This is how the real estate bubble will end
From Mr Bruce Steinberg.
Sir, It was fascinating to learn how Meg Whitman, eBay president and chief
executive, looks 'for markets where there is price and information
inefficiency' yet declares 'real estate is pretty darn efficient' ('From
Netscape to the Next Big Thing'. Comment & Analysis, August 5) in the face
of a much ballyhooed real estate bubble.
In 2001, the Nobel prize for economics was awarded to George Akerlof,
Michael Spence and Joseph Stiglitz for their work on how asymmetrical
information influences economic markets. Their theory, first described by
Akerlof in the 1970s in an essay entitled 'The Market for Lemons' ('lemons'
being a colloquialism for bad used cars), explains how when one party in a
market has more information than the other, this unequal information can
lead to adverse selection and ultimately the collapse of an entire market.
Oversimplified, bad products and services chase out buyers seeking good
products and services and both buyers and sellers of good products and
services suffer.
The full theory can be applied to the efficiency of labour markets as well
as the collapse of the IT bubble.
For the former, workers out of work tend to stay that way because potential
employers assume those workers are not good enough for a job and tend to
offer insufficient pay to attract the best candidates. However, in the case
of permanent recruitment services, staffing services as well as temporary
employees bring more information to the 'buyer' to enable the potential
employer to make a more reasonable job offer than they would offer an
unknown candidate. Perhaps the success of job boards can be partially
attributed to their providing more labour market information to all parties
involved in the employment process.
The theory can also be used to explain how the IT equity bubble burst. Early
in the dotcom era, the casual observer or investor viewed all IT companies
as more or less identical although in reality their profit potential varied
greatly - only insiders knew which were which. Low-profit but over-valued
companies tended to follow the path of least resistance to fund their
financial expansion by issuing more of their own shares and hence attracted
more attention in the early developmental stage of the sector. Although
seasoned investors and experienced venture capitalists may have known they
were backing shaky high-tech and dotcom companies and knew it was a bubble,
they believed they could ride the wave, profit wildly and get out in time.
Eventually all investors became more educated, realised the valuations were
not based on any profit potential, dumped their shares and prices plummeted.
In the current real estate environment, ultimately there will not be enough
inexperienced buyers and real estate speculators - those who do not know the
true value of the property they are purchasing - to go around. The educated
will ultimately regain control of the market and the current bull real
estate market, which at times looks similar to a Ponzi scheme, will end.
Then Ms Whitman may reconsider her view of price efficiencies in the real
estate sector.
Isn't it nice to see a practical application to economic theory?
Bruce Steinberg,
Economic and Employment Consultant,
Alexandria, VA 22309, US
