The Economist – “Momentum effects help to explain why bubbles develop. Put that together with borrowed money and you have a disaster in the making.”

“You talking about me?”

‘The big mo’ [The Economist, 6 Jan 2011], deals with the dangerous situations that arise when herds follow winners, and the implications such behaviour should have for policy makers. The brief article is primarily about stock markets, but any sensible Vancouverite will see that it applies strikingly well to our own real estate market. [excerpts below]

We have long argued that momentum effects are driving our market. Vancouver RE prices are far removed from prices determined by fundamental measures. We believe that almost every Vancouver RE purchase has a speculative component, meaning that the purchase would not take place if the buyer did not think that prices will continue to rise at something like the historically unprecedented speed of the last 7 years. And, consequently, that many purchases would simply not have occurred if buyers expected a flat or falling market. Many in the market, without even knowing it themselves, are momentum players.

When the market turns, as it must, not only will this momentum demand evaporate, but all of the owners who are holding property for speculative reasons will experience some motivation to sell. How they act on those urges will determine the shape of our RE bear market. -vreaa

A few excerpts:

“The momentum effect cannot last for ever or share prices would head for infinity. Over long periods (more than three years or so) an opposite anomaly known as the value effect occurs: shares that are depressed in price tend to rebound. Momentum-chasing investors may get caught out by the switch from one effect to the other, especially when they have used borrowed money to try to enhance returns.”

“Analysing an irrational market is extremely difficult [Tell us about it! -ed.], as those who tried to call the top of the dotcom boom discovered in the late 1990s.”

“An irrational market sends misleading signals, causing capital to be allocated in the wrong places. … The [entities] that find it easiest to raise cash thanks to these market signals may not be those with the best business prospects.”

“Momentum effects help to explain why bubbles develop. Put that together with borrowed money and you have a disaster in the making.”

“Too often, central banks have tended to give speculative buyers a one-way bet—cutting interest rates when markets falter, but leaving them unchanged when asset prices boom.” [= ‘moral hazard’. -ed.]

“Asset bubbles can be deflated through limits on some sorts of borrowing rather than just interest-rate hikes.” [Mr Carney can’t raise interest rates right now, but Mr. Flaherty can tighten mortgage lending. Let’s hope he’s listening. -ed.]

“Economies can get carried away by momentum.” [Yeah, ‘greatly excited’, but at the same time severely distracted and deeply injured. -ed.]

11 responses to “The Economist – “Momentum effects help to explain why bubbles develop. Put that together with borrowed money and you have a disaster in the making.”

  1. Is this person shorting the Vancouver RE market?
    http://www.realtor.ca/propertyDetails.aspx?propertyId=10210286

    It seems to say that the buyer should lease it to the owner for 2 years, for fixed monthly rent of $4k. (This is perhaps a premium of $1k over renting a similar house?) Is this because the owner expects that he won’t be able to sell it for $1.3 mill (minus $24k in excessive rent) in two years?

    • Yes, it seems they are trying to short the market, in a fashion.
      They want to sell now for $1.388M, but also want to continue to use the house for two years at a rent of $4K per month.
      Clearly owners who have done all the math; we wish them all the best, their decision is likely going to prove to be a smart one.
      [Another possibility is that they want to sell but are legally or personally committed to current tenants.]

  2. I do a little part time work for a small company that does some specialized contracting on construction for housing and commercial projects, among other activities. The owner has never seen it so bad with construction firms not paying up after the job is complete. It’s getting crazy; almost every job completed in the past year is unpaid. One in particular stands out because it’s a market indicator: a two house lot in East Van had a six townhome complex built on it. Two or more of the units remain unsold 8 months after completion. (which is probably why we are not getting paid).

    The company has been in business over 22 years, but this kind of cashflow cannot be sustained for much longer.

    • ….and when we post ads for general labourers or welders on craigslist, we get 150 replies in the first day. All qualified trades, all applying for unskilled wages.

      Someone I know who works in government was the other day looking at the appraisals dept. There was an MLS bulletin or publication or something showing the % change in sale price for houses that were actually sold. He said that from six to three years ago, all were double digit gains, then three to one year ago were flat or single digit, and in the past year all were pretty much zero in van and negative further out, in kelowna, hope, etc. I asked whether this was secret because I was under the impression we had no equivalent of the Case-Shiller in BC. He didn’t think so. Anyone know what this report might be? it sounds pretty deadly to the claims that prices keep on rising, which is based on the average selling price of the obviously higher end homes that are the only ones trading right now.

      I have asked him to take another look as he can’t remember what the name of the report was.

      • Teranet.
        For Vancouver chart click HERE
        For Teranet site, click HERE.

      • He says it was called the MLS listings index. I guess its commonly available. He was just telling me that the trend of decreasing increases was very notable. I had drawn his attention to the likelihood of the bubble bursting, and his attention has been drawn to RE matters since. He in particular notes the discrepancy between what he saw in those tables and what the mainstream media has been reporting.

  3. Debt is the problem. Nicholas Nassim Taleb, the ‘Black Swan’ guy, makes a very interesting argument about why debt is bad. He essentially says that Debt forces you to make great forecasts about your ability to pay the debt, but that the world has become so complex that most forecasts are wrong, and with millions of people making the wrong forecasts fragility is introduced into the system and then things blow up badly, and those with political connections get bailed out.

    Checkout these videos on ANTI fragility

  4. I’m on fire today with the anecdotes so here’s from last summer, when I was a truth-blog virgin. I remembered it the other day when reading VREAAs comment that local speculators have helped drive the market along.

    I was at a birthday party and got talking to a couple I barely knew about living out in Abbotsford. They said they have been going to open houses in their neighbourhood because they are looking for a house to “flip”. Their words, not mine. They are just an ordinary couple, no spectacular income, who bought a home in an appreciating neighbourhood a couple of years back and were now “looking to flip a house”. They told me of a guy in their neighbourhood who had flipped two homes in the same street, living in them and renoing for about six months then selling. The prices were escalating rapidly, they said. I hope for their sake they did not find one ripe for the flippin’.

  5. Were things in the seventies pretty dire, economically-wise, in Canada? I was not old enough to remember but it did seem less to go around than now.

    The reason I bring it up is that this new fangle ways of creating money out of nothing has brought prosperity – make sure it does not go all the way and take you off the cliff.

  6. Pingback: TPFKAA anecdote headlined: Spot The Speculator #24 – “They are just an ordinary couple, no spectacular income, who bought a home in an appreciating neighbourhood a couple of years back and were now “looking to flip a house”.” | Vancouver Real Es

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