Bubbles and Crashes

With the near certainty of the US Government trying to spend their way out of another self created problem, I thought I would put some thoughts on paper about bubbles and crashes. To begin let me simply define both terms.

Bubble - a rapid increase in the price of something based upon an unrealistic value.
Crash - the correction of a bubble when the market can no longer sustain it.

There are fast crashes and slow crashes. The crash of 1929 (which we always hear about) caused the Dow to fall from a high on Sept 3 of 380 to a low on Oct 29 of 230. A loss of 40%. This was a definite fast crash. What usually isn't talked about is the slow crash that then persisted for the next 3 years. The market finally reached a bottom on Jun 30, 1932, of 43. A loss of almost 90% from the high. Much of this needless degradation of stock value was due to the actions the US Government took to try to stimulate the economy.

This newest stimulus bill is designed to create jobs, stabilize the housing market, and get credit flowing again. The housing market is what I would like to discuss.

Take a look at this graph here. From 1975 to 1999 there was a slight increase in housing prices from $137,000 to $164,000. This calculates to an annual increase of 0.85%. All of a sudden a bubble hits and between 1999 and 2006 prices go from $164,000 to $250,000 or 6.25%, more than 7 times the annual rate over the previous 22 years.

Since then the bubble has burst and we have had a crash of about -7.25% a year. However, median prices are still sky high compared to 1999. The market may be able to support bubbles every now and then, but in the long term look for it to return to average. That would mean another 2 to 3 years of housing prices falling 7% each year or 5-10 years of them falling at a less shocking (but just as devasting) 2-3%.

Can the bailout fix this? No. I'm afraid that because of the bubble, there was a massive glut of new housing construction, and now, there is more than is needed which will continue to drive prices down. Also, since housing is not a liquid commodity like stocks, the crash will more than likely be slow one as it takes time for people to sell their houses (thus realizing what the true value is). The quickest way out of this mess (not the least painless), would be for people and companies to take their losses and quit trying to sell that $15o,000 home for $250,000. If no one is making offers, the price is too high.

That being said, I think we should change the name of bubble to blister. When they form, they are kind of cool to watch, although one would be advised to stay away. You can get rid of them by pricking them with a needle and slowly draining out the pus, taking constant care over several days of pain. Or, you can be a man about it and just rip the skin off, wash it under cold water, swab it with some alcohol (that will sting), and then let it dry out without a bandaid. The pain is usually gone after a day, and the process heals itself within a week, usually with a nice callous that will work to prevent the same place from blistering again. We need to be men with the housing bubble.