The Cause of All Busts

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Last week we determined that San Diego's early-90s housing downturn was not caused by unemployment, as it is ubiquitously believed, nor by interest rates.

Yet the price of a typical single family home price fell by 17 percent between 1990 and 1996. A price decline of that magnitude and duration must have had its cause in something. And it did -- but that primary cause was not external to the market itself, and it wasn't anything that took place during the downturn.

The housing bust was the inevitable result of the housing boom that preceded it.

A speculative bubble took place in the late-1980s San Diego real estate market. For a brief peak at some evidence, consider the accompanying chart of San Diego home prices and rents in the half-decade leading up to 1990. During this period, home prices rose more than twice as fast as rents, which are influenced by the same economic and demographic fundamentals as home prices and thus should grow at about the same rate. (Those who insist that monthly payment is a better measure of home valuation can take note that mortgage rates didn't change much between 1986 and 1990).

The market was being driven not by fundamentals, but by excess optimism and the expectation of further price gains. By the time 1990 rolled around, San Diego homes were unsustainably expensive.

This period of speculative euphoria ended in the manner typical of all its bubbly brethren: market participants finally exhausted themselves, the self-fulfilling prophecy of ever-rising prices went into reverse, and valuations started to head back down to -- and eventually below -- fair value.

During the post-bubble fallout, analysts always scramble for explanations as to how such an unexpected turn of events could be happening. (Often, these are the same analysts who denied the existence of the bubble and are well-served to direct attention elsewhere.) But those who seek external, after-the-fact causality are looking in the wrong place at the wrong time.

The truth is that all speculative financial bubbles are the cause of their own demise. This was certainly the case for the 1980s real estate boom. The current housing bubble -- far bigger and longer in the tooth than its predecessor, and already faltering -- is unlikely to be any different.

-- RICH TOSCANO