In a bubble, prices rise because people buy based on the anticipation of further price rises. This strategy appears to work for most of the duration of the bubble, and encourages even more speculative buying. Thus, the anticipation of price rises causes price rises, as players attracted by the price action add fuel to the fire. Price rises beget price rises. Prices ‘go viral’ to the upside.
In the inevitable ensuing bust, the reverse occurs. Price drops beget price drops. And this can get every bit as frenzied as the upside action. Moreso, actually, given the intensity of aversion that we humans have to financial losses. The fact that price drops alone will be a cause of prices dropping further is an essential point to understand. Many Vancouver RE bulls believe that sellers will simply withdraw product from the market to await price recovery, or that they “won’t sell for less than their property is worth”. But unwindings don’t work like that, and sellers correctly anticipating price drops will bail, bringing in more sellers, etc, etc. It doesn’t matter if it starts making fundamental sense to buy, or if interest rates remain ridiculously low: market participants will be so terrified by the thought of further price drops that they’ll stay away. Price drops will beget price drops. This will continue until everybody who was planning to sell based on any initial speculative intent has done so. As we believe that ‘speculative intent’ runs very deep in this market, we believe that the bust process will take years and will be very thorough. Prices will overshoot to the downside by as much as they overshot to the upside.
We can watch our future playing out right now to the south of us. See below for an illustration of the ‘Price Drops Beget Price Drops’ process. -vreaa
Distilled exchange from cnbc.com ‘Rates and Consumer Confidence’ 10 Aug 2010:
Q: “With the rate on the 30 year fixed now at an historic low, why isn’t that moving the housing market?”
A: “The insecurity that buyers may have regarding what is the price, the value of the home going to do after they buy.” (Eric Murtagh, Realtor)
Q: “What is going to get buyers off the fence?”
A: “Nothing short of a guarantee that the value of their home is not going to drop.”
[Thanks to Tim (comment at VREAA 10 August 2010 at 11:22 pm) for alerting us to this clip. -ed.]
From G&M 24 Aug 2010 article on ongoing US home sales drops –
“It really is a self-fulfilling prophecy. If all buyers perceive that home prices are coming down, then they will stop making offers – and home prices will come down.” – Aaron Zapata, a real estate agent in Brea, Calif.