While reading a recent interesting article in the NY Times on the housing market, I was struck by the denial by Robert Toll, the CEO of Toll Brothers (NYSE:TOL), of what has been taking place in the housing industry.
Here is a sample of his comments from a year ago: “We’ve got the supply, and the market has got the demand. So it’s a match made in heaven.” This is from last October: “Why can’t real estate just have a boom like every other industry?...Why do we have to have a bubble and then a pop?” Now, after the market has turned ugly: “... [it] is unlike anything he’s seen: sales are slumping despite the absence of any 'macroeconomic nasty condition' taking housing down along with the rest of the economy." He suggests that "unease about the direction of the country and the war in Iraq is undermining confidence. All I have to say is: pop!”
What bothers me about this is that I am sure Mr. Toll is a very smart person. He has built a multibillion dollar company, after all. I have two theories on why he made these comments.
1. He convinced himself that the housing market is going through a normal boom and rejected every other argument that almost any other rational person could see without a magnifying glass. He had so much at stake that he had an inherent interest in rejecting the bubble argument. The sad part is that he may not have been lying when he made his “not a bubble” argument; he may have truly believed it.
2. He lied. His sales organization’s job is to convince potential buyers to buy bigger, better houses. Toll Brothers' salespeople had to answer the “are we in the housing bubble?” question from potential buyers all the time. You don’t sell houses by telling buyers that they are purchasing a bubbly asset. Also, even if his salespeople never read Toll's comments in the Wall Street Journal, bubble comments would send the stock down and with it his net worth.
I tend to buy into the second theory for one reason: Mr. Toll was selling Toll Brothers stock as it was going out of fashion. This is a very important lesson to learn: management’s comments always have to be looked at with a healthy dose of skepticism. The car salesman may be telling you the truth about the car, but you still can't take him at his word, as he has an inherent interest in selling you a car. He is not a bad person, but his kids need to go to better schools and they need braces. What would you expect? Corporate executives arguably have a higher standard on “truth” than car salesmen, but they still have a bias as they need to sell stock.
More thoughts on the housing market:
I don't know if other states have "charity programs" that help consumers to buy houses, but I think these programs were partly responsible for what is taking place in Colorado. As I understand it, according to law, a seller cannot provide a down payment to help a buyer buy a house. But there is a loophole in the law - a charity can "help" a buyer with a down payment.
The game that was often played in Denver was as follows. Let's say a house is on the market for $300,000. A buyer needs to bring a $15,000 down payment to the closing but he doesn't have it. The seller agrees to donate $16,000 to a "charity." The "charity" in turn "donates" $15,000 to the buyer for the down payment. The seller then raises the price of the house from $300,000 to $316,000 and the charity keeps $1,000 as a processing fee. Everybody happy? Well, yes, except that the entity that has arguably created zero economic value just increased the transaction cost by $1,000 and comparative housing prices just registered a 5.3% ($16,000) jump.
By Vitaliy N. Katsenelson, Contributor
This article first appeared on Minyanville.
Vitaliy N. Katsenelson may have a position in the securities discussed in this article.