Open Reply to Rusty – “Just because you perceive a bubble does not make it so. Bubbles are only identified after they’ve burst.”

Rusty at VREAA 30 April 2011 8:47am
Just because you perceive a bubble does not make it so.
Bubbles are only identified after they’ve burst.
Or do you define a bubble as a real estate market where you personally cannot afford to buy?
What is your “pre burst” definition?”


Dear Rusty

Thanks for your question.

It is a myth that “Bubbles are only identified after they’ve burst”. The myth is propagated by those directly or indirectly benefiting from the bubble, and also by vested interests in postions of responsibility, who could make a difference, but decline from so doing. An example of this is Alan Greenspan keeping monetary policy too loose through the tech and US housing bubbles, claiming that you can’t identify a bubble in advance. Greenspan is simply wrong on this point, and many observers saw those bubbles for what they were during the process of them being inflated. Yet, we still hear this myth perpetuated (as in your bold claim). This is closely related to the ‘hoocoodanode’ responses you’ll get from various players after a bubble inevitably bursts. It’s also a way of those guilty of policies and actions that perpetuate bubbles to claim innocence after the fact.

A speculative bubble can most definitely be identified while it is inflating. Such a bubble occurs when prices of any asset lose contact with fundamental values of the asset and start rising higher and higher simply because they are rising higher and higher. All buyers in such a market buy with the expectation of higher prices, some buying solely for the expected higher prices.
Almost all bubbles are supported by fallacious arguments citing ‘reasons’ for differences between bubble price and fundamental value. For instance, during the tech bubble, we heard the argument that P/Es of 1000 were merited because “we’ll be able to sell to everybody” (neglecting to take into account the fact that everybody else will be able to sell to everybody, too).
Bubbles are also facilitated by large quantities of easily available cheap capital.
They are all versions of Ponzi schemes, where, essentially, the late-comers are left holding the bag after prices collapse, and the only players who profit are those who get out early enough (surprisingly few), and those who sell ‘shovels to the prospectors’ (brokers; some developers, some in construction, etc).
All bubbles deflate, no exception (If you can think of any, let us know). Prices return to levels that make sense according to fundamentals. In fact, as we see now happening already in some areas of the US housing market, they often drop well below fundamental value, and may remain depressed for the better part of a generation. Bubbles are very, very destructive to a community, both through the terrible misallocation of human effort & resources on the way up, and through the tragic financial, social, and psychological consequences of the aftermath.

In Vancouver currently, median housing prices are about ten times median income, and rental yields are extremely low, much lower than one would expect even at current low interest rates. Thus, prices are far, far removed from those merited by fundamental value. By our calculations, prices are 2 or 3 times fair value, meaning that we’d expect price drops of well over 50% when the bubble deflates. But people continue to buy believing that prices are only going to go up (or, a slightly different version, that prices couldn’t possibly drop by more than 5% or 10%, before continuing higher). Higher and higher prices are ‘supported’ by fallacious arguments (“we’re running out of land/best place on earth/never-ending demand/foreign buyers”). Capital is very freely available, along with low deposits, long amortization periods, and government loan insurance.
By all measures, we are in a massive speculative bubble. Massive in terms of both the percentage of citizens involved, and the size of the overvaluations. This is not an opinion, it is a fact.

You have suggested that we may define ‘bubble’ as a market in which we, vreaa, cannot afford to buy. That is a fair thought for you to have. We could claim that this information it is neither here nor there to this discussion, but it is fair for you to know if we’re just ‘talking our book’. So, we’ll share with you that we can indeed ‘afford’ to buy, even at current prices, and definitely by all Vancouver standards. But we choose not to, because of the massive disconnect between price and fundamental value; because of the RE bubble. There is a very small minority of prospective buyers in this position in Vancouver. It is never easy to be on the wrong side of a bubble, but what else can you do but call it as you see it?

Say we had to reframe your statement to read: “Bubbles are only identified by the vast majority after they’ve burst.”
That we’d agree with. By definition, once even a minority start bailing, the bubble bursts. We haven’t reached this point yet in Vancouver’s remarkable market, but we will get there, and after we do, there will be a very broad consensus that we have indeed been through a very large bubble.


38 responses to “Open Reply to Rusty – “Just because you perceive a bubble does not make it so. Bubbles are only identified after they’ve burst.”

  1. Why even bother VREAA, Rusty’s a bit rusty on his econ 101.
    We cannot convince the market down, all we can do is take a seat and enjoy the movie.

  2. 6-7 yrs. ago I was buying silver bars like there was no tomorrow. Tried to convince friends and families to buy but to no avail, just got laughed at. I bought my home in 2003 and got laughed at for paying $50,000 too much for a brand new home that was heritage style , I absolutely loved it and the numbers just made sense. The owner/builder took a bath according to my calculation. Fast forward to the present. Sold my house late last year for 125% gain (over a million). Just sold all my silver on this huge spike last week…for 13 bagger.
    Guess what? I got laughed at by my family for selling my home and they are now asking me if it’s the right time to buy silver?
    Like I said , we can’t convince anyone or the market to go up or go down, just place your bets and watch what happens. Contrarian play is a lonely trade but is most profitable.

    PS Silver is going much higher but aI cannot pass up a 13 bagger. Kept my gold.

  3. 13 times what I bought it for.
    bought at $4 sold at $47-$49.

  4. vreaa,
    your definition of a bubble isn’t really a definition at all. It’s a description of high real estate prices. And until there is a bursting all we can say is that there are high prices. Enough said on the matter
    As far as the word “fundamentals” goes – it’s simply shining from the bear camp. Show me a high priced area in the world that is supported by “fundamentals” i.e. Manhattan avg income is 88K/year and the avg home price is 1.5M – is this a bubble? Why are the fundamentals out of whack there? The simple truth is that calculations like this can never be made in demand markets.
    You’ve created an entire website devoted to preaching the bear mantra. Don’t you think you should be doing something that earns more $ so you can afford to by yourself a home?

    • Bubbles are only identified after they’ve burst, eh? Perhaps you should pick up a copy of The Big Short by Michael Lewis and read it.

    • You’ve created an entire website devoted to preaching the bear mantra. Don’t you think you should be doing something that earns more $ so you can afford to by yourself a home?

      But didn’t the guy just tell us that he could buy a $1M home with cash today if he wanted to? Don’t you believe him?

      Yours is a taunt born of insecurity. It’s like Psychology 101 in here. Thanks for the chuckle.

  5. Manhattan price-rent ratio is way lower than Vancouver’s. That some of the brightest investment brokers and quants live there is why. Keep pumping the book — Vancouver is different. Bear bloggers will be here to highlight your comedy in an upcoming “blast from the past” post.

  6. @jesse
    keep scratching your head at those fundamentals. You’ll go to your grave never having owned a home.

    • Idle threats. Do you think I don’t own? You are blessed to live in what Star Trek politely calls a “temporal rift” but what non-fiction writers refer to as a “bug searching for a windshield”. Prices to warp factor 9, Geordy.

      • Smirk!… NiceOne, J!. And speaking of speculative fiction and VREAA’s allusion to “those who sell ‘shovels to the prospectors’ “… I believe that topic was handled nicely in, ‘The Moon Is A Harsh Mistress’ (RH).. [albeit, it may be one of Bob’s earlier works]

  7. VREAA

    I could not agree with you more. When the price of something detaches form fundamental measures and new measures have to be invented to value them , we are in a bubble.

    The dotcom bubble was one such event. Most of the companies had little or no profit so they started valuing them on new parameters, price/income or even price to eye-balls!

    All the while The-Idiot-Also-known-As-Greenspan was being told by influential economists to increases margin requirements or raise rates to burst the bubble. He refuse and later used the excuse that you cannot see a bubble once you are in it!!

    May he couldn’t but hundreds could and many made a fortune from it’s bursting. He then went on and blew up another bubble – the US housing bubble- so being responsible (with his side-kick Bernanke) for the two largest and most catastrophic bubbles of the last 90 years.

    Of course no one knows where a bubble could end. Also fundamentals can be changed to boost the bubble. RE was in free-fall in late 2008 and doubling the CMHC and dropping rates to near zero reinflated it for the final push.

  8. I believe Rusty is confused between the idea of identifying a bubble and timing the burst (deflation) of a bubble.

    Timing the exact moment of when a bubble will burst is indeed impossible although that hasn’t stopped many from trying. And if you engage in such activity, then I believe it’s called “speculating”. There’s nothing wrong with admitting to speculating since you goal is just to make some quick money.

    I agree that a bubble is defined as rising prices in a asset class perpetuated by unjustified expectations of future rising prices in that asset class AND I would define “unjustified” as a detachment from fundamentals such as NPV(for investment valuations) or price:rent or price:income ratios(valuation for consumption in the form of shelter).

    The statement “Bubbles are only identified after they’ve burst.” is simply not true as many economists were successful in predicting the RE bubble in the US way back in 05 and 06. Has Rusty heard of Youtube?

  9. El Magnifico

    Another example of the speculation going on in Vancouver:
    For rent at $1795/month

    And for sale at $549,000!

    Just insane…

  10. Anecdote: talking to friend of mine who lives in Taiwan. Was renting furnished apartment downtown to some guy in the film industry. Anyways the guy had to abruptly leave back to the US. My friend was having trouble finding another tenant so flew back to Vancouver (yes) to administer the tenant search. He says tenant quality has been challenging recently but doesn’t know why.

    Also a few friends of mine have noticed a larger number of cooperative postings recently, from many cooperatives that are typically lined up with applicants. Maybe it is just randomness. Haven’t heard many anecdotes from the rental world recently.

    • pricedoutfornow

      I too, have noticed a lot more postings for co-ops, and also Metro Vancouver’s affordable housing. My friends who bought the Olympic condo to flip (didn’t happen) turned accidental landlords also had a hard time renting it out. They said they had NO calls, and finally rented it for $1200/month to some guy who only stayed 3 months. This is about $1000 less than the mortgage payment.

      My guess is we’re at a point where everyone who could buy, did, in the past few years, leading to the bottom of the barrel left in the world of tenants (apart from those of us who think the bubble is going to burst). This is the point where it all collapses because there just aren’t any fools left to buy.

    • I know a few things about co-ops. I think, for sure, many renters/co-op members are buying. I’ve heard this especially in the suburban co-ops. Also, Homes BC contracts are affected by the area the suites are in and there is change in funding based on market rates, not on median incomes. Rental rates have gone up in Vancouver (at least those on Craigslist), and many co-ops get their funding or loan terms based on a percentage of market rates. … But many contractually also can’t accept people who will be paying more than 30% of their income to housing. So if it’s decided that a three bedroom has a market tag of $2000, then a co-op may be required to charge $1700-. A family would have to make $61200 to qualify. Which is only slightly lower than the median income.

      It’s a simple numbers game. If you look at the new Athlete’s Village Co-op, the net family income on a three bed will have to be $81000 – around the average, above the median. Again a numbers game. People making $81000 are in the territory where they’re being targeted by realtors, right? Co-ops require sweat equity, like ownership, but have zero speculative utility. Therefore, it just makes more sense to either rent or own; you’re either full service for the same price, or you’re hoping for future gains.

      The qualified applicants are drying up in some of these places because of those numbers . (I know of one group that is letting families in who are spending up to 50% of their income on housing, which is what happens in private market, but is obviously more precarious for the co-op.)

      I also know places are trying to figure out how to move overhoused couples whose children have grown; market rates for smaller places in the same complex are sometimes higher than what they’re paying for 3 beds. I don’t know if some of the metro housing or co-op housing groups have figured out a solution: but if any one place did, there might be a bunch of family units coming to market at once.

  11. are gold prices in a bubble? How about oil, stocks? How will you know they are not up permanently unless the prices retract (they don’t stay up permanently)?
    I don’t speculate on any future prices changes, I simply live my life. I’m also a believer, that is to say, I believe it when I see it.
    Nice bear circle jerk you’ve got going here vreaa. An entire site created so your misery could have company. Unreal.

    • I’m not particularly bearish on Vancouver RE, however its clear that you have little idea of how markets work. Every tradable object has fundamental value. Plenty of different ways to value a stock, plenty ways to value RE. There are also ways to value commodities, for instance oil will be cheaper in the near future supply and demand says so.

  12. nice explaination. Keep on going as long as it comforts you and the rest from the aching. Many bear blogs have tried to play the role of saving the communities; it’s not working! Should go buy some more Garth’s books.

  13. El Magnifico

    Fred, Rusty,

    You guys really sound like you’re feeling unsecure. If you spend time on this blog reading all those articles, that means that somehow, you have an interest in what is said and most likely deep inside, you agree with it.
    You you are feeling worried, don’t want to stay up all night, just listen to your heart and sell. You’ll feel so much better and totally free. Freedom is indeed priceless…

  14. Rusty and Fred

    Have a look at the “non-relevant” fundamentals for BC highlighted in the links below. Sure house prices could continue to defy income growth and growth in the underlying economy temporarily, but to what end? There are concrete upper boundaries to house prices relative to underlying fundmentals.

    And would you advise potential home owners to leverage into the largest purchase of their lives at a time when they could rent the equivalent house for much cheaper, and save and invest the difference? On the balance of probabilities, it is overwhelmingly likely that real estate will stagnate (best case scenario) and much more likely that it will realign with long-term trends over a much shorter time horizon (read: correction).

    Sorry my friends…..fundamentals do matter.

  15. Pingback: Softening Rental Market? – jesse and pricedout comments headlined

  16. if I sell one I will rebuy two. This won’t help your cause

    • So rusty, why are you posting here? Just curious. Tell the truth.

      • I don’t expect a reply. rusty is like one of those religious freaks on porn chat boards. He comes on, tells everyone else they are going to hell, but will never admit to himself (never mind us) why he is here. Have fun with your denial, weirdo.

  17. Bubbles are only acknowledged after they burst. Subtle but important difference. Lots of money to be made in bubbles and absolutely no politician wants to be the one to burst one.

  18. “Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often conclusively identified only in retrospect, when a sudden drop in prices appears. Such a drop is known as a crash or a bubble burst”.

  19. WATCH VACANCY RATES IN THE SUBURBS! That will be the sign of the coming collapse.

    If rents drop in Vancouver then this will suck in tenants from the burbs (reducing commute times etc.). Vacant rates in the ‘burbs should spike and investors/speculators will struggle to retain tenants and pay their mortgage. Typically those investor condos in Burnaby, Surrey, etc. were bought by speculators who were late to the party – typically those with minimal net worth who could not afford Vancouver product. The result: If they suffer a few months of rental vacancy then they struggle to cover the mortgage. The reaction: they all list to sell and try to jump out together.

    The lemmings who all bid up prices when they jumped in together end up slaughtering each other as they all pile on for an exit.

    There is precedent for this from the late 1980s in Toronto.

    The dominos roll into Vancouver afterward.

  20. @604x
    How will a move of renters to Vancouver cause a “domino effect” in the city? Wouldn’t higher demand move prices up?
    I’ve never had a vacancy for any one of my rentals in Vancouver. And there isn’t much chance of a vacancy in Vancouver proper on any decent rental.

    • With that kind of confidence in the market, I think you should screw us all and like you said, “sell one and rebuy two”. If you have 5 properties, then double your exposure and “rebuy” 10. There’s absolutely no risk, you have never had a vacancy in any of your rentals and it sounds like you get a positive cash flow and >5% rate of return on all your rental properties + the incredible capital gains. You sound like an experienced RE investor and I bet you have 100% equity in all your properties. Hell, you shouldn’t even sell your existing properties, just use them to leverage up your exposure to 1:10. Come on! You don’t even need balls to go for it; RE is a zero risk investment right?

  21. so long as rents cover any mortgage then I’m OK with more risk. Sometimes you have to wait and build more equity before splitting one property sale into two more. I have a just a couple more years on one home before I’m ready to “double down”

  22. vreaa,
    Not enough. It really is the only investment worth holding.

  23. yes, I’m all in. This is pretty much a no-brainer since the rental market is always strong here. So long as tenants are paying my mortgage is there any reason why I shouldn’t be “all in”? There is an end date to a mortgage after which any rental payment becomes total revenue (or gravy), this is on top of any appreciation. Gold, stocks, etc. do not produce revenue besides any increase in value. Demand for housing is constant, demand for any other investment will wane. What are your thoughts on the matter? I’m taking it you do not share my enthusiasm for real estate.

    • Rusty -> Thanks for notifying me that I’d missed your response. I started composing a reply here in the depths of this (now older) thread and then realized that our discussion would likely simply get lost here, and that it’s possibly worthy of broader debate. So, I’ll headline our ongoing discussion and we can continue it in that new thread. //

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