Bubbles can take a long time to unwind and can go on for longer than anyone would reasonably expect. All one needs to do is look at the stock market bubble that popped in 2000. There were several people calling it a bubble in 1997, 1998, 1999, and early 2000. Take a look at this chart of the Nasdaq 100 ETF. If you shorted this tracking index in 1999, just a year before the bubble popped, you had to withstand a near 50% price increase before the top in April 2000. Don’t think that calling tops and bottoms are easy and that they will always be obvious. If it were easy, we would all be rich.
To get some perspective on how long these things can take, read this story about poster “Rimpy” from the Motley Fool message boards. He believed that the stock market was in a bubble back in 1997. I was on the Motely Fool boards back in those days and Rimpy had to endure tons of ridicule. He was one of the few bears amongst a herd of bulls who were making money hand over fist. Internet stocks would double and triple in a matter of months and then, amazingly, double again in a few more months. People thought stocks would go up forever back in those days. Of course, stocks eventually came down, but now before an amazing run that virtually no one predicted.
You can also see from the Nasdaq 100 chart that the value of that index went from 120 in 2000 to 20 in 2003. I don’t think even the most ardent bear on this board is looking for an 83% decrease in housing prices, so that bubble was much more pronounced than the current housing bubble. The collapse of that bubble didn’t lead to a collapse in our economy, so I doubt that the popping of the housing bubble will destroy our economy either.
Another thing that is going to temper the drop in prices is the lack of liquidity in the housing market. Stock markets are much more subject to emotion than housing markets due to the liquidity. It’s easy for most anyone to buy and sell a stock — not so easy to do with a house. Plus, houses have value above and beyond their economic return. Many people will pay more to buy a house than they would pay in rent just so they can have the stability of ownership and can fix up their place the way they want.
Additionally, you would be amazed at the number of people that have no idea how to value a house. I was talking to a colleague the other day and she told me that even if she decided to move out of her condo, that it would provide good rental income. Equivalent condos near her are renting for about half of her ownership costs. It’s so obvious that this would make a terrible rental property given her carrying costs, but she has been brainwashed to think that owning is always better than buying.
Finally, there are several owners that will do whatever they can to hold onto their houses. Their dream is to be a home owner, so they will get a second job or cut back on other expenses in order to afford their mortgages. The extra work and cutbacks will go towards salvaging a terrible investment, but they won’t care. They are just desperate to be home owners.
