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Market Bubbleology

Light Ranting
Light Ranting
Light Ranting
8/14/2007
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1:55 PM -- Does the following sound familiar to anybody:

  • Large quantities of free and easy financing
  • Increased speculative activity and a "get rich quick" mentality
  • The "sky's the limit" attitude from executives -- including fraudulent activity
  • Outsized expectations How about the telecom industry in 2000 -- or better yet, the mortgage/housing/collateralized debt markets of 2006?

    As the current stock and debt market turmoil plays out, it's remarkable how similar they are to the building and bursting of the telecom and housing finance bubbles. They've both got lots in common, but the primary thing is way too much financing and leverage. In 1999, we had Lucent pioneering aggressive vendor financing and the creation of Winstar. In 2004-2007, we had subprime lending, no-document loans, and a worldwide boom in mortgage bonds.

    Now that it's all starting to blow up, I ask a couple of questions: 1) What lessons can we learn from the telecom bubble; and 2) What's the current market madness mean for telecom?

    On the first question, I would say the primary lesson is, the length and duration of the unwinding of the bubble is usually proportional to the ramp-up in the bubble. In other words, anybody that thinks this housing finance bubble will unwind in a month and be over is out of their minds. Given the size and duration of "house flipper" mentality -- which fueled enormous growth for several years -- this will take awhile to sort out.

    On the second question, I believe that telecom will remain relatively stable (compared with other markets). The reason being that since the washout in 2002, telecom investors have been chastened and somewhat risk averse. Such a subdued environment is not prone to crashes. The other reason is that the supply/demand dynamics in the telecom market have actually been improving in recent years. Pricing for networks is starting to get better. New devices and applications are driving demand while supply for network capabilities is actually declining.

    Bottom line? A hiding spot in telecom -- especially big companies with decent fundamentals -- isn't such a bad place to be in this mess.

    As for your latest real estate deal, don't expect everybody to go back to flipping houses in six months. Think about telecom in 2001.

    — R. Scott Raynovich, Chief Bubble Editor, Light Reading

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    sfwriter
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    sfwriter,
    User Rank: Light Beer
    12/5/2012 | 3:04:05 PM
    re: Market Bubbleology
    Really interesting analysis, Scott. I've been trying to remember how long the unraveling took in the tech and telecom sectors. Tech seemed to unravel more quickly than telecom, but then I heard Seidenberg say in a speech once that telecom is usually late to take off in a tech boom and late to crash, as well.

    I'm wondering how long it will be before my friends who opted for interest-only adjustable-rate mortgages will be in trouble. Prices have dropped a bit in SF, but not substantially yet.
    rjmcmahon
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    rjmcmahon,
    User Rank: Light Beer
    12/5/2012 | 3:04:04 PM
    re: Market Bubbleology
    In my opinion, the primary lesson probably isn't related to how long it takes to unwind the misallocation of capital but rather what have been the conditions that caused the misallocation in the first place.

    Here is the motto used by many responsible for capital misallocation in both instances: "Assume the risk and take the money, shift or offload the risk but keep the money." It's this ability to shift the risk without any repercussions that allows for these massive misallocations in the first place.
    Scott Raynovich
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    Scott Raynovich,
    User Rank: Light Sabre
    12/5/2012 | 3:04:02 PM
    re: Market Bubbleology
    As I recall telecom really started to hit the skids with Nortel's big "warning" in 2001. By then, the debacle was already being priced into the market. The bad news continued for flow solidly for another 12-18 months. By the end of 2002, all the bad news was out and priced into the market. Recovery began in earnest 2003/2004. That was a great time to buy telecom stocks.

    The housing debacle is on the same scale as telecom -- maybe even a little bigger. So, given that template, I'd say housing is going to take at least 3-5 years to recover. I'm just looking at it from a point of view of "when will it be a good time to buy real estate." My best guess is the that bad news cycle will peak in the next six months, and the industry will really hit bottom in 2008. So you can can look for some bargains in late 2008/2009. The industry may start coming back by 2010.
    Scott Raynovich
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    Scott Raynovich,
    User Rank: Light Sabre
    12/5/2012 | 3:04:02 PM
    re: Market Bubbleology
    Very true. But also there has been a fundamental misunderstanding of leverage. And the hubris of the last few years has been astounding, considering that what happened in 2000/2001 was not even that far in the past.

    For example -- banks thinking they could lend pell-mell to everybody and anybody, and many of the borrowers leveraging up. And consumers thinking they could buy $1M McMansions way beyond their earning means -- with adjustable mortages -- and not face enormous consequences if the value actually fell.

    It's a sad but amazing story.

    rjmcmahon
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    rjmcmahon,
    User Rank: Light Beer
    12/5/2012 | 3:04:01 PM
    re: Market Bubbleology
    Agreed that the chart is scary though one would probably want to normalize it vs. comparing absolute values across decades. A simple way might be to show a chart of the percentage of defaults/foreclosures vs. the total number of mortgages over time. Also, what was San Diego's population in 2006 vs. 1990s? Is the recent spike shown in the chart an indication of returning to normal levels of default and that nobody was defaulting when prices kept rising at abnormal rates?
    Scott Raynovich
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    Scott Raynovich,
    User Rank: Light Sabre
    12/5/2012 | 3:04:01 PM
    re: Market Bubbleology
    wow, that is one scary chart!!
    rjmcmahon
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    rjmcmahon,
    User Rank: Light Beer
    12/5/2012 | 3:04:01 PM
    re: Market Bubbleology
    But also there has been a fundamental misunderstanding of leverage.

    Agreed. As well as the income tax implications of unrealized gains when the house sells for less than loan value and the consumer has to report the difference of the loan value and the sales price as income.

    Homeowners behind in their mortgage payments after hocking the house to pay for a major remodel or a new boat or car may be in for a rude awakening.

    If they previously refinanced and their lender decides to foreclose, they may not only lose their house, but the bank also may be able to go after their other financial assets including stocks, savings and their paycheck.

    And even if the bank doesn't go after their other assets, a foreclosure may mean a big tax bill from the IRS and state Franchise Tax Board for any shortfall between what the bank gets for the sale of the owner's home and the value of the loan.

    "This is going to become a hot topic," predicts Bradford L. Hall, managing director of Hall & Co., CPAs in Irvine, who remembers the pain of foreclosures during the 1990s. "There's very little awareness of what can happen when you can't make your payments and are forced to sell your home for less than the mortgage balance or lose your home through foreclosure."

    ...

    For instance, if the foreclosed homeowner has a $500,000 loan and the lender sells the house for $450,000, the homeowner will have to pay taxes on the $50,000 difference. The $250,000 tax exemption for singles and $500,000 for joint filers does not apply to debt relief income, in this case the $50,000.

    The tax owed on the debt relief is based on the homeowner's ordinary income tax rate, not the lower capital gain rates.


    http://www.ocregister.com/ocre...

    Stevery
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    Stevery,
    User Rank: Light Beer
    12/5/2012 | 3:04:01 PM
    re: Market Bubbleology
    So, given that template, I'd say housing is going to take at least 3-5 years to recover.

    During the last bust in CA, prices bottomed 18 months after foreclosures peaked. And if you're wondering what foreclosures look like in southern CA,

    http://www.phfactor.net/wp-pic...

    The only areas that are going to be immune are those that are not dependent on mortgage financing, which is nowhere.
    rjmcmahon
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    rjmcmahon,
    User Rank: Light Beer
    12/5/2012 | 3:04:01 PM
    re: Market Bubbleology
    I perceive a few differences between the housing bubble and telecom bubble which might impact an analysis of how long it will take to correct.

    First, is the liquidity factor. Houses as much less liquid than stocks. This will slow any correction.

    Second is the Federal Reserve's role in the process. The Fed knows that housing equity drives consumer spending and hence the US economy much more than anything else and also that an oversupply of housing has downward pressures on rent which in turn keeps the CPI (and hence the government's measure of inflation) low. I believe 40% of the CPI is owner's equivalent rent. Keeping the CPI low, even if artificially, has huge benefits for the government.

    Finally, the fed would rather see inflation (though not the CPI measure of inflation) wipe out the massive debt loads.

    With telecom stocks, the Fed was more of a bystander. In housing, the Fed has been an active participant in creating and sustaining the bubble and will likely continue on playing this role.
    netskeptic
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    netskeptic,
    User Rank: Light Beer
    12/5/2012 | 3:03:59 PM
    re: Market Bubbleology
    [The housing debacle is on the same scale as telecom -- maybe even a little bigger.]

    Juniper stock went from 230 to 5, Cisco from 77 to 11, Sun from 64 to 3, Foundry 201 to 10, I doubt that we will ever see McMansions selling for 50k.
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