How Tales of ‘Flippers’ Led to a Housing Bubble
nytimes.com
nytimes.com
The big changes to the market when the bubble burst was an oversupply of housing. Mom and pop flipping does not create an oversupply. There's one property at the beginning and one property at the end (in most cases, though there are a myriad of edge cases). Instead the oversupply was created because the important product was in the B2B sector.
The bubble created an oversupply because housing was built as a precondition for generating mortgages. Every extra dwelling built during the bubble generated another mortgage or two for the mortgage market. Big national homebuilders built houses to generate mortgage loans to flip. Local and regional banks wrote construction loans to generate mortgage loans to flip.
The buyers of the loans flipped them off to pension funds and institutional investors. Wall Street loved it for very rational reasons. Individual homeowners were not driving loan prices down and real estate prices up. Sure they thought they were savvy rather than lucky when their house appreciated. But they weren't generating the message.
Pointing to an obscure book as causal misses years of nightly news and decades of standard best industry practice advice that buying a home is a way to accumulate wealth.
The aggregate effect of the mortgage interest tax credit, on the housing market however, is highly dependent on how much income tax can be written off with it, which is itself highly dependent on how much income middle america makes. This is a volatile figure.
Banks have to have limited liability in order to function. They accomplish this limited liability through explicit hedges called insurance policies.
Insurers, unfortunately, have no such requirements to limit their liability, and in this case were liable for VASTLY more than they were worth.
The problem is that this is a rational strategy. As soon as your liability goes beyond what your company is actually worth, it no longer makes any sense to try to limit your liability on other investments. In fact you want to take on as much liability as possible. If someone gives you a loan which you could never repay, then rational behavior dictates that you go to vegas and put the entire sum of the loan on red. If you win, you pay your loan back, and if you lose, you declare bankruptcy.
The only problem with this is that it is fraud. This is where the story gets interesting, because the only thing required for the insurers to maintain plausible deniability in the event of a default on their massively overleveraged positions was for an "independent third party" to call the investments that they intended to insure "triple A".
Regardless of whether or not those agencies were truly independent, the fact is that they are an unacceptable point of failure.
However, in this case, I find the narrative to be simplistic. It is almost shockingly narrow to pin it specifically on tales of house flipping. Yes, lots of people thought buying a house was a good investment, but the attribution to an enthusiasm about house flipping doesn't hold water for me.
Like what?
That is just my perspective on it. I'm a bit apprehensive about characterizing the entire field of conventional economics as I've done. There is a large amount of variation in opinion among economists. But my feeling is that the prevailing consensus before Shiller was about rationality.
Some will say that Shiller didn't come up with the idea, that it's just a packaging of what Keynes said about Animal Spirits. Consider this quote from Keynes, for example:
"Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic"
In any case, Shiller has received a large degree of credit for consistently pressing the issue, and he was lucky enough to be pushing it forward right before 2008, which many saw as a validation of his theory.
All the tales of flipping in the world are not sufficient by themselves to cause a bubble. On the contrary, given the right conditions then tales of flipping will arise and will be symptoms, not causes.
The bubble that led to the great recession had a number of causes, with the most fundamental cause being credit inflation. Other causes included distortions of credit markets causing pressure to direct credit to mortgages, which set off the vicious cycle of demand leading to price rises leading to more credit leading to more demand leading to... Among such causes was a dearth of investment opportunities in aging (low-fertility) Europe. But also the regulatory and tax environment in the U.S. causing more credit being made available for mortgages, and tax preference given to renting capital over renting property.
Flipping? That's just a natural consequence of the rest -- a symptom, a sign of the debacle that would come. In those heady days no one wanted to see such symptoms for what they were. No, people took them as symptoms of the opposite: of a healthy market that would only ever go up -- and sure, in this sense "tales of flipping" added pressure, but they were not _the_ cause, nor among principal causes, and not enough a cause to be listed as such rather than a symptom. Without apparently-ever-rising markets those tales would not have existed in notable numbers.
The funny part is that every single person on the ground, from the flippers to the guy sweeping trash knew exactly what was happening. No one hid the fact that you could buy a dingy house for 200k, put in 50k of work, sit on it, and sell it for 400k.
There was a lot of other interesting types of people as well. I was aware of a company who flipped, but their entire strategy was to move nice furniture into the place to make it "feel" more expensive. Aside from paying day laborers to move the furniture, they didn't spend any money.
It was a perfect storm of people moving across country, free money, and people willing to exploit the situation. The silly part was that there was a mini-pop around the year 2000, and everyone knew history would repeat itself. It was a mad rush to get it while it was good.
I know all of that is ignoring the toxic bank loans (which the flippers took advantage of as well), but just my experience and observation.
You can sometimes see this in financial advice on forums like these: "buy rental property!".
TINSTAAFL. Economic returns tend to even out across asset classes. Of course your highly leveraged rental property looks good amidst a housing boom. Being a landlord isn't easy and has many legal obligations.
Obviously this can happen to varying extents among other equity markets but lenders are much more likely to give someone a $400,000 loan to buy a house than to buy stock. I don't think this is necessarily sustainable.
Government backstop.
But I hear you. I understand the intentions of subsidized mortgages: housing is a necessity, it (generally) appreciates over time so it's "safe", it provides forced savings etc. But too many people are able to take advantage of the subsidies in indirect ways.
I know people house shopping in British Columbia. They have been approved for a mortgage at 10x their household income. Parents are making the down payment. Bank is fine with it, I guess. How does that work?
Buying a property on cash and renting it out is totally sound, with low risk. As an investment vehicle, it is often poor as the same amount of money would likely give you better returns elsewhere. If house values go down, it'll suck, but you don't have a mortgage so it's not too bad. If house values go up, you win even more.
Buying on loan is risky if the value goes down, but that's again an issue with any investment. The upside, though, is that as long as the price doesn't drop too much, your renter is paying for the house for you. You can put $50K down on a $300K house, and the renter is working for a living to ensure you own the house. This can be a phenomenal investment, but it does have a larger risk.
I know multiple people in my town who bought houses and rent them out (some percentage is through loans). Both have recently quit their day jobs, because the rental income exceeds their spending needs. Now they've been lucky: Rent has gone up 30-40% in the last few years. But if prices go down, and they have to lower their rent, they'll simply go back to work. In the big picture, it is extremely unlikely that this will result in a net loss, even with another housing crisis.
>Being a landlord isn't easy and has many legal obligations.
If you do all the work yourself, it sucks. Everyone I know uses property management companies. One guy who's been at it 7-8 years said it's never been a pain. Might have to deal with a repair once or twice a year (i.e. much less than one repair per house). Everything else is handled by the management company. Yes, they take their cut, but he still has enough left over to relax at home and not have to work.
Everyone I know who uses property management companies would describe it like regular expressions. I.e. I became a landlord and now I have a problem in that I have to deal with tenants.
I tried to solve that problem with a management company.
Now I have two problems.
Management companies are not a panacea. Many suck. The rest are expensive.
And nothing stops a tenant from vandalizing your home and skipping town.
As far as I'm concerned being a landlord is a sucker's game.
Landlord insurance covers this.
And if they violate their lease, PMC lawyers can help.
But so far no one I know had to deal with this. All the headaches I've heard come from people who did not use a PMC: They found tenants themselves, so their vetting was poor compared to that of a PMC. They get repair calls at all times of day - not an issue with a PMC (tenants do not know your name or number). Tenants stop paying: Doesn't happen because the PMC vetted the tenants. But if it does, the PMC deals with it.
It's also troubling because the origin of bubbles has been combination of econ 101 and psych 101 since Charles Mackay wrong about the Madness of crowds back in the day[1]. Well, ironically, "it's different this time" is one of the constants in these thing.
And simple explanation for this kind of situation is that Feds are resisting the conclusion that inflating the currency lead to the situation, both to avoid blame and because similar tools are still in use [2].
[1] https://en.wikipedia.org/wiki/Extraordinary_Popular_Delusion...
I'm pretty sure my original post wasn't an uncritical call for a deflationary policy since this isn't the only alternative.
Can you think of any country under a market system at any time and place where the market was not characterized by boom-and-bust cycles?
I made money.
That said, it was such an emotional an psychological effort I'm not sure how anyone could ever do this to earn money. I had a very very large leveraged bet, that could have easily went south. Flipping is crazy.
Because at the time people were saying that housing values would never go down.
If ratings agencies did not assign the issued mortgage tranches a triple-A rating, they would not be bought en masse by institutions seeking safety, and their interest rates would reflect that.
Turn on HGTV today and there are more tales of flipping than ever ("Flip or Flop", "Property Brothers", etc.), CNBC just started filming a reality show following a successful flipper ("The Deed"). Go online, and there are pitches from RealtyShares, RealtyMogul or LendingHome advertising "flipper" real-estate-backed loans. Take an amazing journey into your Gmail's "Spam" folder, and you will be greeted by dozens of experts who made incredible money flipping, selling their flipping systems and holding seminars in a town near to you.
Yet we don't see a bubble, because hard money loans are rated accordingly and turn out to be expensive for most people.
In a free market, this would be true. But rent controls make prices sticky, diminishing their utility as an indicator of the balance between supply and demand. In the worst case, you can see rents staying completely flat -- and a large unmet demand for housing because those flat rents take away any incentive to add supply.
The two figures tend to track each other closely in practice, though, so if you're primarily interested in observing trends the distinction is mostly academic. Here's a graph with data for both indicators going back to 1981: https://fred.stlouisfed.org/graph/?g=dM2A
Rent control, or other regulation, takes many forms. For example, my locale has regulations regarding the amount of window space is required in a basement dwelling, which goes beyond how most homes are built. Therefore renting out your basement becomes impossible without major renovations.
As far as I understand, yes, based on the fact that nobody seems to rent out their basement unless their home was specifically built to accommodate the regulation. IANAL, but with the balance of power tilted towards tenants here in Canada, I don't think you'd do well to shun it.
I lived in a few basement apartments as a student. They're generally more affordable, with shared utilities. I think it really hurts the market.
Rent control artificially reduces supply. Price changes come after.
Rent control generally only applies to existing housing, not new housing.
Also, sticky prices is something else entirely, rent controls are typically price ceilings.
>> There is still no consensus on why the last housing boom and bust happened.
Yes there is. There was widespread fraud on the part of mortgage lenders and investment banks. Wow, crazy. Someone give me a Nobel.
Pretty impressive of this guy to then hand wave around and say inane crap like "The problem for economists is that these changes don’t correspond to movements in the usual suspects: interest rates, building costs, population or rents." As if he's unable to stick his head outside of his office and interpret the world through things other than stock tickers.
Political pressure in the 90's led to deregulation of the mortgage industry, which led to the proliferation of "sub prime" loans, which led to a huge boom in home ownership since people who shouldn't have been borrowing money were borrowing millions, which led to a consumer spending glut, which led to easy money in the market, which led to people papering over losses by playing hot potato with bad loans, until the obviously unsustainable cycle came crashing down.*
We also had multiple wars increasing government spending, continued deregulation, unimaginable leaps in technology and automation, and huge amounts of consumer spending enabled by credit card and other forms of debt feeding into this cycle.*
But yeah, nobody knows, says the Nobel Prize Winning Economist, so lets blame it on the plebes who were stupid enough to think they could get a piece of the pie during one of the greatest wealth booms in history. Silly poor people, taking advantage of unsustainable growth for personal wealth is for the ruling elite! What, you're mad because you got left holding the bag after taking out three mortgages because your lender encouraged you to do so with massive ad campaigns? You were mislead about interest rate hikes by your local banker because nobody cared to double check his numbers? Sorry, but personal responsibility. Oh and by the way we need you guys to pay for all our bad bets because we can't possibly be blamed for this when our models said everything was going to come out rosy!!!
Seriously, things like this make me want to bring back the guillotine.
* To be clear, this is obviously a simplistic version of events, but it's still dramatically more accurate than any of the drivel in this article and actually manages to frame responsibility accurately.
This article being bumped off the homepage makes my brain confused.
Your insightful comment listed many factors that were responsible for the recession.
And none of them can reasonably be classified as fraud. And each action, on its own, can be easily argued to be reasonable.
Like you, I'm in favor of regulation, and can easily believe deregulation played a role. The fact that we need this type of regulation is because it really isn't fraud. If it were, it wouldn't need special regulation.
I always thought it was triggered by the Fed. They dropped rates after the tech bubble and then around 2006 they abruptly raised them:
https://en.wikipedia.org/wiki/Federal_funds_rate#/media/File...
Mortgage rates roughly (directionally) follow that rate, and home prices vary inversely with interest rates. So they jacked up the home prices, waited for that to take effect and then pulled the plug once people were leveraged to a new record level of consumer debt.
There were other factors in play too, but even this article about house flipping - that was enabled by the easy money and related rising prices in the years prior to 2006.
All I can say is that they better raise rates very very slowly for several years or we'll see something similar happen again. Imagine what a 2 percent increase would do (that's tripling the interest rate) if it happened in a short time.
Shiller is ignoring:
* Banks relaxed lending standards.
* Appraisers were pressured to deliver fraudulently high appraisals (see 2005 petition delivered to Congress which was apparently studiously ignored by Shiller (Greenspan's advisor) and Greenspan who claimed "nobody saw it coming").
* The loans packaged into mystery-meat CDOs, misrepresented and sold on to investors by ratings agencies that agreed to look the other way for a fee (and declared their right to lie under the first amendment when challenged).
Shiller has always been a regular apologist for bankers though, much like that other Nobel prize winner who writes regular op-eds in the New York Times, so it's not that surprising he dumbed it down and shifted the blame.
It just feels like one big ponzi scheme to me where most people lose money.
Flipping a house is basically taking a massive futures contract on the house. You borrow most of the money and hope it goes up.
People will say "but you have an asset you can use". Not true. If you have a two condos you are trying to flip and there is a housing glut, you won't even be able to rent them out. They will just sit vacant eating away at your money.
No thank you.
Maybe the real money is in creating books and TV shows about startups...
Your insightful comment listed many factors that were responsible for the recession.
And none of them can reasonably be classified as fraud. And each action, on its own, can be easily argued to be reasonable.
Like you, I'm in favor of regulation, and can easily believe deregulation played a role. The fact that we need this type of regulation is because it really isn't fraud. If it were, it wouldn't need special regulation.
Stopped reading here.
A: hey B, do you want to buy my house for $270,000? I paid $200,000 for it but that was ten years ago.
B: Let me check. Hey mortgage officer, can I borrow $270,00?
Mortgage officer: Let me check. Well, prices have been going up so I think it's a fair investment. Sure.
B: SUre.
A: Thanks.
A walks out of the room.
C walks into the room.
B: Hey C, do you want to buy my house? I paid $270,000 but prices have been very strong. I'd like $290,000.
C: Let me check. Hey Mortgage officer, can I borrow $290,000?
Mortgage officer: Let me check. Yes, prices have been really good. This seems like a safe investment for us. Go ahead.
C: Sure. Here's $290,000.
B: Thanks.
B walks out of the room.
D walks into the room.
C: Hey D, do you want to buy my house for $315,000? I bought it for $290,000 but prices have been going really strong.
D: Well, let me check. Hey Mortgage officer, can I borrow $315,000? I want to buy C's house.
Mortgage officer: Let me see. Well, prices have been really strong - seems like a safe investment to me. Sure.
D: Okay, here you go.
C: Thanks.
C walks out of the room.
Question: if you roll around to A after you get to Z, then at what point do the musical chairs end? Who is responsible for the pricing bubble we have just witnessed?
It seems to me that it's not the flippers.
NY Times takes every opportunity it can to fire a shot across the bow at president trump. Yes, let's blame this on trump, why not?
> "There is still no consensus on why the last housing boom and bust happened."
Seems like there is. Folks were given loans they were unqualified for and had no reasonable way to pay off, some at the behest of the government.
https://en.wikipedia.org/wiki/Government_policies_and_the_su...