A Graphic Look at Housing Bubble

In my new job I’ve been learning a lot about how the markets work. While I’ve always followed them informally via news stories, in recent months I’ve learned much more.

Perhaps the most important tool I previously knew nothing about is called Technical Analysis. Oversimplified: There is a whole world of people out there who study market charts and look for patterns.

Many people trade based on those patterns, perceived or real. Many people have made a lot of money this way. A lot of people have lost a lot of money this way, too.

Unbeknownst to me, my sense that something was wrong in the housing market back in 2004 was a form of technical analysis (with an assist from Economist Magazine) Why? Because I recognized a simple fact: When a market goes up without a sound reason – there was no explanation as to how Americans could afford homes two to five times more expensive than in the past – it’s going to come back down.

In other words, I was channeling the graphic, which I’ve borrowed from the Irvinehousingblog. The epilogue in the Irvinehousingblog post also explains why I was desperate to sell our house last year:

My years of experience trading the markets told me it was a beginning of a financial bubble. I didn’t know exactly what was causing it, I didn’t know how high it would go or how long it would last; I just knew it would prove to be a bad time to buy. Even after watching prices go up significantly from there, I knew it wasn’t going to last. I had seen the cycle too many times before.

This is a key facet of technical analysis: You don’t always know what is causing the markets to react, but that certain patterns play themselves out over and over.

Note that according to the chart, we’re still in the denial phase. Well, actually, we’re at the end of the “return to normal” phase and “fear” is starting to kick in. Read this frank article by Pimco Bonds Managing Director Bill Gross who sees more trouble ahead.

Gross predicts main street will suffer the most – more than real-estate funds – as adjustable mortgages continue to reset:

Currently 7% of subprime loans are in default. The percentage will grow and grow like a weed in your backyard tomato patch. Now I, the curmudgeon of credit, am as sure of this as I am that the sun will set in the west. The uncertain part is by how much.

But I suspect Wall Street is in for more trouble than anyone wants to admit. That market is still in “denial.” Just watch CNBC and listen how pundits keep proclaiming a “return to normal” before the next crisis emerges. Fear will win over soon.

How will we, the non-economist-like homeowners know where we are on this chart? Once fear REALLY kicks in, home price averages will plunge. Wall Street will probably follow right behind.

Then what? Well, we’re going to wait until the market hits bottom or near-bottom before buying again.

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[Frank Bruno]

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