ON APRIL 27, 1637, A NEW DUTCH LAW decreed that people could only buy tulips with cash. Up to that day, people were using I.O.U.s, or investing in a then-innovative financial instrument called an option, or engaging in barter of all sorts—anything and everything to obtain coveted tulips. Farmers, chimney sweeps, and maid-servants were among the ordinary folk who went so far as to abandon their livelihoods and trade away their homes just to grow tulips or speculate in tulip bulbs, which were swapped in the financial markets the way shares get traded today. Credit and debt skyrocketed.

In the months before the tulips-for-cash-only law in the Netherlands went into effect 368 years ago—collapsing tulip prices overnight—the sale of a single tulip bulb known as Semper Octavian fetched an unfathomable sum: two wagon loads of wheat, four loads of rye, four fat oxen, eight fat swine, 12 fat sheep, two hogsheads of wine, four barrels of beer, two barrels of butter, 1,000 pounds of cheese, a marriage bed with linens, and a sizeable wagon. Check that: four barrels of Dutch beer, the really good stuff. The rest is history. No money for a Dutch army or navy, so New York got its name from the British, who could take or leave tulips.

In speaking of irrational economic exuberance, economist Jacob Freifeld distinguishes two types of speculators. One believes that the price of the object of speculation will move way up and stay up. Another—a subscriber to the “greater fool theory”—continues to purchase an object regardless of market levels, “considering only the willingness of other individuals in a market to pay higher prices,” Freifeld writes in a 1996 article, “Speculative Bubbles: Financial Genius Before the Fall.” Trouble is, our financial memory tends to be woefully short-term, which is why the phenomenon rears its head repeatedly.

Now, a home's intrinsic value to its owner—versus a tulip's or an Internet business—is a refrain you'll often hear when housing industry executives argue against applying the “bubble” word to the current home building environment. Are there people who still buy homes now because they think prices are going to soar further and stay up? Are there buyers who will buy irrespective of the price because they're willing to bet some “greater fool” will pay even more money later? Yes. Home buyer psyche is today's “X factor,” and while nobody is capable of predicting it, the leaders of the nation's biggest home building companies are doing a lot of gut-checking these days.

“Bring it on,” a senior level executive from a top-five home builder said to me of the possibility of a market correction in sales in the next 12 months. “If times get rough for the market as a whole, you're going to see the strongest companies get even stronger.”

MDC executive triumvirate Larry Mizel, David Mandarich, and Paris G. “Gary” Reece don't spend days out on a houseboat in the middle of Lake Powell counting on momentum in home sales to keep breaking records. Our cover story (see “Blue Sky Scenario”) subjects' financial memory is not so short-term as society's is, so their plan is a block-and-tackle strategy to manage growth in a downturn, even while the run-up's still running.

Our public builder report card this year shows a group whose collective 2004 performance blew away year-earlier business performance records. Still, amid another banner year in the making, they're trying to decipher the home buyer “X” factor. I caught one of our intrepid course-seekers, (see “Map Quest”) John Peshkin, Taylor Woodrow Homes' CEO, checking in for an overseas flight as we went to press on this issue.

“Are our assumptions based on the velocity of today's environment? Yes,” says Peshkin. “So, am I concerned about home buyer psyche? Yes. For short-term periods, home buyer psyche can make all of us susceptible—big and small. But then, if you can, you get through it, and the long-term underlying fundamentals make us view the future very bullishly.”

John McManus, Editor
e-mail: jmcmanus@hanleywood.com