When A Speculative Mania Ends, Wealth Simply Disappears – “Poof! Gone in a flash of aggregated neurons.”

When a community is caught up in a speculative mania, it seems simply inconceivable to the vast majority that prices could drop. If apparent hordes of buyers are competing to paying $1M, $2M, $3M for solid assets like houses, how could prices possibly plummet by 40%, 50%, 66%? It just couldn’t happen, surely… why would a group of people who’ve ‘agreed’ (via market pricing) that a house is ‘worth’ $3M, then ‘let’ it change hands later for $2M or $1M or even less? Surely buyers would ravenously step in at even 10-15% off [the commonest estimation of the depth of a pullback on this and other blogs]? Surely that ‘wealth’ can’t simply evaporate?
But it can and it does and it will. Most people don’t have any real feel for ‘bubble dynamics’… they don’t understand the massive upward force that expanding credit has on asset prices and, more important, the devastating effect of the reversal of that process.

In an article at ‘Elliot Wave International’, a passage by Robert Prechter describes ‘How $1-million can disappear’ [19 Sep 2011] We take the liberty to paraphrase the passage here to demonstrate it’s relevance to our RE market. –

“The dynamics of value expansion and contraction explain why a bear market can bankrupt tens of thousands of people. At the peak of a credit expansion or a bull market, Vancouver homes have been valued upward, and all participants are wealthy — both the people who sold the homes and the people who hold the homes. The latter group is far larger than the former, because the total supply of money has been relatively stable while the total value of Vancouver RE has ballooned. When the market turns down, the dynamic goes into reverse. Only a very few owners of a collapsing asset trade it for money at 90 percent of peak value. Some others may get out at 80 percent, 50 percent or 30 percent of peak value. In each case, sellers are simply transforming the remaining future value losses to someone else. In a bear market, the vast, vast majority does nothing and gets stuck holding assets with low or non-existent valuations. The ‘million dollars’ that a wealthy owner might have thought he had in his home at peak value can quite rapidly become a small fraction of that. The rest of it just disappears. You see, he never really had a million dollars; all he had was an asset that he thought was worth a million dollars. The idea that it had a certain financial value was in his head and the heads of others who agreed. When the point of agreement changed, so did the value. Poof! Gone in a flash of aggregated neurons. This is exactly what happens to most assets in a period of deflation.”

Housing always has some underlying fundamental value, we don’t believe that a $1M [circa 2011] Vancouver home can drop in price to “non-existent valuations”… but we do foresee it dropping below $500K or even $400K later this decade. It may seem inconceivable, but history teaches us that it is very possible; probable, even. – vreaa

22 responses to “When A Speculative Mania Ends, Wealth Simply Disappears – “Poof! Gone in a flash of aggregated neurons.”

  1. “The bifurcation is found in an orbit that is born in a global saddle-loop bifurcation, becomes chaotic in a period doubling cascade, and disappears in the blue sky catastrophe.”

    Or so I was once reliably told by a ‘rocket scientist’ refugee from TheCity.

    What really irks me is that Jesse probably probably doodles stuff like this when he’s bored [for fun!].


  2. It is very true that very few will sell or are able to find a buyer to sell to at the peak and realize a profit that is within 90% of the peak. I felt that the peak was April 2010 for all lower mainland markets. The Spring 2011 market was hot only in certain areas. I sold at my home for 548K in May 2010 but my neighbour with the exact same type of house said I sold too soon and he will sell the following year for a lot more money. This 2011 spring/summer he asked for 569K and after 4 months of open houses he gave up and un-listed his home. He said there was very little interest and wonder what happened.

    • Yeah, interesting, that’s exactly the kind of thing that happens in the vicinity of a top. Including the demonstration of the ‘stickiness’ of prices… your neighbour doesn’t understand bubbles and is somehow sure that his property is worth what he’s asking… so doesn’t drop the price to current market value, but sits waiting to realize the imagined price. Many will do that while a minority of sellers, more motivated to sell, drop prices around them. Until this starts happening, prices are ‘sticky’… increasing inventory, dropping sales. This process may have already started in Vancouver. (Caveat: we’ve had false alarms before).
      After it’s all over, anybody who sold even VAGUELY near a top turns out to be very fortunate.

    • To expand on vreaa’s comments “that’s exactly the kind of thing that happens in the vicinity of a top”

      We’ve been at the “top” for a while now. Many have tried to sell and have failed, renting, occupying, or keeping it vacant subsequent. I assert those ranks are growing and now we have another round of hopefuls looking for a “safe exit”.

      There were few people in 2008 who sold in a panic at prices 10-15% off current valuations and are likely ruing their decision. They are in very select company. Contrast those who sold in 2007 in California are thanking their lucky stars (and they have stars down there).

      • Agree we’ve been there for a while – Tried to sell Summer 2010, languished (now well-known softness at that time, despite ever higher prices), rented it for 8 months (small negative carry even at prime minus), then hit the bid 10% lower in the “rally” of spring 2011. Now, to be fair, this is North Van attached which is visibly weak even in the CMHC data. I’m pleased with current positioning even though that realized loss was painful (~50% of 2007 down-payment).

  3. Like many assets, real estate is a herd mentality on the way up…and on the way down. There’s a lot more to it of course, but fear is a huge factor. As a real estate cycle moves to a top, people fear missing the proverbial boat. And they climb on board. On the way down, of course, many have already bailed and many more fear they won’t get off that boat before it sinks completely. At some point, the crash becomes self-perpetuating.

    I watched, from an up close and personal perspective, the US market die. Indeed, I was part of the run-up, part of the problem, buying and selling hunks of desert in Arizona during the first half of the 00 decade. We bought our first piece of land wanting to put a manufactured home on it for our personal future use. That was 2001. But by 2002, it had doubled in value. So we sold and bought another, and *it* doubled in price by 2003. We continued “flipping” patches of pure desert until 2006, when I got wind of California mortgage defaults. As it was primarily Californians driving the desert boom/insanity/mania, fueled by the unprecedented rise in the paper value of their own homes, I figured it was time to get out. We ultimately lost money on two pieces of property when the buying utterly and completely stopped, but we made far, far more by feeding the sharks during the frenzy.

    Sometimes, I wish I’d bought and sold five or ten properties each year rather than one or two. Hell, I’d be rich by now. Other times, I feel like total scum, selling these greater fools properties that only two or three years prior were worth a fraction of the price we were asking.

    We in the Vancouer area who don’t subscribe to the buy now or be priced out forever mantra can already see that bailing beginning. It’s all around us, in the periphery – the Okanagan, the Fraser Valley, much of Vancouver Island. And we’re pretty sure by all the figures we see and info we pour through that: 1) The vast majority of Canadians, BCers, and Greater Vancouverites are flat outta money, having burned through their credit already to cover extraordinarily high housing prices and basic cost of living, and 2) Wealthy foreigners don’t prop up the prices nearly as much as we’re led to believe.

    I still maintain prices here will plummet 50%. It’ll be like dominoes, one “event” triggering another, and the imaginary wealth of so many local residents will be destroyed in the process. I have personally given advice to two of my friends, neither of whom are wealthy, to cease and desist immediately their plans to buy bigger and better condos. But they do not listen. They are driven by the “You are nothing if you do not own” philosophy that’s ingrained into all of us from the time we’re in our teens. They can’t conceive that prices *don’t* always rise, despite my best evidence to the contrary. They are part of the herd. And they will be one of those dominoes, selling low rather than high as the fear inside them grows only more intense.

    It’s a vicious, vicious game.

    • Thanks for the comment.
      Will headline excerpts at a later date.

      As you know, we’re in agreement regarding rough size of probable price drops. I expect 50%-66% off, which seems absolutely unimaginable to all but a small handful of apparent lunatics.

      • Hey Vreaa, are you calling me a lunatic? 🙂

        [yes, but you’re in exceptionally good company 😉 -ed.]

      • 60~80% ‘peel’, give or take, least desirable housing in least desirable ‘burbs. 20~35% minimum melt in ultra-prime in spitting distance of ‘best’ school catchments. Bifurcated ‘blue sky catastrophe’.

        Sort of.

        Totally heuristic pulled out ‘o my sphincter wild-assed opinion.

        UncleSam occasionally solicits those, though.

        When he’s in ‘a tight spot’.

      • Hey Nemesis, why do you think the ultra-prime (by which I assume you mean the higher-valued West Side SFHs) will hold its value more than the least desirable burbs? I would tend to think the additional value of the “best” school areas and other attractive variables would already be priced into the prime areas. And I have the impression those areas are the ones that have appreciated the most as well. Are you suggesting that more of the price is speculative in the suburb homes?

    • It’ll be like dominoes, one “event” triggering another, and the imaginary wealth of so many local residents will be destroyed in the process.

      While the wealth may be imaginary, the debt definitely is real.

  4. I was just thinking that for many folks, buying real estate is almost like buying a lottery ticket. They buy it and then they hear…oh you won the jackpot it’s $100,000! Then another neighbor sells a house and their lottery ticket is worth $200,000. They are happy, they are walking around thinking to themselves, hey I won the jackpot…but just like the lottery until you cash it in, it’s just a piece of paper.

    Until you sell and crystallize those earnings, it’s just a dream, and it’s easy to understand the attraction of that state of mind. People even correlate the overall rise of the entire market with their wise neighborhood choices and attribute it to their wits rather than market conditions.

    No matter how many times you tell people correlation does not equal causation if it benefits their ego to believe something they will. Who can blame them?

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