Random Thoughts: Toll's Bias; Housing Market; Russian Oil Production

August 25-26th, 2006 - Minyanville.com

Toll's Bias

There was an interesting article in the NY Times on the housing market. But what really struck me is Robert Toll’s (CEO of Toll Brothers (TOL)) denial of what is taking place in the housing industry until recently:

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?” he asked. “Why do we have to have a bubble and then a pop?”

Now, after the market turned ugly: “... 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 – he's not a dummy. I have two theories on why he made the previous comments:

He convinced himself that the housing market is going through a normal boom and rejected every other rational argument that almost any other rational person would see without a magnifying glass. He had so much at stake for this to be true that he had an inherent interest to reject the bubble argument. The sad part about it is that he may not have been lying when he made his “not a bubble” argument, as he truly convinced himself to believe it.

The second theory: He just lied. His whole sales organization’s job was to convince potential buyers to buy bigger, better houses. Toll Brothers sales people had to answer the “are we in the housing bubble?” question from potential buyers on a constant basis. You don’t sell houses by telling buyers that they are purchasing a bubbly asset. Also, even if his sales people would never read his comments in the Wall Street Journal, these comments for sure would send the stock down and thus his net worth.

I tend 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 transparent and 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 don’t take him at his word as he has an inherent bias to sell you a car. He is not a bad person, but he has a nagging wife, 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 a car salesman, 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 in part these "charity programs" were in part (emphasize: in part) 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 to buy a house. But there is a loophole in the law - the charity can "help" a buyer with a down payment. The game that was very often played in Denver was as follows: Let's say a house is on the market for $300,000. A buyer needs to bring $15,000 down payment to the closing, the buyer doesn't have it. So the following would take place: The seller agrees to donate $16,000 to a "charity." The "charity" in turn would "donate" $15,000 to the buyer for the down payment. The seller in turn would raise the price of the house from $300,000 to $316,000 and charity would keep $1,000 as a processing fee. Everybody happy? Well, yes, with exception 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.

Russian oil production:

Paint me a skeptic or perhaps it's just from being born in Russia, but I think Russian oil production is very likely to decline in the future. Why? Simple, over last couple of years Russian Government has de-privatized a big chunk of oil companies.As we know government is not as effective at managing resources as private enterprise. Don't believe me? Just take a look how Fed Ex (FDX) and UPS have taken share from the US Postal Service - a government run legal monopoly.

Vitaliy N. Katsenelson, CFA

This article is written for educational purposes only. It is not intended as a recommendation (or advice) to buy or sell securities. Author and/or his employer may have a position in the securities discussed in this article. Security positions may change at any time.