Bursting the Bubble

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BURSTING THE BUBBLE….Responding to Mark Thoma’s post about asset bubbles and how to deal with them, Matt Yglesias says:

Part of the weirdness of the housing bubble was that even if you believed there was a bubble, there was relatively little you could do about it. You can’t “short” housing in any easy way. And doing something like selling your house, and moving your family into a rental with the expectation of buying back into the market after the bubble pops involves huge transaction and search costs. Looking for a new place to live is a pain-in-the-ass and moving is both annoying and expensive. It’s much easier for a person who thinks real estate prices will rise to become a speculative buyer than it is for someone who thinks real estate prices will fall to become a speculative seller. It seems to me that that mismatch was one of the driving forces behind the real estate bubble.

Actually, I think this is only narrowly correct. It’s true that there were very few people like Mark Kleiman who were willing to sell their houses at the peak and move into apartments for a while in hopes of making money. Ironically, though, the same derivative market that turned the housing bubble into a global financial meltdown also provided investors with plenty of opportunites to make money by betting that the housing bubble wouldn’t last. John Paulson famously did it by shorting CDO tranches and buying mispriced credit-default swaps. Andrew Lahde made a mint via leveraged shorting of ABX indices and other mortgage-related structured credits. Helen Thomas reports that Hayman Capital, Corriente Advisors, and Passport Capital also profited from betting against the housing market. Ordinary mortals could have done it by shorting stocks of home builders or perhaps by shorting REITs.

There were ways to do it. There just weren’t enough people around smart enough to see the bubble for what it was and with the backbone to bet a lot of money that they were right about it.

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