What Some Folks Really Know About Bubbles

The idea of a real estate “bubble” is scary. Just the thought of a sudden, wholesale decline in housing prices nationwide is nearly enough to get your mind off the stock market plunge.

Almost, but not quite enough.

You remember the stock market — that’s the financial setting where there’s been a, er, correction. Let’s look at where Wall Street has been and where it’s at:

According to The New York Times, between March 24, 2000 and July 18, 2002 U.S. stock values fell from $17.25 trillion to $10.03 trillion — a drop of more than $7 trillion. (See: The Incredible Shrinking Stock Market, July 21, 2002)

At $200,000 each, $7 trillion could have bought 35,000,000 homes. Now that’s a bubble.

What’s disturbing about the recent stock market decline is that so many well-paid people just didn’t see it coming. You might think that securities analysts, those bright people who closely follow companies and trends, the people quoted on TV and in lots of newspaper articles, would have told investors to get out when the market was peaking. Nope.

According to The Washington Post, some 99 percent of analyst recommendations in 2000 advised investors to buy now, buy often and buy more. (See: The Market Scholars’ Star Turn, November 15, 2002)

Okay, so mistakes were made. Maybe your analyst was among the fewer than 1 percent who got it right and said sell.

But you have to wonder, why were so many bright, hugely compensated, quotable folks utterly wrong, wrong to the point that investors who took their advice lost vast sums of money?

If a stock brokerage was fighting for a piece of an IPO you can understand how an analyst might be more friendly to the company — and, in fact, there sure seem to be a bunch of e-mails suggesting that some analysts said one thing in public and thought something else privately. Or you might find an analyst or two who were pressured to give strong recommendations for questionable companies. So much for relying on the famous “Chinese Wall” which supposedly separated stock brokers and investment bankers from analysts in the same company.

But what about the analysts who thought Fannie Mae, Freddie Mac, Enron, WorldCom, and the rest were great buys even when their brokerages were not getting underwriting fees? What was their incentive to recommend such financially-sound entities after they had carefully investigated all the charts and SEC data? After they had spoken at length with company officers and leaders in given industries and fields? How could such educated, well-informed and highly-paid analysts go wrong?

Such questions have been raised by James Cramer, a former hedge-fund trader, co-founder of TheStreet.com, and the author of You Got Screwed: Why Wall Street Tanked and How You Can Prosper.

Writing in New York Magazine, Cramer explains that among analysts “while there was corruption behind some of these buy recommendations, I think stupidity played a much bigger role. Either they thought that stocks would keep rising and they didn’t want to rock the boat or they genuinely believed in the promise of the New Economy.” (See: “Bubble Boys,” November 25, 2002)

So there’s one answer. It’s not thievery. It’s not fraud. It’s stupidity. It’s not that analysts as a group lied (well, okay, maybe some did), it’s that Wall Street told the public that analysts with their charts, projections, and reports knew what was going to happen in the future, an assurance which
defies common sense.

What’s curious about the current surge of real estate “bubble” stories is how often they quote stock analysts as authority figures. But if so many analysts were wrong about Wall Street trends, what suggests they will suddenly be right about real estate?

The next time you see an article, commentary or news report which relies on the words and wisdom of a Wall Street analyst to justify fears of a housing bubble, do the right thing and send a note along these lines to the editor or the program manager:

Sirs:

If we are to believe your article of the 28th (“Real Estate To Plunge, Says Esteemed Wall Street Thinker”) it might be useful to have more information regarding the font of wisdom you quote at such great length:

• What percentage of all stock recommendations made by Mr. Smith in 2005, 2006 and 2007 — just before the greatest financial decline in history — advised securities investors to sell?
• Is Mr. Smith now selling his home and moving into a rental unit, tent or cave to beat the coming real estate decline he advidly predicts?
• If Mr. Smith could not see the securities bubble, and if Mr. Smith is not selling his home, why should readers follow his advice?

As the expression goes, inquiring minds want to know….

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Published originally by Realty Times on December 17, 2002 and posted with permission.

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