Housing Market: Part 3

How the modern housing market is like a Ponzi Scheme?

Dear Reader,

In Part 1 we established that there is a housing property bubble.
In Part 2 we calculated the size of this bubble.
Now, in Part 3, we will illustrated how the modern property market is similar to a Ponzi Scheme.

The US Securities and Exchange Commission defines a Ponzi Scheme as:

“... an investment fraud that involves the 1) payment of purported returns to
existing investors from funds contributed by new investors. Ponzi scheme
organizers often solicit new investors by promising to invest funds in 2)
opportunities claimed to generate high returns with little or no risk. In many
Ponzi schemes, the fraudsters focus on 3) attracting new money to make
promised payments to earlier-stage investors to create the false appearance
that investors are profiting from a legitimate business.”

1) In the real estate market, the usual justification for the disconnect between price and value is the prevailing sentiment that “the value is what you can sell it for in the future and this always goes up”. To justify the price of real estate assets and to provide the promised returns these entail to existing owners, funds must flow from other investors into the market. If the asset doesn’t produce enough for you the owner to justify the price, the only way you can realise your return is to sell it to someone else drinking a stronger kool-aid. If no-one will ever realise an adequate return from holding the asset (rental income), we are simply shuffling papers representing patches of dirt and claiming to have created wealth.

2) Moreover, governments, banks, industry experts, and financial advisors peddle real estate as the safest, low-risk way of building wealth. As I demonstrated earlier, the culture around real estate investment, financing as a product, and the systematic underestimation of risk supports this assertion. Build a cult-like following, understate the risks, and overstate the returns. Sounds like a truly Madoffian method for promising high returns with little or no risk.

3) Finally, if people stop wanting to buy real estate assets and decide instead to rent or put their money elsewhere, what happens to those returns? Where do they go? They disappear. So, we need to ensure there is a constant flow of fresh investors into our scheme. The easiest way to ensure a long-term supply of fresh investors is to indoctrinate future generations into the ‘wonders of real estate investment’ and equip them with an ever-expanding Swiss-army-knife of financing (debt) options for them to pay inflated prices.

The SEC then goes on to explain that:

“With little or no legitimate earnings, Ponzi schemes require a consistent flow of
money from new investors to continue. Ponzi schemes tend to collapse when it
becomes difficult to recruit new investors or when a large number of investors ask to cash out.”

Until next time.

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