All asset price bubbles are essentially Ponzi Schemes.

A ponzi scheme, as many of you probably know, is essentially a pyramid scam where money that comes in from later entrants is use to pay off a "return" on those who have been the scheme longer. Clearly the scheme will collapse when there are an insufficient number of willing entrants at the bottom of the pyramid.

In the original ponzi scheme there was a genuine business plan (esentially arbitraging the different prices of international reply coupons - yeah well) and the scheme had fundamental value although when Mr Ponzi was overwhelmed by demand he was unable to "invest" all that was coming in and had to had to start paying out from new investors. The amount of money to support the scheme needed grew geometrically and it soon ended in tears.

Asset classes should normally be priced in terms of what their fundamental value is. Once an asset class becomes a bubble, its fundamental value (which we can measure in terms of what future returns the asset should bring) becomes irrelevant. Hence the asset class has become a Ponzi scheme. All that matters is that prices go up, not what the prices are based on. In other words the "Greater fool theory" (note big G, small f)- this is worth X because I can sell it some other fool for even more. The asset class is no longer valued for what it can give you, but for the fact it can make you rich without doing any work. And indeed, as long as the Emporers new clothes are not acknowledge, and prices keep going up; you'll be right.

As you've probably guessed I think the UK housing market is currently in this condition. The "chain" of buyers and sellers means that the seller of the £1m five bedder is dependent on a FTB'er coming into the scheme at the bottom of the chain. The people getting money "out" of the system are those MEW'ing, downsizing; or selling their BTL.

Of course there is no Mr Ponzi behind the housing market, only a large number of economic agents (potential and actual homeowners; and landlords).

The ponzi scheme will collapse when there are no further buyers. It collapses not because the underlying asset is worth more or less, but because people stop believing in the scheme. They realise that they aren't going to make 20% this year; that the asset is outrageously overpriced, and its not worth putting new money into the scheme. The banks are also acting as a brake on the ponzi scheme by refusing to lend beyond some multiple of income (though the foot has probably hit the brake too late here); as do the Bank of England with their interest rate rises (ditto).

With all the stories of the dearth of FTB'ers, banks tightening mortgage issuing and chains collapsing due to nobody at the bottom end; it strikes me that this is what is starting to happen in the UK property market right now. There is no new money coming into the scheme; the FTB'ers are no longer there.

This will affect the bottom (and most inflated) end of the market first when people realise that £150k for a studio flat is a little excessive, but the effects will be very quickly felt at higher levels as chains collapse.

And anyone who put their money into the scheme in the last few years, with the expectations of getting rich quick, will be very dissapointed.

Excellent post TT

I have been struggling for the last week or so to put some figures around the structure of the market. Do you think that the net cash inflow into the market per transaction (ncipt) would be an important figure? It seems to me that if you had an equal amount of cash going in as coming out there would be a stable market with prices remaining static. If the ncipt equalled the rise in the average price then one would have a stable rising market.(as long as it did not get too out of hand and was capable of easing back slowly to the norm) To arrive at the actual cash figure is however quite difficult as there seems to be no published data for cash buyers/sellers, cash inputs/outputs by up/down traders ,the fate of inherited property and capital repayments on mortgages. ( the calculation would also have to include new build coming into the market and betterment of existing properties through extensions etc. and the data would have to be to the same base i.e. the UK.)

A quick but probably nasty way of looking at it would be to take net debt as a surrogate. If the debt has therefore increased by approx £300 bn on 4.38 million transactions over the last 3 years (end 2003)the surrogate ncipt would be £68k. whereas the average price has increased £54k. implying a degree of overstuffing.

Any comments?
John


Cash inflows into market:

A. Debt on house purchase. (FTB,BTL and others) CML
B. Remortgage debt (uptraders) CML
C. FTB deposits approx 15% of A CML
D. Cash inputs on remortgage ?
E. Outright cash purchases Land registry - CML?

Cash outflows from market:

F. Inheritance of properties (say 300k p.a.* average price)
G. Downtraders (say 50kp.a. extracting £100k)
H. Capital Repayments ?
I. STR,s ?
J. MEW CML
K. Cash sales inc. rental and second homes

New build additions ODPM
Betterment ? not including depreciating fixed assets
or Colin and Justin's dusting.

Do you think it is possible to assemble all these into a time series?

Some interesting thoughts there. I think that might be an interesting indicator.

A quick but probably nasty way of looking at it would be to take net debt as a surrogate. If the debt has therefore increased by approx £300 bn on 4.38 million transactions over the last 3 years (end 2003)the surrogate ncipt would be £68k. whereas the average price has increased £54k. implying a degree of overstuffing.



Presumably the remainder has been mainly MEW'd out? i.e. extra mortgage debt but spent and not going into housing to trade up?

I'm not sure if this would be a leading indicator, but it might give an idea of how "overstuffed" the market is - a delightful term.

I'd hate to try and look at the figures you're working on. It would be quite difficult to get comparable data for most. But let me know if you have any joy. Does anyone have any ideas for sources apart from the usual places. I think ODPM might be the most copious source. But its coverage is patchy.

Also I don't agree with some of your categorisation. i.e. inheritance isn't an outflow. Some will go to pay Inheritance tax but the rest will stay "in" the market.

Thanks for your reply TT

Actually thinking more about it I have fallen into the trap that I think seduces some BTLers and the more aggressive PPR's. That is to say that value can somehow be CREATED in this market. It is in fact a dumb asset market where the whole £3 trillion valuation has either been paid for ,in part ,in the past years or will have to be paid for some time in the future; and every last penny!(rather like your Ponzi Scheme).

Cash outflows have to balance cash inflows all the time because no value is being created. That is not to say that flows coming out can't re-enter the front. I concede that some value can be created by developers/architects but that is outside of the scope of what we consider the market. Value can be ADDED by new extensions but the price paid to the builder will be fairly constant and therefore only passed on to the next purchaser.

So I think I will forget the cashflow analysis and concentrate on the marginal debt. Should be easier anyway.

However the cashflow view does throw up some interesting insights into what may be happening at the micro level. Inheritances are definitely a cash outflow unless the property returns to the market as a rental (when it is cashflow neutral) and IMHO more than the usual number of beneficiaries have been taking this route in the last couple of years. Downtraders are also a significant part of the market at the moment. (see assertahomes figures showing 30% of their registered buyers are downtrading) If they can sell I would suggest that this probably puts more pressure on the bottom end of the market in the short run. AS you and dosprompt? pointed out the property ladder should be a lot flatter in times of low wage and general inflation. IMHO the top of the market will probably fail first with the bottom only falling into line once the ladder has established its new angle of elevation.

regards John

A post from another board with a link to more info on ponzi schemes:

http://boards.fool.co.uk/Message.asp?mid=8677284

or for the lazy, the actual link:

http://www.crimes-of-persuasion.com/Crimes/InPerson/MajorPer...