Real Estate Bubble
What is a real estate bubbl e? Below, we look at the real estate bubble as yet another symptom of a sick bond market.
Are Real Estate Markets Safe?
I’ve been speaking to real estate mortgage brokers, commercial appraisers and analysts, some of whom have experience levels dating back to the 70’s. In short: they’ve seen cycles, from the S&L crisis of the 80’s to the embarrassing mortgage-backed-security fraud that lead to the 08 disaster—and the even more disastrous bail-out.
They are worried about real estate.
Honest Brokers—a Rare Breed.
During the 90’s, folks who gave honest appraisals that killed real estate deals anxiously pushed by well-dressed brokers looking for commissions were avoided. Their bosses and clients, many of whom later went to jail, kept honest appraisers out of the loop.
Many of these honest types later came back with an “I told you so” smile and began working for the FDIC and RTC to clean up the messes created in the 80’s and 90’s by the very “professionals” (real estate horse-traders) who avoided them at “deal time” in the boom years.
As we all know, however, by 2006 the sub-prime bubble became the catalyst for a derivatives and securities bubble. By then, some of my classmates at the big banks had packaged dog-scheisse mortgagees peddled as solid gold credits which were then syndicated to the global markets as “safe” asset-backed bonds.
By 2008, the creators of those “weapons of mass destruction” faced no penalties; instead they were bailed out by Obama to the tune of trillions and received bonuses—big ones. I remember more than one Nantucket martini listening to these bankers gloat as taxpayers saved their bad, TBTF banks.
One—especially bankers— can easily lose morality in the face of a bonus, commission or promotion. But that’s a Faustian wager with one’s conscience that some of us (even finance jocks) just can’t stomach regardless of the financial carrot dangling before us. (I wouldn’t take a paycheck from Amazon or Facebook either …but that’s a different story.)
As for housing bubbles, which I want to discuss herein, they involve the same dynamics and characteristics of all bubbles: easy credit, lame bankers, clueless brokers, greedy developers and, well: bad investors.
In the real estate game, from residential to commercial, I remember properties worth less than 40 cents on the dollar and commercial properties worth less than the land they sat upon.
As a young Turk “wintering” in Palm Beach years back, I remember a certain condominium project off Flagler’s inter-coastal waterway with Trump’s name on the penthouse. A certain bank (un-named herein) lent him millions to develop it, but the prices were too high and it slowly collected cobwebs rather than buyers.
Net result: the bank took it back.
Developers, however, don’t care. Like most brokers of any widget, they just want the commission or bank money, not the facts or ethics.
Commercial developers take a big fee up front from wide-eyed equity investors hoping to get rich quick on a sales pitch. During good times, the game can work. As markets shift, however, it ends badly.
Investor equity (often described as “dumb money” in busts and “lucky money” in booms) is collateralized for a non-recourse development loan. But when the cycle dies, the investors get smacked as developers pocket their last paycheck and banks foreclose on the assets until the next bubble returns
I was recently in Dallas falling off horses. Cranes were everywhere. Developers were on a tear at the top of the bubble doing the same thing: risking other people’s money for up-front fees and hoping the bull market never ends.
Around DC and the sad sprawl of northern Virginia, it’s the same story. Elsewhere too. The commercial bubble is fattening, and the fall out and downside is ignored.
The residential market is no different—just take out the developer fee. In this space, I’m seeing more “accommodative” lenders (working with commission-focused brokers who sell face shots more than real estate) using cooperative “appraisers” to pitch over-priced homes on the back of low-interest rate seductions.
It seems folks are forgetting the lessons of the past. When my son was smacking soccer balls at age 7 in 2004, I remember telling my wife that a real estate bubble was upon the US—and not just in Palm Beach.
We lived overseas then, but I told the soccer moms and dads wintering in Florida and elsewhere to sell. They smiled and thought I was nuts.
I probably am. But things feel nuts today as well. Incidentally, by 2006, sales volumes had dried up and buyers vanished. Remember?
It’s Just the Same ol Debt Thing…
But across the entire US, folks were taking out more debt on their over-valued/appraised homes thinking (and being told) that they were extracting “equity.” In fact, all they were doing was adding to their debt—which was far outpacing their income.
It’s worth noting that such real estate cycles—i.e. thinking everything will always be fine and surviving on debt and rising appraisals rather than income –is the same cycle we’ve been seeing with central banks around the globe: they print money, take on debt and crank down interest rates while hoping for the “wealth effect” of more borrowing and buying to save them.
But this “wealth effect” (aka “bubbles”) are short-term seductions and never long-term solutions. Unlike central banks, however, homeowners can’t print money and sneak away from their debts by issuing more sovereign bonds.
Instead, they get slammed when the cycle (and their home prices) turns south.
If you think we are not in a housing bubble, that’s ok. It’s easy to miss bubbles right beneath our noses because it’s tempting to feel good/safe when the markets appear safe.
Since the last debt crisis of 08, central bankers cranked interest rates to the floor and thus stimulated more borrowing, and hence more buying, and hence rising home prices. That is how bubbles, including real estate bubbles, are born. Mortgage rates bottom as housing prices skyrocket.
This, again, is supposed to generate that good ol “wealth effect” and trickle down into the so-called “Main Street” economy.
But all such policies/bubbles do is create more debt. Eventually, as home prices rise, they begin to rise faster than homeowner earnings and thus homeowner prudence. When the bubble pops, the homeowners (as well as landlords and tenants) feel the pain. It becomes harder to pay their creditors, landlords etc.
The same thing is happening in the EU. Low rates and money printing (QE) by the ECB have created the same real estate bubble as it did in the US.
In fact, just as the Fed stopped printing money (QE) in 2014, the ECB picked up our QE playbook and started buying bonds ($60B/month) and artificially supporting a broken credit market to stimulate, alas, that “wealth effect” of stimulating credit—and hence house buying/borrowing.
If central bank promiscuity (QE and zero [ZIRP] to negative [NIRP] interest policies) created this bond bubble (and real estate bubble), then it seems logical to anticipate that a reversal of such policies will end this bubble—slowly at first, and then real fast…
The Fed abandoned QE in 2014, and the zero-rate policy of yesterday is now shifting to more rate hikes and QT today. In short, less monetary “engineering” means bond prices are seeing less artificial buying and thus price declines, increasing yield hikes and alas: increasing rate hikes.
Rate hikes, by the way, are bad for bond bubbles…
Watch the Yields!
As the much-discussed yield on the US 10-Year flirts around the 3% figure (which is what happens as more bond supply flows into markets and more bond buyers/demand flows out), we are seeing rates rise.
Neither the Fed, nor the ECB, which is cutting back on QE this fall, can save homeowners or borrowers from market forces forever.
Meanwhile, EU banks who survive by lending to each other via TLTRO programs will eventually have to sell more and more of their US Treasuries to get some liquidity.
This means EU banks will be dumping more Treasuries into the market at the same (worse) time that Uncle Same is issuing more Treasuries to incur more debt in order afford no-pay-for tax reforms, walls, and permanent wars overseas.
Econ 101: Does It Still Matter?
Remember Econ 101? As (bond) supply increases, (bond) prices fall and thus yields and rates rise. As the secular bond market turns from bull to bear (of which we are seeing the first signs right now), rates will rise. Rising rates will eventually dry up home purchases—among other things.
Is a Bond Bear Good for a Stock Bull?
The big question today is this: as bond markets head south, will stocks go down with them, or will money flow into stocks and away from bonds? In short, is a bond bear good for the stock bull?
What Do We Think?
Frankly, we are a bit bemused/confused, which is why we watch technical signals more than opinions. Admittedly, we’ve never seen markets so completely distorted by central bankers. We can’t come up with a prior case study to compare symptoms of “then” against “now,” because we’ve never seen central banks this crazy before, not ever.
That is, it’s hard to do a normal pulse-check on markets so addicted to central bank cocaine. Most of us who remember markets prior to central bank “engineering” admit that there’s no precedent for the everything-bubble in which we are now (and temporarily) basking.
Fundamentals and common sense just don’t seem to matter if investors are confident that the central bank “pushers” of the world can just print more money whenever a crisis (or as Yellen says, a “material adverse event”) should come our way again
As rates rise in a credit bubble, the bubble starts to quiver (as per now), and then eventually…pop. Whether or not more money printing or more central bank rate-cramming will work tomorrow as it did post-08 is a key question.
[We think the Fed is raising rates and tightening its balance sheet today because they know they’ll need to print more money and lower rates again in the next crisis, which they likely know is looming (and of their own creation)].
Chase Tops or Go to Cash?
But will more debt and more fiat money printing work again? Not without currency destruction, and not without a massive market correction. As market volatility slowly returns (we lost 12% in February, not all of which has yet to come back as of this writing), investors may want to sell at tops and go more and more to cash—i.e. like 70% in cash.
That is what prudence suggests. After all, history confirms that it’s nice to have cash to buy at market bottoms, which are inevitable, though hard to see or time, even for the best investors. It all hinges upon your own profile and approach to risk vs. uncertainty.
For patient investors, however, who are willing to stop chasing trends and tops, caution is not foolish, it’s often brilliant. It’s worth repeating that more money is made not by chasing tops (and we are definitely at a top, though perhaps not the top today), but rather by buying at bottoms.
A bottom is coming.
Are you willing to wait—even a long time, or keep chasing tops?
For the rest of you, be careful out there.