"The Floating Pyramid" was the title of a lecture by Gary Evans, teacher of the only econ course I ever took in college. I don't think I ever really understood what Evans was saying, or at most 50% of the time, but I do recall this one metaphor.
He said that the Los Angeles area real estate market was a floating pyramid: just about the only way to buy a house in LA was to have just sold one. There are two groups of people: those who own property in LA, and those who don't; and it's relatively rare for people to move between these groups.
This leads to a disconnect between the market for LA real estate and the rest of the market. If living in LA is very important to you, it doesn't much matter what your house is worth relative to the rest of the economy if the only way to realize that value is to sell it and move. To this extent, the fluctuations in the LA real estate market are independent of the rest of the economy.
I was thinking about this because today I saw an ad in the back of the local rag (Santa Monica Daily News) for 0-down, 100%-interest mortgages. The ultimate in financing your speculative real estate deal. What the owner gets, presumably, is the appreciation that comes from positive fluctuations in the market.
But who gets the negative fluctuations? Suppose a property that was worth $300k before the recent run-up in LA real estate is now purchased for $700k with a 0-100 mortgage. The "owner" puts nothing down. The first bank puts up 80% or $560k at about 4%. The second bank puts up the remaining $140k at about 7%. Now the market drops back to normal and the house is maybe worth $350k. The owner is under water by $350k, and the first bank -- the one with the first mortgage for only 80% of the total "value" of the property -- is under water by $210k. And the owner is still paying nearly 3k in interest-only payments which is about double what his neighbor pays in rent.
In that situation, there's nothing to stop the owner from declaring bankruptcy and walking away. Remember that the owner has no equity to lose.
I think I now understand why people are so exercised about Fannie Mae.
So what did I do about the missing master link? I offered a reward, next time my kids were helping me with the bike. One spotted it immediately, dived for it, knocking the bike over, which then punched a hole in the wall. If it was (evidently) so easy to see, I'm a bit confused as to why I couldn't find it, after looking much harder. Still, I was delighted, and so was the rewardee. Win-win all round. I love market-based solutions.