Identification of the CDS/Housing Crisis

[racemize]

Hi all, I've read quite a bit about the various bubbles and crashes in the stock market throughout US history.  Many of them seem readily identifiable during/prior to the time that they occurred (e.g., various times when stock become extremely overvalued, such as tech bubble, 1929, electronics boom, etc.).  However, I'm curious as to how identifiable the current crisis was--was the board/members of the board aware of what was happening?  Additionally, how identifiable was it for individual companies, such as AIG?  In that case, my understanding is that many of the CDS contracts were written under a single rogue group, which seems fairly hard to spot.

[Guest]

Personally, I had an inkling of it. That's why I stayed mostly away from financials and getting aggressive in early 2008. I read about some of the stuff from Bill Fleckenstein. I can't say I understood it completely, but through luck and being a bit of a chicken, I weathered the storm fairly well. To be honest, I did lose some money though.

[PlanMaestro]

Hi all, I've read quite a bit about the various bubbles and crashes in the stock market throughout US history.  Many of them seem readily identifiable during/prior to the time that they occurred (e.g., various times when stock become extremely overvalued, such as tech bubble, 1929, electronics boom, etc.).  However, I'm curious as to how identifiable the current crisis was--was the board/members of the board aware of what was happening?  Additionally, how identifiable was it for individual companies, such as AIG?  In that case, my understanding is that many of the CDS contracts were written under a single rogue group, which seems fairly hard to spot.

 

I think many did see it. I remember this site that had a virtual rollercoster based on historic housing prices ... it was fun to ride it.

 

http://video.google.com/videoplay?docid=-2757699799528285056

 

What was difficult was finding a way to profit from the bubble. That was the genius of Paulson, Burry and others.

[netnet]

Hindsight bias is such that what is perfectly obvious now was at best dimly perceived at the time.  That said, finding a way of profiting was very hard.  (or at least it was beyond me!)  Even those expecting a down turn did not expect the cataclysm that occurred.

[ubuy2wron]

Hindsight bias is such that what is perfectly obvious now was at best dimly perceived at the time.  That said, finding a way of profiting was very hard.  (or at least it was beyond me!)  Even those expecting a down turn did not expect the cataclysm that occurred.

 

I was pretty sure that a bubble existed in US housing by the end of 2006 the home builders were in a tail spin which I surmised was a pretty reliable tell. I felt the best way to play it was to purchase puts on the companies selling the worst mortgages hence I purchased puts on Country wide in June of 2007. Shorting country wide did not start to work until almost a year later. I would like to be able to relate how I made a bundle on my country wide bet but the options I purchased actually cost me some money as I got in too soon. The lesson learned is that it is ALWAYS difficult to see which side is winning the war in the thick of the battle.

[twacowfca]

Hindsight bias is such that what is perfectly obvious now was at best dimly perceived at the time.  That said, finding a way of profiting was very hard.  (or at least it was beyond me!)  Even those expecting a down turn did not expect the cataclysm that occurred.

 

I was pretty sure that a bubble existed in US housing by the end of 2006 the home builders were in a tail spin which I surmised was a pretty reliable tell. I felt the best way to play it was to purchase puts on the companies selling the worst mortgages hence I purchased puts on Country wide in June of 2007. Shorting country wide did not start to work until almost a year later. I would like to be able to relate how I made a bundle on my country wide bet but the options I purchased actually cost me some money as I got in too soon. The lesson learned is that it is ALWAYS difficult to see which side is winning the war in the thick of the battle.

 

There are clear financial bubbles that are easy to spot, and sometimes it's possible to predict probabilistically within a narrow window when they will pop, according to the research of Didier Sornette.  The Nasdaq bubble that popped in 2000 is a good example. 

 

The most recent housing and stock market unpleasantness that reached a max in  2006 -  2007 didn't display the dramatic upward acceleration in prices that is characteristic of a bubble about to pop.  Instead, these series looked more like markets that were about to roll over more gently.

 

However, this at first mild rolling over uncovered the instability in the system.  This instability led to a phenomenon like the downward LMX Spiral in the 1980's.  The extent of the potential for a death spiral was not evident merely from looking at charts in search of a bubble pattern.  Only a few gifted people were able to forsee the extent of the potential downward spiral, excluding permabears.  This was quite a contrast to the 2000 Nasdaq bubble that anyone not self deluded could have identified.

[returnonmycapital]

I have found that rental yield is a pretty good valuation indicator for real estate. It is not necessarily the easiest data to collect for an entire nation. But if you can compare the annualized rental obligation on a property (net of property tax & insurance) to that of its then market value, and compare that yield to the yield on a mortgage, treasury bond, equity index earnings yield, etc. you can get a pretty decent idea of the relative attractiveness of real estate as an asset class.

 

The areas worst hit in the US were also the areas where the rental yields were very low. People were buying real estate based on future capital appreciation only - yikes. If it doesn't work as a business, it shouldn't work as an investment.

 

The standard retort is: "People need a place to live." But rational people will tend to rent when rental yields are low. The opposite when they are higher than the cost to own. Assuming the law favours real estate as a business (no strange tenant rights, etc. that make it difficult to have 25% or 30% of a nation's real estate market as rental). My father-in-law learned this lesson recently. Owning masses of real estate in southern Europe where the rental market is anti-landlord and yet rental yields were still almost non-existent. That debacle was pretty easy to foresee.

 

The demand/supply should move with demographic trends. And a nation does not need a supply of residential units that is well beyond its near-term demand. And the missmatch shows up in rental yields. Where I am from, it takes about 1 1/2 years to buy a site, plan/approve, build and move in or sell. So supply can pretty easily keep up with natural demand. At least where I am.

 

Incidentally, where I am from, rental yields on new-build condominiums units (high rises) are between 2 & 3% presently. Factor in 1% property tax & insurance and 1% condo fees and you'll see what I mean by 0% value. But they're still building...

[Valuebo]

Exactly Returnonmycapital!

 

I have been looking at the same indicator for valuation of real estate here. Here (Belgium, Flanders) too rental yields are at decade lows, especially closer to larger cities. Everyone seems to believe real estate is the best investment you can make and that the value will only go up. Most people I talk with believe that valuation simply doesn't matter for your own home.

 

I've been looking at a lot of specific situations because someone in our family is planning on buying something (renting now) and it's just crazy. Gross rental yield is below 3% on average. If it's higher, it always needs a lot of work. Then you still have taxes and costs which can run up to 2-2,5%/year. Historically gross yields are probably somewhere between 5,5-7%.

A simple saving account yields 1,7-2,25% net! No work, no worries, safety, liquidity, ... And honestly, I don't see how the current economic situation is going to help. The market is currently being supported by low borrowing costs and tax advantages (that we can't really pay for) and the madness of the crowds.

 

But maybe it isn't crazy enough yet to call it a bubble. I don't know, but net rental yield is close to zero and well below inflation and capital appreciation is a myth at current prices. Can someone help me find the historical rental yields in the US before housing collapsed?

 

This article from The Economist is disturbing. Look at Canada, Australia and France. Ugly.

http://www.economist.com/node/21540231?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Counterparties+%28Counterparties%29

 

 

 

[netnet]

I liked Didier Sornette's dragon king paper--at least the parts that I understood!  What paper was the best on forecasting bubbles?

 

 

[Valuebo]

I've got a new one:

 

"Houses are more expensive now because the overall quality and luxury in housing has improved."

 

That must explain the 68% price increase (after inflation & adjustment for population) over the last 10 years in Belgium and the 400% increase in Norway in 20 years. Silly me.