Greater Fool Theory

It sounds like a fake name but the Greater Fool Theory is a real economic theory taught in business and economics classes. 

https://en.wikipedia.org/wiki/Greater_fool_theory

Basically the jist is that in an environment of rising prices there will always be a greater fool willing to buy your asset from you. The purchaser is the greater fool as they think the value of the asset will continue to increase. i.e. I don’t mind paying $1.2 million for this crappy house because next year it will be worth $1.3 and I can always unload it and walk away with a few bucks after expenses. 

I swear it’s like no one remembers what happened in 2005 and then subsequently in 2008. Remember when everyone was somehow involved in the real estate business? On the mortgage side, flipping, developing, sales… People were buying new homes and taking out lines of credit to buy boats, big screens, vacations? Everyone fancied they were a real estate investor? And then the entire house of cards came tumbling down. 

“This time it’s not the same!” Mortgages are more qualified and buyers have a lot of skin in the game with 20% down payments. 

True, but locally in LA and probably a lot of SoCal and NorCal you have dual income households spending the max amount allowable on mortgages.  Typically a Debt to income ratio 40-45% while some lenders are willing to fudge things (shocker) and get up to a 50% through. You know what happens to a dual income household in that situation where one person loses their job? How many months can a family last after they have blown several hundred thousand dollars on a down payment? 

But my job is secure you say? In a recession no one’s job is secure. 

With real estate prices even in the shitty, undesirable parts of Los Angeles rising 20% yoy there must still be some fools left. 

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One thought on “Greater Fool Theory

  1. Pingback: Lot’s of action in El Segundo – El Segundo Bubble

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