Tuesday, April 24, 2007

Speculation and The Housing Bubble

Most of us have, or at least think we have, a pretty good idea of what speculation means when applied to the stock market. Financial advisers will give us various rules the first among which is to speculate only with money the loss of which won't be a catastrophe for your portfolio and assets in general. But what form does speculation take in the housing market?

At first glance we think we know the answer to this too. It's obvious in the statistics after all. Just look at the sales in the non-owner-occupied category and there you have it. Formally, in other words, we think of speculative buying in the housing market as involving those units bought by investors, either with an eye to the fastest possible capital gain in a rising market, or for the rental market with the same ultimate intention of realizing a capital gain through resale.

It is not usually the case that a property bought for owner occupation is considered a speculative purchase. However, in the period of a bubble such as the present subprime bubble, (actually, as we are daily learning, it's a general housing bubble), it can be said that in fact a proportion of owner occupier buys have a greater or lesser speculative component. This will have a tendency to be amplified in the course of the bubble. The main indicator of whether this speculative component is present will be to whatever extent the buying decision is being made on the basis of the profits to be had from a rapidly rising market. Anyone with a home that serves current needs perfectly well and even has a substantial percentage of equity built up who then sells with a view to cashing out this equity and leveraging it into a more expensive home is speculating. Worse still, they are speculating against the advice of the staid investment advisor mentioned earlier. For who can afford to lose a home should the speculation not pan out without it being a catastrophe? The position is no different in essence to that of someone stricken with margin madness in a stock market bubble. And the consequences when the bubble bursts are likely to be the same: the margin call that cannot be met from evaporating gains or the mortgage adjustment that cannot be met from increased equity.

Unfortunately, a whole fairytale about the home being the "biggest investment you will make in life" has taken hold almost universally in the last few decades. This idiotic idea may be wonderful copy for the Realty world but it is disastrous for the homeowner. And it is especially disastrous for those homeowners who could have traded down and thereby could now have cash in hand ready to take advantage of the coming bargains at the bottom of the cycle.

Read twice: Don't speculate with an asset the loss of which would be a catastrophe.