Smells Like Trouble...

I was listening to some Sunday afternoon gossip today while checking out open houses in the valley. A couple properties were amateurs who jumped into "flipping" and are now in a lot of pain with vacant houses and multiple mortgages. Right here in Sonoma.

Three other houses were folks who "upgraded" before selling their previous house, and badda-bing it was like a memo just went out and overnight the market changed and now nobody wants to bail them out and hold their bag for them. They are now paying two mortgages every month. Another story was kind of sad if you really stop to think about the loss ramifications of their kind of thinking.

A couple bought one of those built in the 1940's can't lose, real estate only goes up, sure thing, everyone wants to live on the East side of Sonoma houses. They went in for cosmetic fix-it up touches, did a lot of work themselves and slapped a million dollar price tag on it to sell ($1,379,000). They were sure a bucket of money was in the bag.

This house is a repeat offender on the Price Reduced list. 3bd/2.5 bath & 1800 sq. ft.
The latest listing information has it on the market for 219 days and going through 5 price reductions.

The current owners caught a fast falling knife as the market was tanking and paid $1,025,000 in January of 2006. The previous sale of this house was: 1991 for $330,000

Starting price: $1,379,000
Current price: $1,150,000
Total Reduction: $229,000

Zillow says: $996,387

This house has appreciated: 340.8% in the last 10 years. Does that sound reasonable to you? Give me one good reason why a reasonable person would believe this.


Conditions in Sonoma County in January of 2006: (news that was available to the general public if they had been inclined to put down the "you can't lose kool-aid")

Sales had declined -23.2% yoy
Median was up 14.8% (probably BECAUSE of their purchase of this house.)
January was also the fourth month in a row that sales were off by double digits year-over-year. The total sales for January 2006 was the lowest number since 1998.

Hmmm....

Maybe it is time to check in and see just where we are in the stage of the bust?

"Can It Happen Again?" -- a book about Booms and Busts was written in 1982 by Nobel Laureate Hyman Minsky. In this book, he described the seven stages of a financial bubble. (commentary below by the controversial Robert Kiyosaki emphasis in green is mine)

Stage 1: A financial shock wave
"A crisis begins when a financial disturbance alters the current economic status quo. It could be a war, low interest rates, or new technology, as was the case in the dot-com boom."

Stage 2: Acceleration
"Not all financial shocks turn into booms. What's required is fuel to get the fire going. After 9/11, I believe the fuel in the real estate market was a panic as the stock market crashed and interest rates fell. Billions of dollars flooded into the system from banks and the stock market, and the biggest real estate boom in history took place."

Stage 3: Euphoria
"We have all missed booms. A wise investor knows to wait for the next boom, rather than jump in if they've missed the current one. But when acceleration turns to euphoria, the greater fools rush in."

"By 2003, every fool was getting into real estate. The checkout girl at my local supermarket handed me her newly printed real estate agent business card."

"The housing market became the hot topic for discussion at parties. "Flipping" became the buzzword at PTA meetings. Homes became ATM machines as credit-card debtors took long-term loans to pay off short-term debt."

"Mortgage companies advertised repeatedly, wooing people to borrow more money. Financial planners, tired of explaining to their clients why their retirement plans had lost money, jumped ship to become mortgage brokers. During this euphoric period, amateurs believed they were real estate geniuses. They would tell anyone who would listen about how much money they had made and how smart they were."

Stage 4: Financial distress
"Insiders sell to outsiders. The greater fools are now streaming into the trap. The last fools are the ones who stood on the sidelines for years, watching the prices go up, terrified of jumping in. Finally, the euphoria and stories of friends and neighbors making a killing in the market gets to them. The latecomers, skeptics, amateurs, and the timid are finally overcome by greed and rush into the trap, cash in hand."

I think ALL of 2006 we were in the beginning of Stage 4. We are now entering the second half below...

"It's not long before reality and distress sets in. The greater fools realize that they're in trouble. Terror sets in, and they begin to sell. They begin to hate the asset they once loved, regardless of whether it's a stock, bond, mutual fund, real estate, or precious metals."

Stage 5: The market reverses, and the boom turns into a bust
"The amateurs begin to realize that prices don't always go up. They may notice that the professionals have sold and are no longer buying. Buyers turn into sellers, and prices begin to drop, causing banks to tighten up."

"Minsky refers to this period as "discredit." My rich dad said, "This is when God reminds you that you're not as smart as you thought you were." The easy money is gone, and losses start to accelerate. In real estate, the greater fool realizes he owes more on his property than it's worth. He's upside down financially."

Stage 6: The panic begins
"Amateurs now hate their asset. They start to dump it as prices fall and banks stop lending. The panic accelerates. The boom is now officially a bust. At this time, controls might be installed to slow the fall, as is often the case with the stock market. If the tumble continues, people begin looking for a lender of last resort to save us all. Often, this is the central bank.
The good news is that at this stage, the professional investors wake up from their slumber and get excited again. They're like a hibernating bear waking after a long sleep and finding a row of garbage cans, filled with expensive food and champagne from the party the night before, positioned right outside their den."

Stage 7: The White Knight rides in
"Occasionally, the bust really explodes, and the government must step in -- as it did in the 1990s after the last real estate bust when it set up an agency known as the Resolution Trust Corporation, often referred to as the RTC. As it often seems, when the government does anything, incompetence is at its peak. The RTC began selling billions of dollars of unbelievable real estate for pennies on the dollar. These government bureaucrats had no idea what real estate is worth."

"In 1991, my wife Kim and I moved to Phoenix, Ariz., and began buying all the properties we could. Not only did the government not want anything to do with real estate, amateur investors and the greater fools hated real estate and wanted out. People were actually calling us and offering to pay us money to take their property off their hands. Kim and I made so much money during this period of time we were able to retire by 1994."

"This is why I say, "I love market crashes."'