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Today's Commentary: 05.23.05
Tulips from Holland

There was time when investors believed that being fully active in the highest priced markets was not only necessary but prudent. Often over the course of decades, even centuries as was evidenced in the ability of investors in the early 1600's to set the market price for tulips in Holland that were not yet planted, investors have been unable to unwrap themselves from their own greed and see the forest for the trees. Or in the case of tulips, the flower from the bulb. Or in the case of homes, the price over the worth.

To compare tulips and houses because of the similarities in the two events in economic history, is actually quite easy. Largely because of the mania that has been taking place in this country, albeit in pockets of increased insensibility, the housing industry has been priced higher than ever before, up 29% in just the last three years.

When tulips were first introduced in Europe, investors saw them as valuable as well and offered exorbitant prices for ownership. That runaway speculation which took place over the pursuit of these bulbs was best exemplified when one particular bulb, the Viceroy, was priced at higher worth than four fat oxen or one thousand pounds of cheese. The zenith of this hysteria was reached when bulbs were bought and sold with no intention of ever planting the prized flower, described at the time as lacking the scent of the rose and the delicacy of the morning glory.

That bubble burst when these speculators realized that this sort of unrealistic enthusiasm could not last forever. Granted, homes are not bulbs but the markets that control them have similar lessons to be offered and like those Dutch traders who saw money thrown their way in increasing quantities, the warning signs are being mostly ignored. Believe me, once the media gets involved, making themselves pre-bubble bursting experts before the downturn, only two things are possible. It will burst and if it does, we will all know exactly who to blame.

Americans are not fond of blaming themselves however. We like to point our crooked fingers at some other participant such as Alan Greenspan. The Fed chairman has stepped well outside of his realm of expertise when he commented on the potential for a possible implosion in the housing market. During a speech on Friday, May 20th, he may have set the tone and hopefully shifted the blame back to the same ones who intended to point the finger at him.

Mr. Greenspan, despite his best efforts will become the center of controversy and its ultimate scapegoat when houses find themselves priced out of range of the average consumer. In fact, many of you could not afford to purchase the home you currently live in because of the accommodative interest rates available that in turn have made rampant speculation possible and forced prices higher than real worth. Pay no attention to those chasing purchases such as condominiums with no intention to occupy the space as a small part of the problem.

The wider problem comes from the belief that real tangible wealth is the roof over your head. Alan Greenspan followers have decided to pick and choose his vagaries and believe what they may. He once said that adjustable rate mortgages were fine with him only to turn around, express worry about that low interest chasing group. They would, he later suggested, would be the first to fall once the effects of the deficit, not the one Mr. Bush is responsible for but the personal equity deficit that was enabled by the Fed's gift of almost-free money in an incredibly low interest rate environment came due.

And true to form, the interest rates have begun to rise. So has Greenspan's interest in housing. It is perhaps too suggestive of me to think that he hopes the bubble will burst after he has left his post as the chairman. But by the same measure, his suggestion that housing prices will not decline that much as interest rates rise shows how little understanding he has of markets he chooses not to second guess. His "irrational exuberance" was just such a hedge against blame, one that has yet to fully work itself out of the investor psyche.

The natural inclination for home buyers to believe they have bought in at the right price is determined by their ability to pay for said homestead should the market tank. Few if any take into consideration the cost of taxes and insurance as well as the possibility that salaries may not keep pace due to inflationary pressures.

Those who think that shifting the equity in their primary residence to the speculative purchase of a second home or those that are buying now without huge down payments will be hurt the most according to the chairman. He did make clear that his group of bankers do not intend to focus their efforts on popping that bubble and their reasons are definitely meritorious if not noble.

But they will be unable to ignore the problem. Their focus on growth and inflation will force them to notice what could be an economic death knell. Pretending it doesn't exist, using his old formulas, and believing he has the understanding and flexibility built into his policies will not help those who have extended themselves. The current tally of tapped equity in this country has hit the $341 billion mark, most of which was borrowed over the last two to three years. When you consider that the market has been moving steadily north for just shy of nine years, anticipating a fall is akin to realizing the value of a tulip bulb not yet planted.

BlueMoney Report

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