Some Thoughts on the Real Estate Crash
- Dec 05, 2007
- admin
- Investing, Uncategorized
WHEN I MOVED TO FLORIDA A COUPLE OF YEARS AGO I HAD AN AGENDA.
Or at least I thought I had an agenda.
At the top of my list was marry my best friend and fiance’ Stacy. Mission Status: Accomplished on November 11 2006.
The second item on my agenda was to buy our first home. Mission Status: Unaccomplished to date.
Reason for mission failure: I outsmarted myself.
Let me explain what I mean:
During the past two years I’ve watched in awe as housing prices in Florida expanded past all reason.
Many friends who were in the market got swept up by circumstance or impatience and bought at the wrong time, clearly overpaying for their homes.
Many friends in the mortgage or real estate industry (or any related industry) lived the high life that comes with the obscene amounts of easy money associated with outrageous bull markets.
New cars, homes, jewelry became frequent. Globetrotting vacations became common.
Now I’m not the jealous type. Far from it. I started working on Wall Street in 1992, right before the Roaring 1990’s so I have absolutely no reason whatsoever to complain about easy money.
I’ve made my share of money, spent my share of money and thank goodness saved more then my share of money.
So get it straight right now – financial jealousy has absolutely nothing to do with my anger…
It’s my PROFESSIONAL PRIDE that’s upsetting the heck out of me these days.
Let me explain.
You see, in my circle of friends I’ve been considered “Mr. Bah-Humbug” every time the subject of buying real estate came up.
Whenever we’ve been out for dinner and I’ve been asked my opinion on the subject I’ve humbly offered that based on historical prices real estate is as overvalued as any time in American history.
Now I’ve been around long enough not to be foolish enough to try and predict WHEN a market would change direction. But I knew I had both human nature and history on my side and those are pretty good friends to have in your corner.
(Of course those around the table with no market experience looked at me like I was “out of touch” but that didn’t bother me. I remember looking at the old timers the same way when I was a young buck on Wall Street and they used to warn me that stocks don’t always go up. As often as I’ve been made fun of for my views on real estate the past few years I’ve never taken offense to it. Getting upset about a persons ignorance on the subject of markets would be as absurd as getting upset with them for not knowing geometry).
But being the butt of good humored jokes is one thing. Losing money for your beliefs is quite another.
Let me explain:
During the past several years I’ve preached nothing but patience to my wife. Every time she saw a $500,000 home selling for $800,000 I would tell her to ignore it. Pretend it doesn’t exist. Think about something else entirely.
“In due time we will get rewarded for our patience,” I promised her over and over again as we continued to rent. “Markets always self-correct and when this one does we’ll be in great shape.”
Bowing to my considerable market experience she took me at my word. So we waited and we waited. All the while we kept making the landlord of the home we were renting richer and richer (to the tune of $50,000 at last count).
Fast forward to today…
As the bottom has fallen out of the real estate market during the past six months I knew my wife and I would be rewarded amply for our patience.
But I knew that the drop over the past six months was nothing compared to what was in store in 2008 – close to $400 Billion in mortgages will be reset to higher interest rates and that means a world of pain for real estate prices.
Just think about it. Right now the real estate market is crumbling largely due to a correction in pricing fueled by and underwriting choices.
But add two million homes to the mix that open their mail one day and see their mortgage has risen from $1,500/month to $2,000/month and what do you have – a financial meltdown in the real estate market!
Or in other words – a prime opportunity for me and every other investor who was patient enough to wait. And not just wait – if you’re anything like me you decided that the money spent renting ($50,000 for me) was a better investment then buying a home that was overvalued by at least $300,000.
So that is where I’m coming from as I write this letter to you today. Many of you may consider that selfish. Yes, it is selfish – I’m trying to do what is in the best interest of myself and my family and I’m not hurting anybody to do it! (It’s called the “American Way” you libveral ninnies)
Now here’s where the story gets very dicey.
On a personal level I’ve been furious at the recent talk of a government bailout. Nobody ever bailed me out when I’ve lost money in the market (have any of you been bailed out when you’ve lost money before? I doubt it).
Even more offensive is that the politicians are framing it as a bailout of homeowners. Good ol’ honest Americans who simply made bad decisions and got in over their head. If you believe that I have a bridge to sell you.
This bailout isn’t about you. This bailout isn’t about your neighbor who is struggling to pay his mortgage.
Did Treasury Secretary and former Goldman Sachs (SYM: GS) CEO Henry Paulson suddenly become a bleeding heart liberal?
Heck no! This bailout is about saving the rich fat cats (read: banks and brokerage firms) who sold the American public a pile of you-know-what and suddenly and conveniently forgot how the capital markets work.
At least that’s what I’d like to think. And heck, it certainly plays well in Peoria. People absolutely love it when we can attack a rich Wall Street fat cat who deserves it.
But as painful as this is to admit I’m beginning to think about this on another level.
You see, there’s a story that keeps popping into my head about a famous trader named Jesse Livermore. Jesse was said to be responsible for, among other things, the great Crash of 1907.
At the height of the stock market meltdown of 1907, when stocks were trading 30, 40 and 50 points below what they were worth, Jesse was sitting pretty indeed. In the months and weeks before the crash he had sold millions of dollars of stock short.
When the market finally cracked, not only was he proven right professionally, but he had made millions in profits (remember, this is 1907 I’m talking about).
But as far as the market had already declined Jesse continued to short more stock (this was before the zero-uptick rule). Throughout the entire day he just kept hammering away, shorting thousands and thousands of shares, sending stocks that were already down 50% falling further.
But there is an old Wall Street story that at the very height of the panic, just as Jesse was about to sell more stocks short, a small, powerfully built man made his way out of his office and walked across the street to speak with Jesse in person.
This wasn’t just any old man – this was Mr. JP Morgan himself, the most powerful financier in the history of Wall Street.
The way the story goes, Mr. Morgan appealed to Jesse’s sense of patriotism to stop shorting stock. He reasoned that although Jesse had many more millions to make, the entire financial system was at stake.
Mr. Morgan left Jesse to think about it. On one hand, his analysis was right and in the great system of capitalism his prize for being right was money, pure and simple.
On the other hand, it would be in nobody’s interest if the entire financial system collapsed. That could create a situation that could spiral out of control with intense speed and destruction.
What did Jesse do? Not only did he stop shorting stocks, he pulled in all his shorts and began issuing buying orders to all of his brokers. In many ways, his orders to buy the leading stocks of the day put a solid floor under the prices and the markets stabilized.
I’m not Jesse Livermore here but for the first time in my life I understand exactly what he was facing.
On one hand, I want the housing market to collapse into a ball of flames so that I can prove to myself that my reasoning was spot on. And of course, in the world of investing, proving your reasoning is sound means that you’ve made some serious money.
So here I am, proven right in my reasoning on the real estate market and its ultimate decline. And here I am, out $50,000 in rent while I waited for a correction that would make the $50,000 I spent on rent a great investment.
But just as the bottom of the market falls out the government steps in to help.
What does that mean to me personally? The $1 million dollar house I wanted probably won’t drop as far and as fast into my price range if the government didn’t intervene.
In a true real estate collapse the house that was selling for $1 million would be selling for $600,000. But the government intervention will probably insure that there is an artificial “floor” under prices which means the house will probably sell for no less then $750,000.
The difference between $750,000 and $600,000 means that on each house I planned to buy I’m probably out $150,000 in profits.
But at the highest level of the game I have to wonder if its better to protect the “system,” as JP Morgan reasoned to Jesse Livermore, then it is for me (and others like me) to profit that extra $150,000.
At the very least I know I’ve learned a couple of things here:
1) Next time I make market estimates I’ll calculate the odds of a government intervention that cripples my profit opportunity.
2) That sometimes the government has to step in and act on behalf of the majority even at the expense of the minority.
Sure, I’m mad as heck that I won’t be buying the home I wanted for the price I “should” buy it at. And you have a right to be upset about it as well.
But isn’t it better then walking down the street and seeing that 40% of your neighbors are unemployed due to a financial crisis that spiraled out of control after a dogged belief in free markets came back to bite us?
At this stage of my evolution I think so but I’m open to debate.
Interested in hearing what you think…
Dylan Jovine