A friend from the other coast writes:  "There is a complete collapse in demand. We here in California are almost certainly in the midst of another property slump." 

Haven't we seen this movie before? California and nearby boom states see moonshots of value and bull-market property geniuses, followed by cyclical shakeouts, despair, lather, rinse, repeat.

In places where property itself was a central business — Miami condoland, the Inland Empire of SoCal — the ugliness can be protracted. Add in the visibility of the problem, and you have the storyline being promoted by The Thundering Herd and other recession-callers. 

Let us look at some national figures.  From today's GDP report: Residential Fixed investment dropped 20.5% (annualized Q/Q change), its contribution to the change in GDP was -1.08%. This data shows how much damage has been done by the contraction in housing. A 20% decline in the sector lopped one percent off GDP. But residential real estate is still "only" ~5% of the economy, and it makes sense to keep that in perspective.

Stefan Jovanovich dissents:

Guys, I am not saying that this is the end of the world; but what used to be a real estate problem has become a banking problem. The Financial Times says that real estate loans are now 40% of bank assets.

I was all-in only a few months ago and took money out of the market only because I wanted to buy a new business. What convinced me that this was not just another slow-down was the spread between our bank's normal jive talk and what they were actually willing to do. We have had the same business in the same location long enough to have seen our "local" (sic) bank morph from Security Pacific to the B of A, and we have seen literally half a dozen people come and go as the branch managers. This is the first time, however, that no amount of collateral was sufficient to get them to say "yes" to a loan even though they are now dealing with a potential borrower who has no debt! They didn't even bother with the usual soft pass — "Have you considered an SBA Loan?" The silver lining that, in this environment, people are going to be able to "trade up" houses is comforting; but it is pure fantasy if the suppliers of actual credit have frozen up - as I think they have. Of course, it could be my bad breath and my charming manners. We shall see. 

Phil McDonnell says:

"News follows price." After a decline bad news will come out to explain it; after a price rise good news stories will come out to explain it.

To some extent the markets are pretty good predictors of events. That partially explains the relationship. However there is a deeper truth in the News Follows Price saw. Simply put the media needs something to write about. They sell fear, they provide information. It is all in pursuit of market share which ultimately leads to advertising revenue.

An author writes a book if and when  he has something to say. The situation is quite different for a media writer. He HAS to say something everyday. It doesn't matter if he actually has something important to say today. His job is to write something anyway. Ideally it will be something so compelling that you, dear reader or viewer, will stop your busy life and check it out.

One of the classic ways to make up a story every day is to look at the market action and try to explain it rationally. After the fact you can always write keen insights like 'The market went up on higher interest rate fears'. The next day might be, 'The market went down on fears of higher interest rates'. Invariably this leads to reinforcement of the meme of the day. In the 90's it was the dot com meme. Recently it has been the declining real estate meme.

But memes evolve. They evolve because the media is under pressure to make the story new. A new twist or angle keeps the meme fresh and compelling. First it was the real estate bubble has burst. Then it was the sub prime mortgage market collapse. The latter evolved into the liquidity crisis. Then the Fed eased. Oops, better not talk about that too much that could be good news. It is better to milk this meme for all it is worth. Then it was the dollar is crashing. But when a meme has been around for a while it gets stale. The media needs to turn to the 'how bad could this get' angle. Perhaps you have heard the old Johnny Carson jokes. Carson could tell a new 'How cold was it' joke every night for decades.

That is why we are seeing stories about recession. More media is piling onto the meme. This could lead to recession, global warming, nuclear winter and a falling sky! Today's article featured the new angle that real estate prices are inaccurate. It is really worse than they are telling us! The article cited one estimate that 1.5% of houses in Denver might be reported as 10% higher in price than they really are. Do the math. That would result in a .15% overvaluation in the Denver market stats - a fraction of 1%.

Quick! Check the sky! Is it still there? I live in the Seattle area so I can't check the sky, as usual. But I trust it is still there.

Bruno Ombreux agrees:

News coming after price has often very low (0) information-content. Easily/rapidly written/understood.

- Easily written: one must be amazed how newswriters are able to produce/pick descriptive "models" in often less than 24 hours ! (should they have thought of it some hours before, they would be millionaires !). Or maybe those models are just fake ?

- Easily understood, at least for people confusing understanding and memorization.

- It's either tautological "markets up because they didn't range nor gone down",

- Or completely incantatory.

Just some words from the liturgy, put together. No predictive power, even not explanatory power. But it may _look like_ something. That's enough. A majority of people will be happy with it. Thanks for this good stuff for self-deception.

- The most elaborate form may be a linear model: "things will continue". Tautological, incantatory, linear … what are others forms ?

After a market move there is always an open question : why ? Few people have time/skills/tools/data to count/answer. Even few people have time/knowledge to read a true, but a bit long and complex, explanation. (A frank explanation being most of time: "we don't know"). Though, we need to fill the question's volume, to reassure ourself, keep up appearances.

Better a void/fake explanation than no explanation at all, At least, better than an true explanation beyond ourselves.

Vincent Andres asks:

After a market move there is always an open question : why ?

The post-mortem explanations of market moves show the huge random element combined with human weakness.

Humans don't want to believe that things happen without a (knowable) reason. Ego, insecurity, uncertainty about death after life. So we ascribe explanations irregardless causation.

This is well exemplified by many of the SP500 moves in response to FED rate announcements this year. On Sept 18, they dropped 50 BP and the market jumped 50 points, because "The FED put is still there" (they will counter market declines). OK, but it is also possible the market could have dropped 50 on the same news, because "The FED sees the economy as sliding into recession", and that they cannot stop it.

Then on Dec 11, they dropped 25 BP and the market tanked (biggest drop on a FED day in recent history), "Because traders were looking for a cut of 50 BP". Yes, but it could also have gone up because the FED determined that recession risk was abating and the original crisis overblown.

Some non-human animal experiments are relevant. Recall the pigeons who were fed after pecking a lever: When the feedings came at random intervals, they began to repeat movements and rotations they thought caused the food to appear - not realizing their dance accomplished nothing. Or the rats with electrodes attached to their tails: One group had levers which stopped the painful shocks, the other's levers worked only intermittently. The rats who couldn't control their stress lost weight, shed fur, and became unhealthy, whereas the ones with control remained normal.

The terrible pain and joy generated by markets and other mostly random gambling is more than enough to bring out the animals, as well as herd them to the chapel on Sundays to ask for explanation.

Save my seat!






Speak your mind

4 Comments so far

  1. CynicalToTheMax on December 20, 2007 6:45 pm

    The point Dr. McDonnell makes is true but rather jejune. Of course the media tend to exaggerate problems in order to sell copy. But all readers of this web site above the age of 14 already know that. And what should our reaction be: hide our head under the sand and assume that recessions never occur? (Dr. McDonnell could have made exactly the same point in 1932: the liberal media are making up a meme in order to sell copy and make Mr. Hoover look bad, but actually the economy is doing just great! ROFL!). Presumably the readers of this site do not get their economic news from glancing at the headlines of USA Today at the supermarket without paying for it, or from listening to television while waiting for a haircut. We have access to govt stats within seconds of their release (as well as to how they compare to the consensus), we get economic analyses from a variety of sources and compare them, and some of us even do our own research. Surely those who feel that the chance of recession has increased recently are not just "victims of a meme".

  2. gabe on December 20, 2007 8:04 pm

    you might find this interesting. he’s obviously biased on the doom side, writing from crash ground zero, but nevertheless some good observations. and the # of comments got to be some record.

  3. Mike Desaulniers on December 26, 2007 5:00 pm

    “There is an old Wall Street saying that says "News follows price” –- more interesting to readers here might be the idea that price anticipates news. Recent moves before and after Fed rate decision days are a good example. Assume that due to post-hoc news reports, coincidental timing, or even the rate decision itself, traders associate a scary move with a Fed action. Due to that association, traders will fear that the next Fed decision (or governor’s speech) will cause the same move. All thing equal (which they never are), if the market went down 40 SP handles the day after the last rate decision day (as on Nov 1), the next “Fed uncertainty event” will be bearish until the announcement, then bullish. With a Nov 8 Bernanke speech looming, you could guess bearish for 11/7 thru the time Bernanke spoke on 11/8. Likewise for the 11/20 minutes release, maybe a down on 11/19. The “Fed event bias” might have changed after Kohn’s saber-rattling on 11/27. So; bullish up to Bernanke’s speech on the evening of 11/29, bullish until the 12/11 rate decision day. The market having gone down a lot even after the 12/12 TAF announcement, now you could guess that the Jan 2 FOMC minutes release would be a “bearish uncertainty event”. Same logic might apply for many other events, and best of all it would take a Vic Niederhoffer to in order to quantify it! What events? What time frame before and after? How to guess whether there was an association made between the move and an event? I can hear the Greenwich Russian math Phd’s scoffing all the way down here in Miami!

  4. CynicalToTheMax on December 1, 2008 2:35 pm

    Here is Dr. McDonnell writing on December 20, 2007 to debunk pessimistic economic stories about a recession (they are just a media fabrication):

    memes evolve. They evolve because the media is under pressure to make the story new.

    That is why we are seeing stories about recession. More media is piling onto the meme.

    This could lead to recession, global warming, nuclear winter and a falling sky!

    Here is official retrospective announcement almost a year later:

    Bloomberg December 1, 2008 12:40:15

    Recession in U.S. Started in December 2007, NBER Says

    The declaration was made by the cycle-dating committee of the National Bureau of Economic Research, a private, nonprofit group of economists based in Cambridge, Massachusetts.

    Perfect timing for Dr. McDonnell's forecast! LOL!


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