was due to pure speculation in the build up. Everyone became a builder/developer. Your neighbor, sister, wife. And they all owned multiple properties purchased under fraudlent mortages (sound familiar). By the way, you will recall, some people were prosecuted. When the market topped out, these people were holding cash hogs that were sucking them dry. They all sold in desperation. After that, I guess your staticstics take over, unemployment, interest rates, ect.. How History does repeat itself, I hope it happens again.

BW

Submitted by jg on November 21, 2006 - 3:57pm.

Analysisguy, thanks for the San Diego data and analysis, and keep up the fine work.

Outstanding work on laying out the run-ups and downs, deflating such, and laying out the three scenarios (the last one is the one that I think will happen).

C'mon 57% drop!

Submitted by FormerSanDiegan on November 21, 2006 - 5:10pm.

If I may jump in here, I have to question the 17% drop from 1990 to 1996. Prices degraded significantly more than that. I can name specific properties in Newport that were cut in half. I am no statistical expert, but I am quite suprised to see only 17% decline on the typical home.

Statistics are composed from a composite of samples or a sample set. In any statistical measure (mean, median, median per square foot, etc) there are samples that are above the measure and samples that are below the measure. As human beings we tend to latch ourselves to the outliers since they are more memorable.

Submitted by fencewalker on November 22, 2006 - 10:47am.

"...As human beings we tend to latch ourselves to the outliers since they are more memorable."

Some cases that we remember may be lost in the aggregate data, but that does not mean that the aggregate data were not also masking the extent of the downturn in some areas. I remember what the downturn looked like in West Los Angeles by the mid 1990s. Prices were down dramatically in Brentwood, Santa Monica, Westwood, Mar Vista, Hancock Park, Rancho Park, Cheviot Hills, etc. Seeing places down at least 30% from their peak was very common. Of course, there were unique circumstances that likely exacerbated the downturn, such as the 1992 riots and the 1994 San Fernando earthquake that hit the Santa Monica area extremely hard. But the deeper downturn was very real in these typically desirable and high-priced areas of Los Angeles. Ultimately enabled us to buy our first house.

Submitted by ibjames on November 22, 2006 - 3:26pm.

I really hope what everyone is saying is true, my wife and I are saving in the hopes of buying, while renting a beautiful house 3 blocks from the beach. A house we'd never be able to afford, but would love to be able to one day.

We are going to wait till 2008 and see what things look like then, if it doesn't look like things are going well I can imagine her wanting to move. I don't want to leave the sun :(

One thing I do know is, of all my friends, none of them are even thinking of looking. We are all around 30, professionals, and do not believe it's worth it to own anymore.

I did consulting for Century 21 for the OC and San Diego, working on their computer systems. You should see the morale of realtors these days.. offices are closing, realtors are finding new careers. I can't tell you how many sales pitches I heard while working on their computers. All the pep talks to keep the realtors motivated, many have never had to work to sell a house. Now there aren't enough realtors to cover open houses it seems.

All I can hope is prices plummet, a beautiful place opened up across the street from me. Rooftop decks with fireplaces with an ocean view (townhomes), 2 bedrooms, beautiful, 650k. They had showings and they didn't even have carpeting in or any type of flooring. The developer just wanted bodies in there as fast as possible. We have already seen one flyer circulating around the area, the are advertising $35k price drops. The need to add a 0 to it to make me or my friends think about it :) $350k price drop? SOLD!

Submitted by Nozferat on November 26, 2006 - 12:37am.

It's quite obvious that if you remove the in-flow of money in any market regarding any tangible item that requires money to be purchased, you'll have a collapse of value. That's granted.

BUT I firmly believe that to tie employment with the maintaining of housing prices is utterly false...and wrong in the most fundamental way.

While I have no crystal ball, I've had arguments with many people regarding the pricing of housing in the coming years in California. The ones that are now sitting fat, dumb, and happy with their ill-gotten gains pitch the viewpoint of:

"Incomes will increase to match home pricing rather than home prices coming down."

I ask why and they unanimously say because there is a huge in-flux of people in California...everyone wants to live here.

I said..OK...let's assume that's true (and God only knows why anyone would want to live here so badly these days but that's another story)...let's say people are coming here in droves. I stil think that mentality is wrong because I know for a fact that my income will not double or triple in the next 5 years..hell even in the next 10...so I have no clue how the hell they come to that conclusion. But as I said, they are now sitting fat, dumb, and happy.

I'd say at this point, a good majority of people coming here are not so well to do. While it may be a generalization, when a native Californian is having trouble affording a home, people from third world countries (or from areas where life may not be so easily handed to you in a credit card) will not be able to afford a home at all.

It would be a safe bet to say that much of the population explosion will be composed of such people. For the sake of argument and example, if 300,000 additional Mexicans come into the State to live and work, they make money...sure. But do they make enough to buy a $650K home in So Cal?

The only way I would see them doing so is by grouping up and living together...which by the way is what is happening more and more. You won't believe the number of ethnic families I see living together in order to be in a home...Mexicans, Koreans (particularly), Chinese, Armenians...some of whom I personally know have parents and grandparents living together so as to get SSI/SSA checks to help out.

Essentially, the fundamentals are still in place but the methods of achieving the balance is not normal anymore. A single couple simply cannot compete with 2, 3 families living in a home. Period.

But what it proves, after all this, is that simply because their are jobs, it does not mean that homes are affordable in the traditional sense...what makes them affordable (per say) is the fact that you have the incomes of 2, 3 families to make it affordable. Why? Because most jobs do not pay enough to support today's stupidly priced homes. So employment does not equal a better housing market.

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