The Housing Bust

by Lizzy Conroy
February 15, 2010

Recently, I read the book, “The Greatest Trade Ever”, by award-winning Wall Street Journal columnist, Gregory Zuckerman.  It chronicles a few Wall Street hedge fund managers and an obscenely successful California real estate developer, among others, who predicted and profited from the housing bust just as the rest of us (the U.S. Government included) were convinced that housing prices could never go down.  How did these guys have the foresight to ignore the hype and to see the crash coming?  Conviction, creativity, persistence and the ability to create new models that defied conventional thinking and challenged the statistical geniuses employed at the power house investment banks like Bears Sterns and Lehman Brothers that ultimately collapsed.

“What does this book have to do with residential real estate in Northern Virginia,” you ask?  It gives us the hindsight to understand why for those Americans who purchased their homes during the rise and peak of the market (2000-2005) the value of their homes have taken such a precipitous fall, yet at no fault of their own.   Now-famed hedge fund manager, John Poulson (no relation to former U.S. Secretary of the Treasury, Henry Poulson), who made billions in the housing bust, and his mortgage and housing analyst, Paolo Pellegrini, discovered the obvious: “Housing prices had climbed a puny 1.4 percent annually between 1975 and 2000, after inflation was taken into consideration.  But they had soared over 7 percent in the following five years, until 2005.  The upshot: U.S. home prices would have to drop by almost 40 percent to return to their historic trend line.” (page 107)

The irony of it all is that the credit default swap (CDS) market – a sort of insurance product created by savvy traders to bet on the direction of the value of mortgage-backed securities – didn’t even exist in until 2005, the peak of the housing market.  CDS contracts were created because investor demand for mortgage-backed securities (primarily sub-prime) far outweighed supply, and traders needed to create a new product that would satisfy the thirst for mortgage-related investment vehicles.  Buying and selling CDS contracts was akin to placing bets at the craps table in Vegas.  Red or black?  Up or down?

The few institutional money managers like John Poulson who predicted the housing bust paid pennies on the dollar to purchase insurance protection on billions of dollars worth of mortgage-backed securities and other similar securities called collateralized debt obligations (a bond for pools of all kinds of debt, credit card, car loans, home loans, etc.).  Translation – what most of the market deemed as a safe investment was actually doomed to fail and only a few were willing to accept this.  Some would say purchasers of the insurance protection were speculating because in fact, housing prices were still rising, mortgage default rates were in line with expectations and the ratings agencies had supposedly correctly rated the risk of the instrument.  But these guys were not speculating – they knew what was coming and they bet big in the calm before the storm.

Please contact the Huckaby Briscoe Group at 703-734-0192 or Lizzy@HBGroup.us to discuss the present state of the housing market in your location.  We would be delighted to provide a current market analysis for your home or property in the Northern Virginia market area.

Part II: “Were Home Owners naïve or Wall Street Reckless?”

Lizzy Conroy is a Partner of HBC Group. She has served as a real estate professional since 2009 and has worked with hundreds of clients. Lizzy graduated from Georgetown University with a B.A. in Economics and has served in a number of professional capacities in the Washington, DC area – first with the international trade group of Hogan Lovells, then as a marketing manager with MicroStrategy of McLean, VA. She also held business development positions with Kalmia Construction, a Maryland-based commercial construction company, and Newmark Knight Frank, a commercial real estate firm.
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