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What a party it was. At the end there was a lampshade on every head, and dancers on every table. Some revelers are just now waking up, slowly, one by one, with dry mouths and headaches, wondering who that is in the bed and what it will take to get him to go home. Oddly enough, there is still a crowd around the empty punch bowl waiting for a refill.

I’m referring, of course, to the recent Florida Keys real estate bash.

Many are trying heroically to keep the party going. The Key West Citizen reports an Upper Keys broker telling property owners to withdraw or withhold properties from the market. It boggles the mind. The hooch obviously hasn’t worn off. In a business where listings are “money in the bank,” such a suggestion would normally be a sign of madness.

The broker isn’t crazy, however. The decision is perfectly logical. The logic is the same as that used by dairy farmers who dump milk into sewers. It is an attempt to limit supply and thus maintain or increase prices.

This broker’s efforts will fail, as, in the long run, all efforts to manipulate markets fail. They will fail because supply and demand achieve balance through a third critical element ─ price. There are a lot of houses on the market right now because prices are high. There is little demand for those houses for the same reason. Convincing a few sellers to take their properties off the market won’t change those simple market fundamentals. Only changing prices can do that.

A fit of collective madness during which otherwise rational people truly believed in magic has thrown real estate prices in the Keys wildly out of whack.

How far out of whack?

The National Association of Realtors (NAR) just announced that the inventory of houses currently on the market in the U.S. will take some seven months to sell at last month’s sales rate. That is the largest inventory/time figure since 1993. Traditionally, a six month inventory is thought to represent a market more or less balanced between buyers and sellers. Inventory has been under six months for many years, representing a seller’s market.

The degree to which this statistic deviates from the mean can be viewed as a measure of how far prices are out of balance with traditional measures of value. A seven month inventory indicates the market has some adjusting to do. Either incomes must increase or prices must fall to meet incomes.

NAR’s chief cheerleader, its in-house economist, David Lareah, is optimistic of a “soft landing” and confident that we will see a “market turnaround” soon. He can afford to be optimistic; it’s what he’s paid for. But he’s only looking at a seven month inventory. I wonder what Dave would think of the Keys, where the picture is very different.

Right now, Keys’ inventory numbers make the worst national stats in 15 years look like a sellers’ paradise.

There are currently 832 Key West residential properties listed with members of the Key West Association of Realtors. Last month there were eleven sales. That works out to 75.6 months of inventory. As recently as 2005 that figure was under six months.

With over ten times the national inventory to unload, even Alan Greenspan, the original party animal, couldn’t keep this soiree going.

The maestro’s relentless spiking of the punch with printed money is the main reason things got out of hand, but not the only one. A whole constellation of circumstances conspired to inflate the price of real estate to levels that defy common sense. Easy credit, loose appraisals, speculation, low interest rates, and many other factors share the blame. But mostly it was just a good old fashioned, tulip bulb, South Seas Bubble, dot com style financial mania.

Throughout history, every now and then, a powerful, irresistible, irrational optimism reaches a deafening crescendo in the collective human consciousness. This time it happened here.

Rational people believed in magic. Money appeared like loaves and fishes each month in home equity checking accounts. Borrowed money, invested in houses, created what people have always dreamed of ─ wealth without saving, income without work, riches without risk. The magic was real.

Charles MacKay, the 18th century author of the classic “Extraordinary Popular Delusions and the Madness of Crowds” wrote:

"Men, it has been well said, go mad in crowds and only come to their senses slowly and one by one."

Over six years of inventory on the Key West housing market is a clear sign that buyers are coming to their senses one by one, even as sellers continue to harbor delusions of magical riches.
There are many still who believe prices will recover and that buyers will once again stand in line to bid up asking prices. I believe they are right.

It happened once. It will happen again. Home buyers will once again believe that dilapidated Conch shacks are worth $1500 a square foot. Investors will once again believe that houses renting for $1000 a month are worth $800,000. People will once again believe in magic.

The question is, “When?”

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