Surreal estate

In tomorrow's column, Paul Krugman worries about the housing price bubble. He mentions record numbers for both interest-only mortgages and for the number of houses bought speculatively.

But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end. ... That's why it's so ominous to see signs that America's housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble.

[snip]

Even Alan Greenspan now admits that we have "characteristics of bubbles" in the housing market, but only "in certain areas." And it's true that the craziest scenes are concentrated in a few regions, like coastal Florida and California.

There are a few things he doesn't cite that make it look even worse. Florida and California have traditionally been among the frothiest real estate markets.

They are both showing signs of a slowdown. In California prices are going up more slowly than for the country as a whole. More importantly, major markets in both states are selling fewer houses.

Both Southern California and the San Francisco Bay Area had fewer houses sold than a year ago. And metro areas all over Florida, especially in South Florida, reported declines in the number of houses sold.

Southern California	-4.5%
Bay Area	-10.2%
Fort Lauderdale	-19%
Miami	-4%
Orlando	-2%
Pensacola	-17%
Sarasota-Bradenton	-12%
West Palm Beach-Boca Raton	-10%

Declining sales volume is a classic sign of a late bubble. One of the sustaining ideas of any speculative bubble is the "greater fool" theory. A buyer rationalizes, "It doesn't matter that I foolishly overpaid. Soon, an even greater fool will come along and I'll make a profit."

The greater fool theory founders on the fact that, while the supply of fools is very large, it is finite. Eventually, there are no more fools left to sell to. A decline in sales volume can be a sign that you are beginning to run out out of fools speculators. If you're lucky, after that the bubble deflates. If you're unlucky, it pops.