Bubble, Bubble, Toil, and Trouble

Uh-oh. The housing bust is just beginning.

As the housing boom comes to an increasingly ugly end, the parallels between the real-estate industry today and the technology industry in 2000 and 2001 are astonishing. Blogger Barry Ritholtz last month posted eerily similar charts of the NASDAQ composite index in the tech-bubble years and the index of housing-related stocks in the real-estate-bubble years. Both show rapid rises, a swift correction, and a subsequent rally when analysts and insiders proclaimed (prematurely) that the worst was over.

Echoes from 2000 can also be heard in the continual false calls of a market bottom. The Web site Minyanville has documented the repeated bottom-calling attempts by National Association of Realtors economist David Lereah. Lereah believed the housing market had stabilized in March 2006 and again in April, June, October, and November.

Robert Toll, CEO of high-end home builder Toll Brothers, told the New York Times in 2005 that his company, which had enjoyed astonishing growth for more than a decade, would grow by 20 percent annually in 2006 and 2007, and then go for 15 percent annual growth. Yet in virtually every quarter since the article appeared, Toll has lowered expectations, called a bottom—and then lowered expectations again. In February 2006, Toll Brothers projected it would deliver between 9,200 and 9,900 McMansions for the fiscal year ending October 2006, down from the previous projection of 9,500 to 10,200. But Toll reduced its expected deliveries in May and again in August and wound up delivering 8,787 for the whole year. But bitter experience hasn’t made Toll any better at calling the bottom. In November 2006, the company said it expected to deliver between 6,300 and 7,300 homes for fiscal 2007, down from the prior prediction of 7,000 to 8,000 deliveries. By February, Toll said it expected to deliver only 6,000 to 7,000 homes. And it’s doubtful Toll has successfully called the bottom now. The Census Bureau data on new housing sales for January, released earlier this week, showed a whopping fall of 20 percent from the year-ago level, and down 16.6 percent from December.

It sounds like a replay of the 2000-01 period, in which software, technology, and dot-com companies, riding a wave of growth, thought the slowdown was a small blip. (David Lereah, who published a book in 2005 telling readers how they could get rich participating in the endless housing boom, published a book in 2000 advising readers how they could get rich from the endless information technology boom.)

Cisco Systems was the Toll Brothers of its time—a rapidly growing juggernaut led by a charismatic, deep-thinking CEO. At the end of the company’s 2000 fourth quarter, in which it reported revenues of $6.75 billion, Cisco expressed great confidence about its growth. Even after revenues plummeted sharply in early 2001, CFO Larry Carter was talking about the ability of Cisco to keep growing at an impressive recent rate. “We recognize there is a healthy debate about whether we can grow 15-20 percent or 30-50 percent. In the long-term, only time will tell if our industry grows between 10-20 percent or more than 30 percent.” Instead, Cisco’s sales dropped for several years. Cisco wouldn’t reach sales of $6.75 billion in a quarter until the quarter that ended in April 2006.

Across the tech industry, executives were similarly sanguine about growth—even as the business was collapsing. Check out this poll of information technology executives. In August 2000, IT executives projected IT budgets (and hence sales at IT companies) would grow at an 18 percent rate for the next 12 months. They stuck to those outlooks through the fall of 2000, as orders began to fall. Rather than rising 18 percent in 2001, IT spending fell for the year, as executives continually called a bottom in the spring of 2001. At the end of 2001, professional forecasters promised rapid bounce-backs in 2002—bounce-backs that never occurred.

The persistent optimism of housing and tech advocates has the same basic source. When a set of changing circumstances—an exciting new technology like the Internet or a climate of low interest rates and easy credit—comes along, executives start to believe that their blessed industry has slipped the surly bonds of the business cycle. The prospect of a slowdown that lasts for two years simply doesn’t jibe with their new worldview.

By the end of a boom, all the pessimists have been demoted or passed over for the optimists. Executives who come of age during booms are punished for caution and rewarded for doubling down. In 2000, this translated into companies building insane amounts of fiber-optic cable ahead of demand or blowing hundreds of millions of dollars on warehouses for Webvan. In 2005 and 2006, this translated into Wall Street firms paying large sums of money for subprime lenders—right at the top of the credit cycle—and home builders shelling out cash to lock up thousands of empty lots. Just as investors in technology companies had to write down the value of that fiber-optic cable and Webvan’s warehouses, investors in lending companies and home builders are already writing down the value of those subprime lenders and all that land.

The other reason it’s so hard to call a bottom has to with how bubbles burst. After investors and corporations overreact on the upside, they overreact on the downside. As a result, it generally takes more than a few quarters for equilibrium to return to turbulent markets. For example, lenders are just now starting to tighten standards on the loans they make to subprime borrowers—a measure that is sure to weigh further on an important sector of the housing market.

All of which means that the housing industry in 2007 may be where technology was in early 2001—engaged in the first serious hard times the industry had seen in more than a decade, finally aware of the problem, but still a long way from the bottom.