House Prices Are Supported By Fundamentals... Not!

By Author: Lawrence Roberts
Total Articles: 4717
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In every asset bubble people will claim the prices are supported by fundamentals even at the peak of the mania. During the Great Housing Bubble, people believed everyone was making two-times their actual income, and that the unstable loan programs developed during the time were innovations that changed the fundamentals. It was all nonsense.

Stock analysts were issuing buy recommendations on tech stocks in March of 2000 when valuations were so extreme that the semiconductor index fell 85% over the next 3 years, and many tech companies saw their stock drop to zero as they went out of business. Analysts even invented new valuation techniques to justify market prices. One of the most absurd was the "burn rate" valuation method applied to internet stocks. Rather than value a company based on its income, analysts were valuing the company based on how fast it was spending their investor's money.

When losing is winning, something is profoundly wrong with the arguments of fundamental support.

The same nonsense becomes apparent in the housing market when one sees rental rates covering less than half the cost of ...
... ownership as was common during the peak of the bubble in severely inflated markets. Of course, since housing markets are dominated by amateurs, a robust price analysis is unnecessary. Even a ridiculous analysis, if aggressively promoted by the self-serving real estate community, provides enough emotional support to prompt the general public into buying.

There is no real fundamental analysis done by the average homebuyer because so few understand the fundamental valuation of real property. Even simple concepts like comparative rental rates are ignored by bubble buyers, particularly when prices are rising dramatically and such valuation techniques look out-of-touch with the market.

When rental cashflow models fail, which they do during the rally of a housing bubble, the arguments justifying prices turn to an owner's ability to make payments. The argument is that everyone is rich, and everyone is making enough money to support current prices. It seems people began believing the contents of their "liar loan" applications during the bubble, or perhaps they counted on the home-equity-line-of-credit spending to come from the inevitable appreciation. Even when confronted with hard data showing the everyone-is-rich argument to be fallacious, people still claim it is true.

One unique phenomenon of the Great Housing Bubble was the exotic financing which allowed owners the temporary luxury of financing very large sums of money with small payments. There was some truth to the argument that people could afford the payments. Unfortunately, this was completely dependent upon unstable financing terms, and when these terms were eliminated, so were any reasonable arguments about affordability and sustainable fundamental valuations.
About Author:
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author's daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/ Visit House Prices Are Supported By Fundamentals... Not!.