History Always Repeats Itself - Part 1

Thanks for your post RE-Economist - I think the link re the auctioneering got duped from the 1988 link. Maybe you can repost the link - very interesting reading.

Nevermind - think I found it.

http://www.nytimes.com/1991/05/05/realestate/gavels-falling-in-manhattan.html?scp=5&sq=may%201991%20iver%20peterson&st=cse

Good thread, good insight.

Matches a lot of what I've been saying for quite some times... these things take YEARS to "bounce".

Nice, thoughtful posting, RE_Economist!

one thing to remeber is that interest rates are MUCH lower than during the last slump, so that should keep the floor in housing prices higher.

Interest rates are meaningless in the long-term. In the long-term all that matters is carrying costs to income, which are the same as rents to income.

So if interest rates fall 1% but incomes fall 50%....

Agreed, good insight and worthwhile citations on the last downturn. Mapping out the possible timeline for this one makes me think I wont be buying again until 2012 or later!

I like your 6 points. For the most part, they are applicable to almost any RE market recession. One of the few sensible posts I have read here in weeks.

and I bet that all the way down 1988-1994 brokers were using any hint of higher activity to predict a bottom.

"one thing to remeber is that interest rates are MUCH lower than during the last slump, so that should keep the floor in housing prices higher. "

Of course, since the ceiling was 10x higher, thats not going to mean a whole lot... not to mention incomes in the toilet.

"one thing to remeber is that interest rates are MUCH lower than during the last slump, so that should keep the floor in housing prices higher"

Steve is absolutely correct in that interest rates are meaningless in terms of comparing macro conditions around pricing trends across two time frames.

But while we are at it, just imagine how much downward pressure on pricing will occur when inflation kicks in and a 30 yr jumbo hits 10+% for qualified buyers.

bjw2103,

The nasal sourpuss will be here to dispute this.

nyc10022, you have been saying this for sometime and so have I.

Low rates are bearish, not bullish. That removes a potential stimulus to the market (rates falling).

Thanks for an excellent post.

Re Interest Rates: Thinks are so volatile, so much money is being printed, that to value anything based on today's rates would be a mistake. Inflation is practically guaranteed and if it doesn't come that means the economy is in really really bad shape, which does not bode well for RE here or anywhere.

I don't see massive inflation in the near future. For those on the Peter Schiff bus, the dollar has not collapsed. Instead, it has actually risen against most foreign currencies.

also, China has said they will continue to buy our T Bills so as long as they do that, I don't see how we can have inflation.

You might be right Alpne292 but wouldn't that be because the reflating, easy money, printing money strategy of the whole damn govt, has not gotten growth rolling, so that there would be a bad market for RE. If inflation does come along it will send rates shooting higher, perhaps resulting in very high real rates as investors have to be compensated for the inflation risk volatility. And no matter what, NYC hyped real estate bubble is clearly bursting, so the hype element is gone for a long long time, and will continue to put downward pressure on prices.

RE_ECONOMist.... you I like....

Considering that housing prices make up a HUGE chunk of the CPI, gonna be tough to have inflation anytime soon.

This notion that gets tossed around as fact on many of these threads that we are certain to have massive inflation (recent example: "Inflation is practically guaranteed") essentially assumes that current Fed policy, which is admittedly loose on an epic scale, stays that way forever. If that's the case, then yes, we will eventually be looking at Germany in the 1920's for precedent. However, we have also experienced an epic shock to confidence and demand, combined with a collapse in the velocity of money, that together make the immediate risk of inflation minimal. The medium term outlook is pretty simple. If the Fed reigns in monetary policy appropriately as demand recovers and the banking system regains its footing (i.e., velocity and the money multiplier recover), we will not have an inflation problem. If it doesn't, we will, and yes, in that case it could be a big problem.

This will end up being an interesting case study in the independence (and therefore future credibility) of the Fed. The big worry should not be current Fed policy but the risk that Congress (in particular) and the administration will prefer to inflate our way out of the current problem and let the currency slide, and that the Fed will not have the guts to stand up to them. A big risk, admittedly, but not a certainty, so as a result I don't see rampant inflation as certain.

Thanks for this analysis - did not read all of the support documents, but methinks I get the gist!

sidelinesitter who was your ecom prof in college? or did you get that knowledge for free from SE? :)

sidelinesitter, I agree with you entirely. what do you think the odds are that the Fed can time money withdrawal/moderate interest rate increases properly under these circumstances? i know Bernanke came out recently with some talk of trying to formulate a plan.

and if they can do so, doesn't that beg the question of why the f*** they couldn't have done a better job interpreting where and why the money was entering the economy from 2003-07?

"one thing to remeber is that interest rates are MUCH lower than during the last slump, so that should keep the floor in housing prices higher."

Ummmm....no, actually, it means that there is one less arrow in the quiver to fight this thing! Rates had a long way to fall in the recession of the early 90's...now, they have nowhere to go, except perhaps up if Obammy's spending has the impact his economic team hopes it will have.

Sidelinesitter -- excellent point. Quite a few economists don't think they can pull that off, but who knows.

In any case, in my simplistic view, regardless of inflation, overall economic growth, consumer confidence, etc., the fact is that there was an irrational bubble in NYC real estate, and there is a permanent decline in size and income of a major part of the NYC economy (finance industry), which is not likely to be replaced shortly by growth of other sectors, so..no matter who is right about the macro issues...NYC is deflating from a bubble, and nothing can stop that. Macro economic issues could exacerbate or slightly ameliorate the bubble popping process, but not change popping.

It would also be interesting to compare demographic trends in the late 80s to now. Don't we have a lot more empty nesters and retirees on the east coast, who, 20 years ago would have been parents needing large homes? Don't we have a lot more people in their 20s and 30s who haven't had kids yet and want to live and work in the city? How do these trends impact demand for housing? Will smaller, lower cost housing be all the rage? Even for the wealthy?

Will the fact that rich people are struggling desperately to sell their enormous digs impact the way in which wealthier people purchase real estate in the future? I'm thinking that diversification could be the new buzz word in real estate investing, which could mean that demand will exist for smaller units, but will dry up for large, expensive units.

Who will be demanding large-sized housing in the future if large families are no longer all the rage?

stevejhx
about 7 hours ago
ignore this person
report abuse Interest rates are meaningless in the long-term. In the long-term all that matters is carrying costs to income, which are the same as rents to income.

Can you explain?

abouteady - I don't delude myself about having a crystal ball, so I'll pass on the invitation to give odds.

Your question is important though. As I wrote the post, I was thinking that a major qualification to the whole thing is how effectively the Fed can actually implement a reversal of current policy - a monetary soft landing, if you will. If you are suggesting (as jimse does explicitly) that it could be rocky, I agree with you. And that is assuming that the Fed actually tries hard (see my previous point about political interference). For example, I don't think that Bernanke has anything like Paul Volcker's backbone when it comes to tight but necessary monetary policy. To your last question, yes, big boo-boo on the Fed's part on 2003-07 and cause for concern about how they handle the back end of the current cycle.

For you serious economists, it may be a simplistic take, but what do you think of the view that the bubble has/is burst in NYC and that regardless of macro issues with the whole economy the market here is much more likely than not bound to move to lower level (from which macro issues will effect magnitude). [Put differently: the tech bubble in numberous company stock valuations was such that there was truly nothing the govt could have done to reflate prices of those stocks, and of course they did not try, but instead pumped easy money into the economy that ended up in real estate]

sidelinesitter, wasn't really asking for the crystal ball, just an opinion since I respect what you've been posting.

And you're right, how hard the Fed tries depends on their current perceived needs, which could be greatly influenced by so many things.

watchnwait, I LOVE demographics, really. faxcinating, all around. but your problem with looking at demographics (as reported) right now is that it is moving faster than models can account for.

jimse
I agree that the bursting of the Wall Street bubble - in employment, income level of those who remain employed, wealth and, very importantly, confidence in the outlook for all of the above - is the game changer in Manhattan RE. At least at the high end, but probably all over through pricing to relative value. Macro indicators - GDP growth/decline, inflation, national housing mkt trends, etc. - don't seem to me to have the direct shock impact in Manhattan of the evaporation of Wall Street wealth creation as we knew it.

One macro factor that could be more significant in terms of impact would be interest rates. There have been a lot of posts in recent days on this topic and I am not the most informed by any means. Intuitively, I am skeptical about low interest rates as a cure-all. If banker X doesn't know if s/he will have a bonus, or even a job, next year, does the monthly payment really matter? More likely, banker X is not a buyer of any property at any price until the storm clouds clear. Also, in the case of coops a large % down payment and ability to pass the board are at least as large constraints on purchase price/ability to pay as mortgage rate. Low interest rates have to help compared to the alternative, but I'm not sure it's clear how you put numbers to it.

I would also note that a number of posts in recent days have argued that Manhattan is more than just Wall Street. They have been on both sides, arguing on the one the hand the bear case that other industries are also getting killed and on the other the bull case that diversity means that the market does not live and die by Wall Street alone. This either augments your argument or weakens it, depending on the side you take. I tend to see the world more through the Wall-Steet-makes-the-Manhattan-real-estate-world-go-around lens, because the scale is so huge and it is what I think I understand. But that's just me, and I don't really undertand the size and economics of the other industries.

If this was a bubble , truly a bubble, that means prices did not make sense even given the state of the economy during the bubble, ie before the decline of the finance industry. That is my view. The decline of Wstreet is a severe exacerbating factor, and was sort of the pin that pricked the bubble. But it was a bubble , so saying 'ny is not all Wstreet" doesn't mean RE will not severely correct. Because it was a greater-fool, bubble in large part.

Again, the tech bubble burst and there was no going back to those crazy valuations, and in retrospect everyone thought " why were we so foolish", and the answer of course was greedy, human nature herd instinct. No one argued after that bubble burst that "if only the govt macro policy was this or that, stock tech prices would come back ".

Now in NYC we will see something similar. People are just now starting to take a deep breath and ask whether $1200 psf for apartments, or even more, makes any sense other than in a greater-fool world. I think it was nutty and that that will be the concensus shortly. But...we have to wait and see.

jimstreeteasy, in 2004 I asked myself where the hell is this purported "wealth" coming from to cause prices to take off like a bull looking at a red flag. Couldn't find an answer. Productivity increases were real, and could account for some of it, emerging markets and the weak dollar could account for some more, but I couldn't figure out the equation until 2007 when I looked into buying and was told that "nobody has to put down more than 10% for a condo anymore, including, generally, large jumbos." I thought, holy shit, batman, why the fuck hasn't anyone been talking about this??????

sidelinesitter, NYC is more than Wall Street. But people are putting off going to the doctor because they don't have great insurance (or any), lawyers are having clients default on bills at an unprecedented rate, who wants to pay for advertising to a consumer who has no extra disposable income, etc.? I'd say that we'll come out of this eventually, and we will, but at what cost I'm not certain. Go to wwww.ritholtz.com and check out the 1999 and 2009 graph charts of bank market caps. The corporate titans have well and truly screwed us, all for a few decades of profit.

As for real estate, NYC is really a remarkably small market for such a large city. 10000 sales in a good year, 6000 in an average year. You add the huge numbers we've seen in the last few years to Wall Street's ranks, along with the huge income increases, and you have an immediate shortage of properties to buy. If those additional employees, and their wages, weren't justified by anything more than artificial wealth creation, well, there's your bubble. jimstreeteasy, don't you sometimes look at the shack in Orange County and wonder why the hell someone would pay $800K for it? The same is true for the $1M studio in NYC, but probably, in the end, more so.

With bubbles, the way up is driven by irrational exuberance and most people will remember the ridiculously inflated valuations on the way up. When the bubble pops (for lack of a better term) most observers simply stop observing as it's typically of little interest to watch something bleed out. This emotional disinterest creates an abandonment of the asset class and a sharp immediate downturn is felt.

The same groupthink that created a bubble effect will also drive perception to the downside in equally irrational ways. A good example would be the dot come era where it made sense, at that time, for a VC funded company with no revenues or customers to be valued at $10bn based off the size of the potential market. A year later, economically viable and rapidly growing companies were trading at single digit P/E ratios because the ship was burning and emotions said get the heck out of dodge. I am not directly comparing the stock of dot coms to Manhattan RE as there are a world of differences, but I am pointing out the repeatable behavior patterns associated to bubbles.

I am quite confident the irrational exuberance that led people to purchase $2000/sf units across the city during the development boom will also create an opportunity to eventually purchase these units, in some cases, below their construction costs. I believe a good indicator of this occurring would be when multiple new developments or blocks of unsold apartments are auctioned off without a reserve.

Great argument RE_Economist. And great list of articles.