Sunday, August 27, 2006

All asset bubbles are alike

From Stephen Roach at Morgan Stanley:

Another Post-Bubble Shakeout
Five and a half years ago the equity bubble popped. Within six months, the US economy went into mild recession, and the global economy was quick to follow. Today, America’s housing bubble is finally bursting. Is the die cast for another bubble-induced downturn in the US and global economy?

All asset bubbles are alike. Sure, there are obvious differences between equities -- a financial asset -- and homes -- a tangible asset. But to me, the Shiller definition says it all: A bubble is an outgrowth of powerful amplification mechanisms -- both real and psychological -- which create an unsustainable condition whereby “… price increases beget further price increases” (see Robert Shiller’s Irrational Exuberance, second edition, Princeton University Press, 2005). The rise and fall of the US housing market fits the Shiller script to a tee. House price appreciation surged to a 27-year high in 2005, and as of the first quarter of 2006, prices were still rising by 20% or higher in 53 metropolitan areas across the United States. Both pricing and demand were feeding on each other through classic Shiller-like amplification mechanisms.

As always, the upside of a speculative bubble lasts for longer than you think. But when it finally goes, it invariably unwinds with greater force than widely expected. That seems to be the way the chips are now falling in the US housing market. Demand for homes is falling like a stone and inventories of unsold dwellings are ballooning -- up 40% for existing homes and 22% for new homes in the 12 months ending July. These are the classic quantity adjustments that set the stage for price destruction -- the endgame of any asset bubble. So far, home values just seem to be leveling off at still lofty price points. As the bid-offer gap widens in an excess inventory and rising interest rate climate, price declines will come as they always do. This bubble is not different.


Anonymous Anonymous said...

As much as I like reading Roach's stuff, can anyone point me to a correct call he's made in the last three years?

8/28/2006 06:18:00 AM  

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