June 07, 2008
The Greater Fool Theory

There was no such thing as overpriced real estate, there being no limit to people who wanted to live in the sun and the orange groves – and who would pay any price for their slice. Buying a house, which had always been primarily a way to provide comfortable shelter and security, became an investment, a way to get off the treadmill of salaries and rent.

Real estate developers responded. If people wanted to buy houses in Southern California, they’d be glad to sell them houses. Orange County, L.A.’s southern neighbor and home to miles upon seemingly endless miles of the orange groves that gave it its name, was systematically “deforested” of orange trees as developers built miles upon seemingly endless miles of suburban tracts of houses and malls.

Then came a fierce countervailing force, dubbed by the media stagflation. Stagflation was a previously unknown phenomenon wherein economic productivity flat-lined even as inflation roared upward, seemingly out of control of a clueless central government reduced to printing WIN (Whip Inflation Now) buttons for government employees to wear.

Prior to stagflation (stagnant economy joined to rampant inflation) an economic downturn had always induced recession, which served to deflate prices. (That’s what’s happening in the US real estate market now; an economic growth rate currently measuring just over 1% has resulted in housing prices dropping an average of 13% in the past year.)

Recessions are natural and inevitable to an economy. The historical “business cycle” produces a recession about every 7 years. The US economy slipped into recession in about 1976. Now, a well-managed economy adjusts to over-heating by cooling down when things start moving too fast. In the US that process typically takes about a year. But the Greater Fool phenomenon thwarted what should have been a natural slowing of the SoCal property market. Prices continued to roar upward for several years.

Immovable object meet irresistible force. By 1979, with the supply of housing significantly exceeding the supply of people who could afford the sky-high prices, the real estate bubble burst. Home values dropped by 25% overnight. And even prospective buyers who could still afford the prices couldn’t get a bank mortgage. Home loan rates soared to close to 20%, if they were available at all, (the banks having loaned all their funds to the real estate developers who suddenly couldn’t sell their properties – and who, therefore, couldn’t repay their loans.) The Greater Fool had left the building.

Sound familiar?

Starting in about 2000, after the 1997-98 “Asian Financial Crisis” devalued the Thai baht to historic lows against Western currencies, the Pattaya property market took off. Foreigners started flooding into Pattaya, drawn first by the wide-open nightlife. Many foreigners who came to Pattaya for an exotic vacation decided that they liked the warm weather, the low prices, the chance for a new life, the lovely Thai ladies. Some decided to make Pattaya their annual holiday destination, staying for a month or two at a time every year. Others decided to cash out from their work-a-day lives back home and simply move to Pattaya full time.

Either way, they needed a place to stay. Real estate developers responded. If people wanted to live or stay long-term in Pattaya, they’d be glad to sell them condos (the law against foreigners owning land making house sales difficult). Miles upon seemingly endless miles of the beaches that had first attracted American GIs to Pattaya for R&R (rest and relaxation) during the Vietnam war gave way to what is becoming miles upon seemingly endless miles of high-rise condo complexes and, now, malls.

L’aissez les bon temps roulet. The Pattaya real estate market roared. Condo prices soared: a million baht, two million baht, five million baht, ten million baht, twenty million baht. More and more developers built more and more condos. Hey, there’d always be a Greater Fool.

The good times rolled right up until September, 2006, when the Thai army deposed the elected government of Thaksin Shinowatra in a bloodless coup. Faced with frightening uncertainty about the future of the economy, and growing uncertainty about whether the Thai government really wanted the growing numbers of foreigners living and doing business in Pattaya, the number of new arrivals from Europe and North America dropped. Dramatically. And those who came partied and left. Sales plunged.

But the building continued. And continues. The property market has turned cannibal. New condo projects offer “free” bathrooms, “free” kitchens, “free” furniture and air conditioning. Most newcomers opt for the glitzy new developments, some of which have begun offering new condos at startlingly low prices. There’s a complex in Pattaya right now offering condos starting at only one million baht, a price not seen here in at least five years. Woe to the unhappy “investor” who bought a condo for 1.5 million in 2000. They’re lucky if they get an offer above 750,000 baht when they try to sell – if they get an offer at all.

The Greater Fool has left the building. But still the building continues.

by Phil Helms