Economic & Financial Analyst of iTulip, Inc.
On October 14th, 2011, The Norris Group returns with its award-winning event I Survived Real Estate. An expert lineup of industry specialists join Bruce Norris to discuss current industry regulation, head-scratching legislation, and the opportunities emerging for savvy real estate professionals. 100% of the proceeds support the Orange County Affiliate of Susan G. Komen for the Cure. This event would not be possible without the generous help of the following platinum partners: Foreclosure Radar and Sean O’ Toole, Housing Wire, The San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops and President Shawn Watkins and Angel Bronsgeest, Invest Club for Women and Iris Veneracion and Bobbie Alexander, San Jose Real Estate Investors Association and Geraldine Berry, Real Wealth Networks, Frye Wiles Web and Branding, MVT Productions, and White House Catering, who will provide the 3-course meal for this black tie event. Visit iSurvived2011.com for more details.
Bruce is joined this week by Eric Janszen. Eric is a serial technology company CEO, economic and financial market analyst, author, and speaker with more than 28 years of executive experience in high-technology startup companies, venture capital, finance, and economics. Eric is the founder and President of iTulip Inc., a data-driven economic analysis firm. Started as a website, iTulip.com in 1998, Janszen is widely recognized for more than a decade of accurate forecasting of major economic and market trends. He has also written in 2010 a book that Bruce has enjoyed called The Postcatastrophe Economy.
Eric first came up with the name iTulip when he started the site back in 1998 when he was the managing director of a venture capital firm called Osborn Capital. They invested in 20 startup companies, mostly friends of his who he and his friend Jeff Osborn knew the industry. Out of the 20 companies, they had 7 liquidity events, including sales to Cisco, Nortel, Microsoft, and EMC. The purpose of iTulip was to publish the research he had been doing when he was running Osborn Capital. The research steered him in the direction of concluding that they were participating in a bubble. iTulip is a takeoff on the tulip mania that happened in the Netherlands in the 1630s. When Eric first came up with iTulip, it was tradition at the time to put an “I” or an “E” in front of everything and also come up with a .com version of everything. The interesting thing about the tulip mania was that it seemed reasonable for other people to participate in it at the time because there was no reference point for the price of these newly discovered plant bulbs. As a real estate investor you rely on comps, which are past decisions of other people.
Bruce remembers looking in one of the books at an actual transaction where a tulip bulb was exchanged for everything the man owned. This included 50 acres, a barn, cattle, and at the time it seemed like a reasonable transaction in terms of market value. Janszen says we can learn a lot from human nature from this period of time, especially when looking at bubbles which are very different from each other depending on the asset class. Commodity bubbles are very different from stock market and property bubbles. Therefore, the role of the retail participant is different in each case as well, although it does seem to be similar in a lot of ways. The tech bubble ran on a recycling of money from IPOs back into the venture capital industry back into more startups. This is typical of a late stage bubble in that they generate and start to run on their own fuel, their own money. They don’t need an outside source, but they are always launched by some kind of outside event that distorts the market. This was the case of the tulip bulb mania, which included the simultaneous discovery of the tulip bulbs and a bond that was floated by the government that produced a big surge in credit and the money supply. There is usually some distortion that occurs in a market combined with some kind of discovery that gets the ball rolling. In the case of the housing bubble, it was the introduction of a securitized debt and the and mis-rating and mis-pricing of it that fueled the beginnings of that bubble. This was reinforced by accommodative monetary policy and weak regulatory policy. The retail investor does not get in on the game until prices have been going up for a while and a lot of positive memes start to develop, propagated in the mainstream media, which reinforce the trend of rising prices.
Bruce says it’s easy to understand the attraction of participating in a bubble because it is exciting and it gives the regular guy hope to escape the daily grind. Everyone around him seems to be cashing big checks. In one example, Bruce had a relative invest in penny stocks back in late 1999, and everything he touched doubled. Bruce became curious and had a lot of real estate at the time, so he took $250,000, put it with Merrill Lynch, and in 40 days turned it into $800,000. He thought he was a pretty wise stock picker, so he began writing an outline for a penny stock course, which he didn’t have the chance to finish until his $800k turned into $100k. However, it was an exciting period, and he really learned a lot about the emotional cycle of investing. Real estate is his field, so he was able to get off of the bandwagon in time, but you can understand the emotion that goes on in it and where you are enjoying participating. If you don’t have a real exit, like with the stock market bubble. You understood the stock market was a bubble, so you can understand the attraction; but the damage path probably hurts more people than it helps. This is usually the conclusion of a bubble.
Eric says bubbles are manufactured. In the case of the tech bubble Eric participated in personally, Eric was watching a group of intelligent and thoughtful people come to believe in a set of fallacies. In one of their deals with a company called Arrowpoint, they received back a 220 time return on their investment. Eric knew there was something amiss because there was no rational pricing and the way that pricing typically maintains irrationality during a bubble is the desire for it to continue and the hope to get rich quick is hard for them to avoid. Eric, who he said himself tends to be more skeptical, was on the boards of several of these companies and knew something was wrong. He started to do his own research, and it became very clear to him not only that it was a bubble, but he also had a good sense of when it was going to end as well. In March of 2000, he published on his site iTulip.com that if they were still in tech stocks, now was their last chance to get out of it. They needed to be out by March or April at the latest. Osborn Capital sold all of its positions from sales and IPOs of portfolio companies in April, May, and June of 2000. They were able to capture the gains that they made in the previous period. He started watching the housing market go up, and he wrote his first piece about the housing bubble in August of 2000 where he said the early stages of the housing bubble would go on for 3 to 4 years. However, it has a very different dynamic than a stock market bubble for several reasons, one being that it is debt financed. There is going to be a lot of damage when it crashes, he warned, and the crash is going to be macro economically very damaging. The housing bubble collapse is going to be bad for the banking system and much worse for the economy than the stock market bubble was, he warned in 2006. Eric said that for the housing bubble to develop it had to have the cooperation of policy makers, which to Bruce seems kind of odd considering there is a history of bubbles not working out too well and the aftermath not being pleasant. You would think we would learn to make smarter decisions, but we didn’t.
If you go back and read some of the articles Eric wrote around the time when he met Sean O’Toole back in 2005, his warning was if they did not reign in the housing bubble and it went to its logical conclusion, then what is going to happen is we are going to have a massive financial and economic crisis. When he was working as an entrepreneur in residence for Trident Capital, a large venture capital firm in Connecticut, he told the committee there that the financial crisis will occur starting in 2007. He also had a theory that if the housing bubble ran to its logical conclusion, then we would have a very unconstructive conversation later on about how to prevent a recurrence. The political policy response to the collapse of a bubble is the collective punishment of the innocent. With the stock market bubble, it was Sarbanes-Oxley, which Eric calls the Accountants Full Employment Act. It probably won’t fix anything, but it will make people feel better. His warning about the housing bubble in 2006 was that after it pops is that there will be a massive populist movement to try to reign in the banks, reign in the lenders, and constrain the housing industry exactly to the point where the opposite should be done. So instead of having a countercyclical policy response, it will be a pro-cyclical policy response, and it will make the housing crash even worse. There is movement right now to make it very difficult to buy real estate in the future with big down payments exactly at the time the payments are less than rent. The stunning thing about it is the utter predictability about it, Eric said.
iTulip attempts to understand the underlying process of the political economy and the interaction between markets and policy within our political system. This way, we can see how markets will tend to respond later on and how to allocate capital. Here we are in this situation where the housing market is as bad as it has been in recent memory, and it is not recovering. Particularly, residential construction spending is back where it was in 1996.
Bruce agrees and says there is no way you are going to have construction pick up again. In California, Riverside County has been damaged by about 60-65%, which with the price of a home now built even in 2004-2005, is selling for half of replacement costs. The one thing Bruce had not really thought about when he looked at the foreclosure list growing was that it represented every time a property sold, for example, 1,000 homes selling in Riverside, 70% are either short sales or REO. This means 70% of the closings don’t reproduce a buyer, they produce a renter.
Our short run problem is we have a lot of inventory that is being presented, and a refusal to have financing for investors because they are viewed as speculators. You really have a challenge because you don’t have people migrating to Riverside when it has 15% unemployment. It does have to have some calmer heads prevail, and there do have to be some common sense decisions made. This is actually a problem because the thing that happens when you have a market event like the housing bubble class that causes major macro economic distortions and a big downturn in unemployment is that unemployment is the most politically difficult change in the economy for politicians to deal with. You are not going to get elected if you don’t help solve an unemployment problem. If you want to really understand what is going on in our political system right now, it’s all about long-term unemployment. If you look at the mean duration of unemployment today, it is even worse than it was when the recession started. It just keeps going up and represents a large and growing pool of very unhappy people who are looking for a quick fix, most of whom didn’t really think much about economic issues or about markets. Therefore, they are listening to different voices out there, and the voices they are going to tend to respond to the most are the populace voices that they have come down hard on the real estate industry and the banks. Instead, they need to level with the American people, tell them the mistake that was made, how they got here, and what viable paths out of it are. If we sit around trying to figure out who is to blame, we’re never going to get out of it and it is just going to keep getting worse.
Real estate was a big participant in what Eric referred to as the “fire economy,” which has been going on for about 30 years. Real estate insurance, financing, has all been part of what we were accustomed to. When Eric wrote his book back in 2008 and 2009, his thinking was after the crisis occurred it would be a forcing function for significant change in the structure of the economy. The crisis would would enable the next leader of the country and members of Congress to stand up tell the public that the structure of the economy is the problem and needs to be changed. They could have gotten the economy aimed in the right direction so that by 2011/2012 the economy would be growing 3-4% a year and jobs would start coming back. However, starting back in about 2010 it became apparent that none this was going to happen and the leadership was not even framing the problem correctly. Now we have wasted years and also a considerable amount of public credit in attempting to re-start the FIRE Economy that is not sustainable. Now we have fewer options and even less time.
To get an idea of how to make the change in the right direction, Eric has talked to a lot of people in interviews, among them former Senators Phil Gramm and Bill Bradley. The general consensus is that we have to have a crisis that is even worse than what we had in 2008/2009. In the words of one of the political figures Eric interviewed, “We need a crisis that gets everyone kneeling at the cross to come up with a solution.” Everyone has to be effected equally, and the political pain has to be more shared across more groups than it is today. This is why we cannot get a consensus even on what the problem is let alone how to fix it.
One of the things Bruce was most impressed with in Eric’s book was that he views America as having the legacy of treating everyone equally and giving everyone a fair shot. These are the roots we have to go back to of resurrecting that entrepreneurial spirit and be willing to put infrastructure in place that goes to the future instead of thinking we are going to resurrect what was working for the last 30 years. We have to start thinking about maybe what doesn’t even exist today but we know can exist. Instead of some ad hoc, road fixings, and other fiscal stimulus projects, we should have invested in bolder projects which were intended to make the U.S. more competitive. The higher level goal was not to create jobs in hope that we can muddle through the next few years until the next election, but rather the thinking was how to square the country to be competitive in ten years. The issues facing us will be very high energy costs, heavy global competition for the smartest people in the world, which we have traditionally won but over the last ten years have been starting to lose. We need to get the differentiators back, and if we had done this we would not be where we are today where public spending on construction has been steadily declining since the end of the recession. It should be growing, particularly if private spending on construction is continuing to decline. This just shows very bad planning and unclear thinking about what has to be done to get the economy going.
Our economy is dominated by the FIRE Economy but we need to be getting to the “TECI” economy where the focus is instead on production, specifically on transportation, energy, and communication infrastructure. In the meantime, we are going to be stuck in this transitional economy. Back when everyone was doing their forecasting around the time of the tech and housing bubbles, they were short the S&P in December 2007. All these forecasts and decisions were based on an understanding of the cycle of asset price inflations, crashes, and then re-flation via monetary and fiscal policy. Today, the challenge is that the economy is clearly weakening, but we don’t have the option of spending our way out of it. Our credit is not strong enough, and if we try to significantly expand the public debt to finance major public projects it is very likely that we will start to see interest rates go up and then we will go into a cycle that we see in countries like Greece and other places where you simply do not have enough economic growth to credibly finance the existing debt. Eric and iTulip made a huge bet on gold back in 2001, which has turned out to be doing quite well. This is actually unfortunate because with the rise in gold prices and the current trend in national governments becoming net buyers versus sellers of gold, happening since 2009, is a very bad omen. This is a trend that indicates the extent and severity of the failure of public policy and leadership. This applies not only to the U.S, but in other countries as well.
Problems in Europe have a chance to spill over and cause grief here in the United States. Eric just returned from a trip to Europe, and it is quite clear that there is a tremendous amount of anxiety over there about how they solve their debt problems politically. The reason the German people are so upset about Germany carrying the load is that everyone knows that the top 5-10% of wealth group in Greece doesn’t pay any taxes, so when the idea of austerity comes up, the rest of the population knows that they have been carrying the load anyway. Now, they are being asked to pay even more and receive even less. It’s like there is two separate worlds now: the people that have and the people that don’t. There is going to be some political and societal upheaval for that.
Eric Janszen will be on the panel for I Survived Real Estate 2011, taking place on October 14th. The Norris Group would like to thank their gold sponsors for the event: Adrenaline Athletics, Coldwell Banker Pioneer Real Estate, Conaway and Conaway, Delmae Properties, Elite Auctions, Inland Empire Investors Forum, Keller Williams of Corona, Keystone CPA, Kucan & Clark Partners, LLC, Las Brisas Escrow, Leivas Associates, Mike Cantu, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Pacific Sunrise Mortgage, Personal Real Estate Magazine, Realty 411 Magazine, Rick and LeaAnne Rossiter, Southwest Riverside County Board of Realtors, Starz Photography, uDirect IRA, Wilson Investment Properties, Tony Alvarez, and Westin South Coast Plaza. Visit isurvived2011.com for more details.
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Tags: bruce norris, Eric Janszen, fire economy, housing bubble, I Survived Real Estate 2011, iTulip, Osborne Capital, stock market bubble, Susan G. Komen, the norris group, The Norris Group Real Estate Radio Show, The Post-Catastrophe Economy, tulip bulb mania