Binge and Purge, Baby! Binge and Purge!

Advice from a Senior Analyst at UCLA

"Buy a house, just don't expect to make any money on it until 2012. Get a mortgage, just don't get a negative-amortization loan or an interest-only loan, because you may well find yourself foreclosing on it. Read the press releases from National Association of Realtors, just don't believe them.

That's just three of the gems Chris Thornberg, a senior analyst at the University of California, Los Angeles Anderson Forecast spent an hour showing off and polishing Thursday morning.
Thornberg, who was in town for an economics roundtable at the UCSD Faculty Club, gave the crowd of mostly faculty, economists and industry insiders a sneak preview of some of the Anderson team's forecasts for 2006 and beyond. He predicted -- not for the first time -- dire straits ahead for California's economy as a direct result of the so-called housing bubble.
"Yes, I used the B-word" grinned Thornberg at the start of his breakfast speech. "…We're in a home-driven economy from the top down."

Drawing parallels with the dot com crash, Thornberg discussed the reasoning behind his many bleak predictions at length.
He said the real estate market has witnessed nothing less than an extraordinary run-up in prices, with 10 consecutive quarters of above-average price growth. At the same time, Thornberg said, while employment has remained steady, job growth has been in sectors directly related to the real estate boom. A boom constructed around building homes, trading homes and remodeling homes is simply unsustainable, he said.

The real estate fire has been fanned primarily by consumers, Thornberg said, who have spent themselves into the lowest private-savings rate in the United States ever. The average American now spends more than they save, he said, and this "spending binge," -- which is being mirrored by the federal government -- has led to the economy becoming "seriously out of whack."

The Average American's spending binge is being driven by one thing, Thornberg said: Home value appreciation.

To illustrate his point, Thornberg recollected an epiphany he had while eating lunch at a West Hollywood restaurant. Sitting in the booth behind Thornberg and his colleagues was a trio of actors, who were discussing home vales. Thornberg recalled the conversation he overheard.
"One of them said 'Dude, my condo's gone up in value by $100,000, what should I do,' his friend told him 'Pull it out, buy yourself another condo. … It's free money.' "

That "free money" line sent shivers down Thornberg's spine. He said it signaled to him just how dangerous the real estate "feeding frenzy" could become.

Thornberg said all the statistics show that he was right to be concerned. In the past, when the real estate market has seen bubble-type home price appreciation, things have been more measured. In the bubble of the 1970s, home prices appreciated 55 percent, he said. In the 1980s, they rose 45 percent. In this latest boom, prices have increased 85 percent.

"A bubble is when the market price of an asset has no basis in what the rate of return on that asset is going to be … when the fundamentals say one thing and the market says another," he said.

That's the market we are in right now, Thornberg argued.
The real value of a home is defined by its rental value, he said, and in California rental costs have simply not kept up with home values. The value of homes in California in 2006 are akin to Amazon.com's $200 per-share value at the peak of the dot com bubble. That share price was never realistic, because it didn't take into account the fundamental economic factors at play. All the indicators are saying one thing, but the market is doing another, he said. That's a bubble.

He's expecting home prices to drop slowly and steadily for many years to come. There isn't much historical data to illustrate what happens when a superheated real estate market like California's finally loses its steam, but Thornberg said the best example is what happened to Japan's real estate market in the early 1990s. Japan's homeowners saw their home values sink gradually over the next 15 years, and Thornberg thinks something similar likely to happen here.
But when's it going to start happening?

"Every economic bone in my body is saying that this is the peak, we've got to start coming down the other side," Thornberg said.

Valerie Ramey, a professor of economics at UCSD was at the roundtable. She said Thornberg gave a refreshing look at a lot of ideas that have often been floated but are rarely backed up by such compelling data.

"It was very solid statistics, very solid analysis, good theoretical basis -- everything was there," Ramey said.

John Karevoll, chief analyst at DataQuick, a real estate information service, said he has a lot of respect for Thornberg and his work. Though Karevoll did not attend the UCSD presentation, he said he has discussed many of these theories with Thornberg before.
If there is a bone to pick with Thornberg's research, Karevoll said it is with his timing.
"He was saying the same stuff three and a half years ago. During those three and a half years in San Diego we've had prices almost double," Karevoll said.

That's a point that Thornberg addressed during his presentation. He lumped it together with a number of other "real estate myths," as he wrapped up the talk. Then he sought to explain exactly why it is that he and other bubble-predictors have been so off on their timing.
"Asking us what's the market is going to do is like asking a psychiatrist 'What's that crazy guy going to say next?' The answer is we don't know. If we did, he wouldn't be crazy.""