Tulips, Tech Stocks and Townhomes

What do these three “T” items have in common? In their respective markets, they have all been the source of severe overvaluations and bubble bursts because people failed to pay proper attention to the foundations and fundamentals of value in the hope to get-rich-quick.

 

The so-called ‘tulip bulb craze’ that occurred in 16^th Century Holland is one of the most vivid demonstrations of wild speculation run amok. When the “bulb bubble” burst it created a prolonged depression in Holland. 

 

The tech-stock crash of the ‘dot-coms’ in the late 1990s is probably still fresh in the minds of most investors. The “irrational exuberance” (a phrase of former Federal Reserve Chairman Alan Greenspan) of that period resulted in significant Wall Street losses as company after company that had been buoyed by over-inflated stock values went under. 

 

There are dozens of examples of speculation bubbles, big and small, that transpired between the tulip-bulb craze and the dot-com disaster. As soon as one speculative phase ends another quickly fills the void. Everyone, it seems, at some point convinces themselves that this time it will be different.

 

Most recently we’ve experienced in some markets (for example, in the greater Washington, DC – Baltimore corridor) situations where entry-level townhomes would sell for well above asking price the same weekend they went on the market. Bidding wars on homes was rampant, pushed along by many lending practices that were highly suspect. It has been reported that nearly 30% of residential real estate transactions were investor-based, not homeowners.   

 

It may be that the real estate market conditions and sub-prime mortgage fallout we are currently experiencing is, at least in part, the result of another greed-induced bubble that neglected underlying financial fundamentals.    

 

Given the losses that many are now experiencing in the real estate market, will people finally learn the lesson from Tulips, Tech Stocks and Townhomes? Somehow I doubt it.

 

(For a fantastic analysis of how financial markets work and how speculation bubbles are created, I highly recommend the book “A Random Walk Down Wall Street” by Burton G. Malkiel.)

• A Random Walk Down Wall Street