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The Real Morons of Orange CountyWhy America's most reckless real estate investors come from Irvine, Calif.

By Daniel Gross
Posted Thursday, July 26, 2007, at 5:05 PM ET

Until recently, Orange County was the New Jersey to Los Angeles' New York City. Upscale, but generally ignored, and nowhere near as chic or happening as its urbane neighbor. Television helped change the image, with glitzy offerings like The O.C., Laguna Beach, and The Real Housewives of Orange County.

These shows portray the beachside O.C. as the capital of plastic surgery and extreme consumption. But inland, just over the hills, the massive planned community of Irvine has become the nation's capital of real estate folly. And that's surprising, given that Irvine is itself a result of one of the great real estate investment plays of all time.

The transformation of the Irvine Ranch from a sparsely populated agricultural tract into a densely populated upscale edge city is astonishing. The Irvine Ranch's owners have amassed huge fortunes through their financial acumen. (Donald Bren is No. 27 on the Forbes 400.) Incorporated in 1971, Irvine boasts a diversified economy and superb university, is populated by many blue-chip companies, and projects an image of suburban perfection, thanks to strict zoning laws that enforce design continuity. When I visited in the late 1990s, the mayor freely acknowledged that many non-Irvine dwellers view it as sort of a Stepford community, but smilingly noted that it was all about maintaining standards and, hence, property values.

As subprime lending grew in this decade from a tiny niche into a substantial market presence, Irvine-based companies surged. Its corporate citizens include: Option One Mortgage Corp., the subprime subsidiary of H&R Block sold in April at a knock-down price to private equity firm Cerberus; New Century Financial, which went tapioca in spectacular fashion in April; and mammoth, still-solvent subprime outfits Ameriquest and Argent.

The subprime loans made by Irvine-based subprime lenders were rapidly securitized—sliced and diced into bonds, packaged together with other securities, and molded into pools dubbed collateralized mortgage obligations. Leveraged investments in CMOs have caused a great deal of pain everywhere from Wall Street, where they helped sink two Bear Stearns hedge funds, to Australia. But the locals also ate some of the toxic effluent produced by Irvine's debt factories. In June, Irvine-based Brookstreet Securities ran into trouble after it allowed customers to buy CMOs obligations on margin. It shut down completely on June 30.

Brookstreet's rapid demise is an object lesson in how highly leveraged investments can turn sour quickly. Another Irvine-based operation, IrvineHousingblog, brilliantly drives home the same point with daily dispatches. The blog is a guide to the seventh circle of real estate hell—people who buy houses on spec with no money down. A typical entry chronicles the purchase price, tracks down the amount of debt on the property, and then calculates how much each party—the buyer, the first mortgage holder, the second mortgage holder—stands to lose assuming the seller receives the asking price. My favorite thus far is the house for which somebody paid $1.29 million in May 2006, putting down only $91,000 in cash. Today it's on the market for $850,000, a whopping 34 percent reduction in about a year.

It's not surprising that Irvine is a center of reckless real estate lending and borrowing. It's a classic industry cluster of the type seen in areas that lack natural resources. Detroit's auto manufacturers encouraged the local growth of auto parts suppliers, companies that finance auto purchases, and publications that cover the auto industry. In Silicon Valley in the 1990s, the people who created dot-com companies were co-located with the venture capitalists who funded them, the investment bankers and brokers who helped take them public, and with many of the investors who got killed when the NASDAQ tanked. Irvine may have built up a diversified economy, but it remains a company town—one whose fortunes are highly leveraged to the highly leveraged real estate industry.

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Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at . He is the author of Pop! Why Bubbles Are Great for the Economy.
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Remarks from the Fray:

Californians are not idiots. But they are known for their enthusiasm and their optimism.

For us Midwesterners, we find it charming, but we're aware that winter comes some time after summer.

But I must say, after owning west coast real estate for 17 years, and having it appreciate to the point where my home equity exceeds the value of my retirement accounts - and yes, I've been saving the proverbial 15% for those 17 years, I really do understand both the optimism that is standard in California, as well as the eccentricities, excesses and foolishness that comes with it. You can have a great life and be rich, just by being there.

So many people have gotten rich by doing nothing more than owning 2-3 rental properties, or by the accident of having Grandpa leave you his tiny 20 acre orange grove in Irvine or lettuce farm outside of Sacramento, that it's like the laws of gravity - and economics - don't apply. So if there are the occasional massive lapses in judgment, well, what can you expect? There are many smart people who have prospered in California due to their great judgment and courage, but there are a far greater number that have just put all their chips on black (real estate appreciation) and just repeated the process endlessly, that they think they are geniuses. Then they move on to a game that isn't fixed for them - like subprime lending in the Northeast - and well, nature selects.....

--Certainly

(To reply, click here.)

(7/27)

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