Bubble Task Force

“How a Bubble Stayed Under the Radar” was the headline in the New York Times business section this past Sunday (3/2/08). The esteemed Yale professor of economics and finance Robert J. Shiller said “One great puzzle about the recent housing bubble is why even most experts didn’t recognize the bubble as it was forming.” After reading this, I shouted, “YOU HAVE GOT TO BE KIDDING ME!!!”

Dr. Shiller described why many smart people (including former Fed Chairman Alan Greenspan) get caught up in bubbles because seeing “only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.” This behavior has much to do with the fact that people are human beings, “subject to emotional reactions,” and are often led astray by information that they believe to be “expert”. That’s all well and good, but why do people who are confronted with a contra-argument throw their lot in with the bubble?

I pose this question after reviewing my past articles about mortgages and housing. On February 24, 2004 (“In the Merry ole Land of Oz”), I compared Alan Greenspan to the Wizard of Oz and warned that the Wizard’s advice of using an adjustable rate loan, could lead to “real problems of credit card defaults, foreclosures, repossessions and a litany of unfulfilled financial goals.” That was in 2004 when the bubble was just starting to form and so I did not take it personally that many scoffed at my point.

By 2006 as the froth had morphed into mania, I tried to sound the alarm bell. On January 20, 2006 (Homeowners’ Revenge), I wrote: “There is nothing like a bull market to make an industry of excess…like every other mania, a correction is never too far off. Tulips, stocks and now it’s time for the homebuilding and construction market to come back from the stratosphere…There have been many signs that the housing market is cooling off.” On March 1, 2006 (Is it here yet?): “For some time, experts, analysts and plain old regular folks have been expecting the end of the housing boom…it looks like we are indeed seeing the end of the awesome streak for home sales in the US…the writing appears to be on the wall: the housing market is undergoing a gradual shift away from the manic pace of the past five years.” How much clearer could I be when I said the following on May 25, 2006 (Cinderella at the Housing Ball)? “Like any speculative bubble, the housing bubble will end—the way it will end is unclear right now. Unfortunately, for those who viewed real estate as a way to make quick money (perhaps to replace losses experienced from their stock portfolios!), it may end badly.”

I go back in history not to point out that I was right, because I wasn’t exactly right—I was a bit early in my call about the housing bubble. But here is some news from your friendly correspondent on the Bubble Task Force: the action that we are currently seeing in commodities has many of the signs of a bubble…we may not be there yet, but I sure do recognize many of the tell-tale signs.