patrick.net

A common error that many people make is to think that market direction will not change. This is the mistake that bubble buyers made during the housing bubble. They thought prices would keep going up, or at least not decline. But it is a cycle that alternates between rising and falling.

Today, many people are making the same mistake that the bubble buyers made - only in reverse. They think the prices will keep going down or at least not rise. They are just as wrong as the bubble buyers were.

Every single one of us colors the information we hear with our own past experiences and future desires. Everyone "talks their book" as it were. You can see the change here with members who were bearish on housing suddenly switch when they bought a house. It could be that they caught the bottom in their area and they made the right call. But at the same time they are looking for validation that they made the right decision.

For me it's quite simple. Where I live (mid-peninsula, SF Bay Area) it is still cheaper to rent than it is to buy by historical measure. Current price/rent ratio is at 22 in my neighborhood and it should be less than 17. So until that ratio comes down, I'll keep renting and keep stashing away extra money into savings. If it never comes down I'll just keep renting or move somewhere where prices are in balance.

"1. buyers credits to stimulate buying
2. FED buying MBS’s to keep rates down.
3. Foreclosures delayed due to attempted workouts, and banks being overwhelmed.
4. 50% increase in homeowners not paying their mortgages in the last 12 months, 100% in 18 months.
5. California/City budgets all must be cut, bad for jobs, bad for housing."

All very good points. Very difficult issues.
But these are all temporay issues.
We have seen similar things in every down cycle.
They do get worked out.
The world is not ending now.

I am seeing Zephyr's point. Sometime, maybe not now, the crash will reverse itself, and it would be very easy and very human to continue to believe the truth that has worked for so long, to believe that real estate is going down, and to utterly miss seeing a very real upward trend.

That said, we continue not to buy because it does not make sense for us. A home identical to ours just went up for sale down the street. Buying it would more than double our housing costs and lock us into a financially troubled school district in a financially troubled state for a very long time. Since we are happy where we are, and since we actually do save the difference in cost, we are much more comfortable letting our savings grow toward an ever-larger down payment and maintaining a larger range of possibilities for our family. Eventually, one of two things will happen: either the cost of housing will come down to a level that feels good to us, and we will buy; or we will continue to look at other locations that might work better for us and take our money and skills there to buy a home.

In just the last year or two, I have seen several houses on our street bought and foreclosed within the same year. The people who would like to live on our street--largely lower-to-middle middle-class families--cannot afford the average home price for this neighborhood yet. The people who can afford to live on this street don't seem to want to buy here. So it goes. I would rather be a renter than get in over my head.

I am open to the possibility that we might be wrong about real estate prices dropping or staying flat. And I am cool with the possibility that we might get locked out of Bay Area real estate forever. Because buying in right now would be bad for us financially and emotionally, and I would rather be a happy renter, or a happy homeowner somewhere else, than miserable here. So, based purely on our own perspective, I am not big on the idea of housing going up. But I am OK with the possibility that it might.

@Eliza

If you read what he said, the bottom has mostly come and gone, but it will be fairly flat for years to come as things work themselves out, and inventory is flushed. You've still got a few years before any price increases could really dampen your abilities.

People who move in/out within a year had some other issues. Perhaps they were renters who were used to spending all the "extra" cash they had. But something major has to happen for someone to move in, screw up, blow through all their savings and move out. They obviously didn't have a 6 months emergency fund!

Eliza says

I am seeing Zephyr’s point. Sometime, maybe not now, the crash will reverse itself, and it would be very easy and very human to continue to believe the truth that has worked for so long, to believe that real estate is going down, and to utterly miss seeing a very real upward trend.
That said, we continue not to buy because it does not make sense for us. A home identical to ours just went up for sale down the street. Buying it would more than double our housing costs

This is a common analytical mistake -- I made the same thing in 2000-2001 when my housing costs were $750/mo and decent pre-GOOG-IPO condos in/near Los Altos were still under $350K. I shoulda bought anyway.

The rent vs. buy decision will rarely make sense in any given point of time. There is an immense number of very wealthy forces that comb through the market looking for anything that will cash flow or close to it, supporting the high end, because everyone expects the history of the 20th century to repeat in the 21st, where every 20 years rents doubled.

When making the buy decision you've got to first NOT count principal repayment as a cost like rent to the LL. Then you should factor in the tax benefits (less the $11,400 standard deduction).

I don't know if RE is going to go up or down from here.But I do know it will respond to larger macro forces, and these macro forces are very different compared to the economic history of any time period in the past you care to name.

tatupu70 says

Sorry to burst your bubble, but housing is NOT going down right now. In the future, who knows, but in the present it is going up.

That was the point of my posting the graph with 30-year rates overlaid. Shoulda also put the $8000 tax credit overlaid too I suppose.

Rates on a 15-year mortgage are under 4.5% and a 5/1 ARM is under 4%. If wage inflation is coming any time this decade, buying now will NOT be a bad decision since paying down these mortgages will be a walk in the park compared to rents.

But it's important to note that the macro picture is still out there as a force, even though Fed intervention was papering over the problem with the historically low interest rates.

San Jose just announced they need to slash tens of thousands of jobs. Regardless of what they do a lot of sh-- needs to happen this decade to return to any good times.

We need to raise taxes & cut spending, increase health insurance contributions, devalue the dollar more, all the while being on the flipside of Peak Oil and with OPEC with the whip hand in setting price as the 2.5 billion people of China and India collectively try to replicate the American standard of living as it was in the immediate past.

This is not your grandfather's recession. Well, it is my grandfather's, he was born in 1911 and I'll let you do the math on that.

Zephyr says

Job markets and the economy are cyclical, and do change

We've gotten used to the cycle since the postwar, a sharp recession every 10 years and then everyone gets back to work.

I think there's an argument that things are different now. The 2001 tech recession was only stopped by the massive SIX TRILLION over-investment in housing, which pushed a lot of debt but not much new actual produced means of production (ie fixed capital) or labor skills into the economy.

It's my thesis that the 2003-2006 so-called recovery did more damage than good, and we're collectively behind the eightball more now than we were in 2002.

What if we simply have more people than jobs, thanks to NAFTA and wide-open merging of our labor market with India and China. Clearly their wages will be going up over time, but I think it's possible wages will meet in the middle. This does not bode well for current RE price levels!

The future is unknowable and it is very likely that the PTB will continue to throw everything they can at the housing market to try to keep prices from falling more. They have a very large set of options they can try, but every one they do puts us more in the Japan camp.

Japan experienced a beat-down from 1990 through 2003. I was there for most of it and saw how it works first-hand. Rents in Tokyo now are where they were when I got there in 1992.

Japan is not the model. The problems of Japan are very different. They have no population growth, shifting to actual population decline. So housing is in a permanent oversupply. When supply exceeds demand, prices fall. Even with low interest rates.

What's happening in Japan is the hollowing out of the rural areas as all the young people pick up stakes and move to the cities. There's oversupply of housing in the cities no doubt, but if you take out immigrant hispanics, the US population pyramid looks a lot like Japan's.

Even if the demographics are different thanks to immigration, the problems of Japan are NOT very different to us. Their labor market too has been utterly clobbered by economic integration with China. They've luckily got a language impedance problem with India so integration with the Indian tech labor market is relatively less.

Japanese banks put their customer's money into way too many bad loans 1985-90. We had millions of Casey Serins that banks found to replicate that behavior.

As far as households go, Peak Debt here in the US was Q308 @ $20.2T. This is up TEN TRILLION from $11T at the end of 2001.

We're not out of the woods after just one year of unwinding, just as Japan wasn't out of the woods in 1992 or the US was out of the woods in 1931.

What happened in Greece... stays in Greece.

This may sound cold, but it really doesn’t matter what 90% of Americans spend their money on. They own so little wealth that their actions are irrelevant. What matters is what the aristocracy decides to do....Who’s going to stop them?

Perhaps Zzzax, The Living Dynamo?

Real personal consumption spending bottomed in Q2 2009.

Debt Held by the Public

01/01/2009 $6,369,318,869,476.54
03/31/2010 $8,290,068,831,046.49

two trillion dollars of deficit spending in 15 months.

That is $18,000 per household of just deficit spending, and that's not even counting the $1.25T expansion of the Fed's balance sheet aka QE.

In 2000, Federal receipts were $2.0T and outlays were $1.8T.
In 2009, this was $2.1T and $4T, LOL.

You pump $4T through an economy -- $36K per household -- and you're going to get some voom.

Hello Zimbabwe, tho where we're gonna get wage inflation is something of a mystery to me . . . at least Zimbabwe's labor market isn't wide open to India, China, and Mexico's, unlike ours.

This is not to say I discount the inflationary case. Everybody wants it, and where there's a will there's a way. I'm just curious how it's going to happen, and when, and how we'll be able to get the wage growth that Japan failed to get in the 90s, having done to ourselves last decade pretty much what they did to themselves in the 80s, which was throw trillions of dollars of borrowed money into pipe-dream land values.

The RE buying binge of the 1980s happened in the US as well as Japan. We threw trillions into the pipe dream of land values in the 1980s as well. And we also had a RE bubble at the same time. The bubble burst at the end of the decade, and led to serious RE problems in the early 1990s. But after the bubble burst Japan followed a policy course similar to our 1930s path and got a result similar to our 1930s result. The US policies in the 1990s went the opposite direction and got a much better result.

INFLATION

Government spending must be paid for. If the government does not collect enough tax to pay for its spending then it must get money some other way. One way is to print money and spend it. This is something that governments normally do (in at least a modest amount).

As long as the economy grows as fast as the domestic money supply there is no inflation, and the government gets the real value of the growth. However, if the new money exceeds the growth in the real economy, then prices must rise to balance the money with the supply of available goods. The process is slow and messy.

If the government uses debt to finance its spending, and if it can make the payments on the debt without printing money, then the deficit will not cause inflation. But it is hard to accomplish this when the deficits are large. So the likely outcome is that taxes must rise, or inflation will rise. People resist taxes so printing money is easier for politicians to do.

In addition, we benefit from world demand for our currency to use in trade unrelated to the US. Any growth in this demand for US currency has a deflationary effect. So when the world economy and trade in US dollars grows, we can print the appropriate amount of money and spend it overseas without increasing the money supply in the US. Part of our trade deficit is the export of dollars for use in world trade.

@Troy,
you are correct, but that view is not popular because (in my opinion) it brings into focus the political issues that the liberal/progressive/biased media is trying to ignor.

From where my company sits in the construction biz, I believe it is far too early to say things are getting better. Only U.S. activity we see hinges around continued Katrina caused work around New Orleans to fix the levees, port work so that people can import more useless junk from China and military projects. Infrastructure work funded by local, state and federal governments is much lower than 3 to 4 years ago even with the stimulus money, as governments at all level are broke. Very little privately funded construction still, as well.

The only bright spot is that many firms are getting big jobs in Central and South America and in the Caribbean Islands.

I think we are 12 to 18 months away from U.S. business picking up.

Zephyr says

But after the bubble burst Japan followed a policy course similar to our 1930s path and got a result similar to our 1930s result. The US policies in the 1990s went the opposite direction and got a much better result.

You really can't compare the two bubbles of the late 80s. Japan's was nuts and it came partially from easy credit and their currency doubling (from 250/$ to 130/$ 1985-1988). "Japan as #1" thesis in the press combined with 40 years of postwar collective sacrifice led to a consumption & RE bubble greater in magnitude than what the US experienced in the 2000s.

Also, you can't compare the last decade to the 80s either. The RTC had to handle about $400B in assets, and the loss was around half that. Painful, but doable. Plus IIRC a lot of the bad lending in the 80s was just commercial, and there wasn't really the home-equity -> cash -> spending -> jobs -> home equity cycle that we saw last decade.

In the US, mortgage lending rose from $150B/yr before and after the late 80s bubble to $200B during 1986-1990 (1987 saw $260B of mortgage lending), about a half-trillion of total lending over the bubble years.

The interest rates regime of the early 1980s was over 15%, and then quickly fell to the 10% level for the latter half of the 1980s, which was a large driver of the real estate boom. Recovery in the 90s was greatly assisted by rates falling from that 10% level to the 7-8% level of most of the 90s.

Now the Bush boom. Total mortgage lending rose from $5.6T in 3Q01 to $11.1T in 1Q08, a debt overhang an order of magnitude greater than the 80s bubble. Also, the price levels of 2006 were driven not by the sustainable 10% interest rates of the late 1980s, but rather the unsustainable suicide lending allowed to go on 2003-2007, where millions of borrowers were allowed to rope themselves into suicide loans designed to blow up in 2 to 5 years.

Throwing what they could at the problem, the PTB have managed to raise the FHA limit to over $700K, provide 30 year money at 5%, expand the Fed balance sheet with a $1.25T in mortgage paper -- ~four million mortgages are now owned by the Federal Reserve (!) -- and hand out $8000 buyer tax credits from Uncle Sam (plus more from some states) on top of it all.

I don't know where we go from here. But I do know how we got here.

I agree that wild and expanded lending was the heart of the problem. And the Fed lowering interest rates in 2002-2005 threw gas on the fire. And the fire was worse this time. So the workout should be more difficult this time. And so far it has been. But not by so much.

It was really bad last time too.
This is not a completely new experience.
Mostly a worse than remembered one.

The 1980s bubble was mostly driven by demography – the boomers buying houses.
Less onerous interest rates assisted the boom.

The 1990s strong economy was driven by the largest generation being in the middle of their working careers. Not because they were great workers, but because there were so many of them working. And there were fewer children to feed. We had a high ratio of workers to dependents. That freed up cash for discretionary spending (like never before).

The 2000s saw the excesses of constantly rising expectations being aided by very cheap credit and cheap goods from overseas. That would be fine if we lived within our means. But we did not. And by spending excessively we drove our markets to bubble levels. And bubbles always crash. And pain always follows.

In addition, rising labor competition from overseas has been eroding our competitive position. This (combined with many of those laborers coming into the US) has undermined the wage levels for most workers. So the average worker has not benefited from the bubble economy.

It will get even more difficult for the average worker in the future. Half the world was starving 20 years ago. To a starving man a job that pays enough to eat well is good enough. Their expectations are much lower than ours. So they will work for less in real terms.

The average American will not work for such a lifestyle. Even our poor live better than the workers in places like China and India. So I expect that even more work will go to the starving poor overseas.

This competition will make it difficult for our standard of living to improve. The average of the world is improving dramatically. But it is the starving poor of the world who are seeing the biggest change in their lifestyles.

The wealth advantage that has favored America (and other developed countries) is eroding. The question is whether we can offset the loss of competitive advantage with rising productivity. So far it has been a very close race.

Our government is now trying to spend its way to prosperity.
This will not work in the long run.
We must produce our way to prosperity.
The more jobs we have in non producing activities the less wealth we will eventually have.

Our new level of government spending cannot be supported by tax revenues, so I expect the printing press will soon be used to ease the burden. This will lead to rising inflation.

@Zephyr
What exactly do you do? I really enjoy your posts, they always try and take into account several aspects of the economy, not limiting your posts to just one angle.

A couple questions and/or thoughts.

I would agree with you that printing money is a half decent solution. It will mostly hurt countries using the dollar and/or holding it. It probably will to a lesser extent hurt Americans because as everything rises here with inflation, countries that heavily rely on the dollar won't see the full rise, they will just see their net worth decrease compared with their local currencies. How far do you think we can take the currency without causing major international issues? Such as China, they're holding onto a lot of dollars, with no other alternatives. How long before they really start doing something? What might they do, other currencies isn't really viable. Their own currency isn't viable, as that would push it through the roof and destroy growth. Obviously hyper inflation isn't necessary, a few years at a slightly elevated rate would probably offset much of the burden, but how much higher and for how long?

I do think that many of these countries are almost at a tipping point where they will become consumers themselves. Such as china/india. At least china has a full economy from manufacturing up to services setup. The people there are starting to buy more luxury goods, I suspect they will need a few more years of prosperity before enough feel comfortable with the consumer life style. I think it's less likely we will stay ahead in terms of productivity and more likely others will create their own economies requiring higher wages. Our productivity gap is closing because we can only makeroughly a 3% gain every year (average we've seen over decades I believe?) but other countries can look to us and make large improvements year over year by copying us. Of course, the closer they get, the slower their rates become, but eventually the gap will become small enough that cheap labor+their productivity will far far outpace us.

@Troy
I'm betting that much of the wealth is being generated by people who are interested in generating that wealth. The average American isn't interested in sticking their neck out and opening up a business or doing what it takes to run a business. They're happier being a worker bee, with dreams of becoming rich and dreams of using a get rich quick scheme to do it. They spend everything they have, instead of being prudent and saving. The rich can't spend everything they've got, so it goes back into savings, and thus they accumulate more wealth. This is just how the system works. As companies have grown in size over the last 50 years, so has this wealth because fewer and fewer people were needed to run, own and operate these massive organizations.

I dont know why you would need to "double up health premiums" there is only something like 10% of the country without insurance. Obviously doubling up wouldn't be necessary.

Likewise, I saw something on social security needing 1-2 extra % over the coming years to offset the dooms day that everyone is predicting. 1-2% isn't much, which makes me believe this is more hype than a problem.

Pkennedy,

You asked what I do.

I study the macro economy and bet on what will happen.
This has been my focus for about 35 years.
The economy has been my favorite topic for more than 35 years.

More specifically, I am an investor/speculator.
I make my living by betting on what the economy and markets will do.
When I am right I make money.
When I am wrong I lose money.

I have over 30 years of experience in the financial services industry (risking other peoples’ money), including more than a decade of CEO experience running large ($1+ billion in assets) financial enterprises within the Fortune 500 environment. I have retired and do some consulting/advisory work for private equity/hedge funds and an investment bank.

pkennedy,

I agree with all of your observations above except one. You stated that the cheap labor combined with higher productivity will far outpace us. The more likely scenario is that their real wages will eventually climb until the wage gap is closed. So they will at least lose their wage advantage.

As for how far we can inflate our currency, we can go forever as long as the other currencies inflate at a somewhat similar pace. If the dollar loses value relative to other currencies at a fast pace it will cause problems. But if the dollar loses real value, but at a similar pace to other currencies it will not stir shifts in global currency uses.

Troy,

There is no contradiction to my assertion that we must compete with a global labor pool, and the likely expansion of money supply leading to inflation. In fact, the tough global competition will make it more difficult for government to raise enough revenue by taxes. So the incentive to inflate is increased.

10% owning 90% of the wealth is not ideal. But, that does not mean it cannot continue. For one thing you are looking at only one country in the world. During the last two decades (since the fall of the communist system) most of the world has experienced significant improvement in their wealth and well being. The richest elites of the world have also become richer. But, the average American worker has been in competition with the starving poor of the world. Their wage needs are lower, so the world labor demand has shifted away from the average US worker. It will continue to do so until the wage disparity between the US workers and the poor foreign workers becomes much smaller than it is today. Not a pleasant path for the average US worker.

It is certainly possible that average home values might not increase in real terms over the next few decades. But they will go up in nominal price. It might be entirely due to inflation, just keeping pace with the cost of everything else (ie no real gain). Along the way home prices will rise and fall in a cyclical pattern around the long term trend. And there will be regular future bubbles and busts, as there have been in the past.

High end homes in the preferred neighborhoods will rise in real value as a growing population competes for the best spots. This will be most visible along metropolitan coastlines. It is the affluence of the top few percent who determine the price for those homes. So we could have stagnant real values at the low end along with rising real values at the high end.

The likely cyclical pattern from here is that home prices will be stagnant for 2-3 years before starting a noticeable cyclical climb.

Zephyr says

I have over 30 years of experience in the financial services industry (risking other peoples’ money), including more than a decade of CEO experience running large ($1+ billion in assets) financial enterprises within the Fortune 500 environment.

I doubt a Fortune 500 CEO will come and read a "house price is too high forum".

Most people here are the people who got priced out by the house market and wonder what to do.

Xeno, I look for interesting information in a broad range of places. Mostly I read economics blogs and business news sites. But, with a third of my money invested in CA rental properties, I am interested in the sentiment of renters. As a real estate speculator, I am interested in the sentiment of people who will want to eventually buy. So, occasionally I come to this website to see what people are thinking.

You are entitled to your doubts, but my description of myself is accurate.

pkennedy says

I dont know why you would need to “double up health premiums” there is only something like 10% of the country without insurance. Obviously doubling up wouldn’t be necessary.

There's having insurance, and actually being covered.

"An estimated total of 61 million adults, or 35 percent of individuals, ages 19 to 64, had either no insurance, sporadic coverage, or insurance coverage that exposed them to high health care costs during 2003."

http://www.commonwealthfund.org/Content/Publications/In-the-Literature/2005/Jun/Insured-But-Not-Protected--How-Many-Adults-Are-Underinsured.aspx

61 million is a bit different than 10%. We lower our insurance burden by simply not covering the most expensive cases (speaking in general, obviously people have expensive procedures done thanks to their insurance every day).

The recent reform bill stops recission (dropping people once they become expensive) and also stops the preexisting condition exclusion -- children this year, and everyone in 2014. THIS IS NOT GOING TO LOWER OUR MONTHLY INSURANCE BILLS, LOL.

Whether it doubles them is up for debate, but whatever the cost of the health insurance reform. it's not going to be putting more money in your pockets. Unless you're associated with the medical industry directly or indirectly.

I agree that the reversal of the FICA surplus that is starting now and will continue until the OASDI-held treasuries are sold off (around 25 years from now) is not that big of a deal. But for the past 25 years the FICA overpayments of the toiling classes have helped prop up the overall tax picture. SS is scheduled to rise from $700B/yr now to $1.1T in 2020. That's $400B more in taxation that is going to need to come from somewhere, a burden we have not had to face in quite a while, and one we were supposed to have been preparing for since the 90s.

Zephyr says

There is no contradiction to my assertion that we must compete with a global labor pool, and the likely expansion of money supply leading to inflation. In fact, the tough global competition will make it more difficult for government to raise enough revenue by taxes. So the incentive to inflate is increased.

This is pretty vague. Throwing words like "inflation" and "difficult" around without really digging down into what you're saying doesn't help me much.

Inflation can be a complex monetary phenomenon. The 30 year at 5% right now is telling us something. What, I don't know, either the PTB have their fingers on the scale right now, the market knows something you don't, or space aliens have a mind control satellite helping the Fed out.

Since 2005, assets of the private sector have risen from $37T to $42T, against liabilities of $16.4T and 19.4T. So our net worth has increased $2T in 4 years, I think Uncle Sam should be able to take half of that back. Times are tough and all.

With the S&P almost back to pre-crash levels, looks like the market likes corporate earnings power going forward. The big guys seem to be making money again, as the thread title says, so I fail to see why raising additional tax revenue from our corporate masters is necessarily "difficult".

I, personally, think J6P is due for liquidation this decade so I agree with your general thesis that land values for the middle tier and lower are going to be stable. If the rich are going to be bidding up the price of land in the enclaves, seems to me that it would be better for everyone that they carry a bit more of the tax burden instead.

Kinda stupid to have undertaxed people just bidding up the price of housing all the time, but I guess we'll never learn.

Troy, I am not describing what I would like to see happen. I am describing what I think is most likely to happen. Politicians almost always run deficits. And when spending surges, taxes will likely not keep up. So the deficits will surge as well. It will be very difficult to pay for the recent surge with tax increases. Therefore the printing press is likely to ramp up.

But I am curious how you could have a problem understanding the possibility of inflation and labor competition happening at the same time. There is always labor competition. And nearly always inflation. A little more of both is not at all contradictory.

Zephyr says

Troy, I am not describing what I would like to see happen. I am describing what I think is most likely to happen. Politicians almost always run deficits. And when spending surges, taxes will likely not keep up. So the deficits will surge as well. It will be very difficult to pay for the recent surge with tax increases. Therefore the printing press is likely to ramp up.

Well, I think Obama's approach at drawing the class warfare line at $250K/year/earner has merit. Separates the wolves from the sheep. (I'll leave the reader to apply their biases to determine who is who.) I don't see any inherent "difficulties" here either politically or economically. Hell, the Bush tax cuts are scheduled to sunset without any action required at all.

But I am curious how you could have a problem understanding the possibility of inflation and labor competition happening at the same time. There is always labor competition. And nearly always inflation. A little more of both is not at all contradictory.

"Nearly always" is a useless assertion IMO since we are in terra incognita compared to past situations. We can apply our understanding and arguments of how the present power structure will generate policy going forward, but other than that I don't think anyone can state with any certainty how events are going to unfold this decade.

In the 1970s the Gang of Four was still running China's economy, what was left of it, back to the state it was in the 19th century. India was not connected to the US labor market via 24/7 satellite and cable communication. Mexican labor was for lettuce picking not VWs and NAFTA industries. In 1975 the baby boom was turning 20 and not turning 55 like this year. The national debt held by the public was $1.5T in real terms not the $8.3T of last Friday. The North Sea oil supply boom was still a decade off. Foreigners didn't hold almost half our gov't debt, either.

http://www.ustreas.gov/tic/mfh.txt

When I think inflation, I think the minimum wage and the COLAs social security recipients get, ie wage inflation. THAT'S inflation.

Price inflation without wage inflation doesn't concern me in the slightest, even tho it does mainstream economists for some reason. This is because I look at real estate valuation as an immense buffer -- it is 20% of our GDP -- that sucks money from us schmucks when times are loose and disgorges said money when times are tight. Mainstream economics IMO simply fails to acknowledge that the present production cost of the existing stock of land and improvements approaches $0, ie real estate is simply not a good like a commodity or a normal product of labor.

My general thesis, which I consider applicable for this decade, is that Income -- less gov't taxes, less mandatory insurance, less energy costs to get to work, less basics like food, less quality-of-life -- ends up in (ie determines) Land Values.

Hold Income constant and raise anything else in that intermediating list of life expenses, and Land Values will go down, eventually.

Government outgo has seen an immense expansion over the past 10 years. Up to $6.5T this year will flow through government -- that is 65 MILLION jobs at $100,000 each (stupendous!). There are three options going forward: cut government spending, raise taxes, and/or raise borrowing. The first two are deflationary and the other IMO doesn't automatically result in wage inflation (see Japan), and the price inflation it can engender isn't necessarily a good story for rising land values, like I said, show me $10 gas and I'll show you hundreds of housing markets utterly slaughtered.

edit: Well, there is a fourth option I neglected: sheer printing. It has a lot of benefits but also some costs; the China conduit from which we get so much of our consumer goods will be constricted, and OPEC will want their customary adjustment. Printing money will certainly result in higher consumer prices but I fail to see how it will result in higher home values.

In 2014 the health insurance reform is going to really start taking more money from our paychecks. This guy:

http://brucekrasting.blogspot.com/2009/11/oct-sstf-report.html and http://brucekrasting.blogspot.com/2010/04/size-buyer-now-size-seller.html

has a handle on the SSTF surplus or lack thereof. Social Security and the baby boomers are now officially a net suck on the general fund. Raising the cost of money for the Treasury and a lot of bad things can happen.

Again, I don't dismiss the inflation hypothesis. For all I know Walmart will be paying $20/hr in 2020. That's not what happened in Japan, 1990-now, but we are not necessarily Japan, no matter how much we try to repeat the mistakes they made.

The ultimate symptom of deflation is local government taking payroll/overall compensation reductions. We are beginning to see the change of course like Mayor Reed (or Newsom) following the example of Michael Bloomberg saying "back atcha" to the unions: let the unions decide, paycuts or layoffs.

Now it is about the union leadership saving face.

@E-man
Arnold. Granted he didn't get anywhere, he tried. I give him credit for going from 0 political experience to one of the most important positions in the country and trying his best.

@Zephyr
I think productivity + cheap wages will ultimately out pace us, but wages will be the factor that puts the break on their progress. Once they've tapped out all the easy productivity gains, wages will be the factor that slows everything down. I agree with you here for sure, I just think that low wages + productivity boosts for the next 5-10 years will really hurt us. After that, I think their own wages will balance everything out.

I figured your experience had to be fairly significant, your ideas are fairly all encompassing, which many people miss out on. It's easy to point a finger at one issue and another finger at a "solution" and say that is how it must come to be to fix everything! vs an understanding that with every action there is a reaction somewhere else. That many things have multiple counter balances and not just one input which can be turned to straighten it out.

Media is the worst for bringing these people out. They come out with solutions that essentially ignore half the market and say to fix this problem we just need to do X, ignoring that it would bankrupt half the country, or send interest rates way up or down, or the employment might be massively effected.

I'm always on the lookout for new information sources, do you have any that you regularly use that you would recommend? Or books that you've read and found balanced and informative? Without a major in economics, it's often easy to fall prey to these one sided arguments, so balanced information for me is most important aspect when I'm looking for new sources..

@troy
There was a piece I read last night on cnnmoney I believe on the insurance issue. They actually stated that many of the uninsured are in their 20's and 30's when they believe they are invincible. I know I'm invincible, but I keep insurance anyways :) They said that the insurance premiums might even drop at the higher ends because there will be a larger pool of people paying in, but fewer medical payouts in the lower end. They also had a figure on the emergency room visits for the 20's and 30's, and it was fairly significant, meaning they just wait until it's emergency room time and then go there.

To: Patrick, I tried to find the correct forum and don't want to hijack this one, but it is important. Please read this.

I recently saw your Google interview and thought you did wel! However, I think that there may be more variables to assess with the" Rent costs vs Buy with mortgage costs vs the pay cash for a house theory?

I have always accepted your hypothesis until recently. Here is what I have experienced. When you only look at the amount of rent vs cost of monthly PITI you may be missing two variables that might keep house prices high (above structural value).

1) This is the cost to replace the structure. yes a plot of dirt has value but look what happens if you ever have a disaster like a house fire. Even if you are FULLY insured lets say for a fire, and have zero deductibles with stated value on contents, insurace companies will NEVER pay the cost it takes to replace the structural damage. If you look carefully at THEIR objective evaluation of the value of the house it is MUCH less. Everyone knows that BUT there is an elephant in the room. Who owns personal lines insurance companies? It could be an investment bank which might even own the mortgage on the house. So the SAME people are willing to loan you MORE MONEY than the house is worth to them to fis it under the insurance part of the business. There must be a nexus between the two values. A TRANSPARENT VALUE. The house can NOT be worth two values to the SAME FIRM (not including land value---which does not burn--in my example) The banks want it both ways---put you in debt to them as a debt slave AND NOT PAY what THEY think the house is worth on the insurance claims side of the business.

2) I live in an exurban area with population of about 70,000. I noticed that local rents are still very high even though house prices are dropping. I started checking and here is what I have so far.
Single family dwellings, duplexes, triplexes and small apartment buildings under 20 units have different rents based on WHO OWNS THEM. The small operator including wannabe rentiers, mom and pop type investors are forced into lowering rents and many are hurting for one basic reason: THEY OWE A MORTGAGE that is less than 15 years old on the property.

But I noticed that about 12 families own over 70% of the rental units including single family residences. A simple records check with the county recorder shows liens and mortgages on these properties and the small investors are losing these properties. However the "GOB" or what we call locally the "Good Old Boys" property mafia happen to be in 3-4 of these businesses: Real estate sales, small building contractors, developers and property management. Many are all four of these. They also own their own small mortgage shops and cross fertilize with each other with 3-4 small banks that they may have in the "family".

This is not a big deal until I noticed something unusual. I know one of these people who is "all of the above" and aI looked at one of his websites and actually checked out some of his rental inventory.
He has many vacant houses that look less than ten years old, they all have "curb appeal" and look okay from the outside (I know all of these are junk on the inside---another story---this group includes city officials and the building and planning departments---If you are an "outsider" good luck with getting a building permit).

These houses if they were for sale today would get under $225K (MAX) . Okay thats not a big deal until you look at rents for those same houses. If the houses were owned by othersm the investor-owner would quickly take no more than $1100 month AND would look the other way about sublets. These "little people" are in PAIN. House prices down ---rents are dropping EXCEPT.

These SAME type and SIZE cheesebox tract houses have rent signs for 1350- 1500/momth ! If they are owned by the GOOD OLD BOYS. The GOB will never sell low as REALTORS unless they get the property for next to nothing. But they will NOT RENT IT OUT for anything but the maximum they can get. This means there is a LARGE inventory of RENTALS AT ABOVE MARKET RENT RATES.

How can this be? They own the property management firms as well. They get a cut out of ANYONE who thinks they will go into the RE business in this town.

They would rather have the houses sit in the sun EMPTY rather than rent them! One reason is that the RENT TO BUY simulation that the average local person sees make sit appear that they can not afford to rent SO THEY MUST BUY---FROM THESE SAME PEOPLE. So these are either faux rentals or unlisted properties for sale, and this keeps house prices high and the buy/sale machine running. All of these "rentals" have a price BUT ARE NEVER LISTED. I live in one of them. They houss are like marbles trading back and forth BETWEEN THE SAME PEOPLE.

Two blocks from here is a small development---mostly empty lots. I checked the recorders office and found that I see person A sell the lot to person B who sells the lot to person c who sells the lot back to person A LIKE A MERRY GO ROUND. They never seem to do anything materially to the lot or house but sell it to another friend for MORE MONEY. I can see a lot of criminal reasons for this such as building comps so the mortgage companies take a hit. A buyer overpays---can't sell it---off to foreclosusre and they buy it back again.

One thing they ALL have in common- EVERY ONE of them is a REAL ESTATE BROKER.

In this scenario, house rent vs sales price are artifically manipulated to keep house prices high!

I first guessed this was going on during the bubble but could not prove it...who can read minds? I can not be these same people are NEVER hurt buy the bubble collapse.

In 2004, I was right on the edge of buying----but I don't like listed properties since the REALTORS always get first dibs on the good ones. I called up the "landlord" for the place I rented and asked him if he wanted to sell the property. He told me he would think about it. Within one week one of his property managers was hanging around and gave me a notice to look inside. He bought the house that day. BTW my landlord was a REALTOR, BUILDER, PROPERTY MANAGEMENT FIRM, DEVELOPER, a former city councilman, former mayor, his two brothers were both city councilman or mayors and they are ALL IN THE SAME OR similar business. The planning department, city manager , building department directors all work for one or the other GOB. they take turns proteting their turf.

I know this happens all over the USA, and so fore the purposes of you rent/buy decision matrix you should think of including this in at least small areas cities or counties. One of these small town GOB's is actually on the FORBES 500 list of most wealthy US persons. It is may be a small town , but they are running a small kingdom for THEMSELVES ONLY.

Oh ths house I wanted to buy? The idiot property manager whou bought it---got a HELOC and bought a new VIPER and a car for his wife, raised my rent to cover bhis PITI and sold in 13 months and barely broke even.

The new owner is upside down by 300k and has turned the place into a pig sty. There must be AT LEAST four families living in the place---according to neighbors. The GOB are trying to bust the neighborhood and use a Redevelopment AGENCY to fix the BLIGHT they made---by hiring them to fix their OWN rental properties. The only non-realtor on the city council is a real estate appraiser who works for them .

bottom line ---The Rent vs Buy ratios can not be the ONLY determinant for a decision. My experience tells me that INTRINSIC replacement value AS WELL AS acknowledgement that in some geographic areas you will find this GOB type ownership - control system.

You may ask what about mortgage for construction loans to build this junk? Its easy SHODDY construction, low paid or unpaid laborers and construction workers keep HIGH equity positions in these properties. They pay CASH for the dumps and flip or rent. Its that easy.

Linda

Why homes aren't good investments.

1) A home is a place to live. If you gamble with your shelter you are gambling with one of the basics required to have a stable life.

2) A house is a tangible asset that is only worth what someone else is willing to pay for it at any given time, and this amount varies widely over time given socio-economic factors that are beyond most people's control.

3) As a tangible asset whose primary purpose is a basic necessity like, shelter, houses won't appreciate faster than inflation or wages over the long haul, as shown by hundreds of years of tracking house prices shows. This is true because the very basic purpose of this asset is shelter. It's utilitarian. It's not a blue chip stock that can be allowed to fluctuate wildly independent of a customer's willingness or ability to pay. The basics are always priced so that most people who work and earn income can afford them over the long haul. When prices get too high for that, we have a bubble. Eventually bubbles pop (if left alone in a capitalist system). Prices historically return to the pace of wages and inflation after bubbles and valleys.

4) Investments like stocks have consistently out-performed real estate over time. If you're counting on your house as a store of value to sell when you're ready to retire, you could be earning higher returns in the stock market. (Of course, this is based on past performance and doesn't necessarily dictate future performance.)

5) When you retire, you have to live somewhere. If you sell your house, you have to find somewhere else to live. It costs money to find shelter. It costs money to sell a house. It costs money to move your possessions from one shelter to another. You may not be able to find shelter that costs less than holding onto your house unless you are willing to majorly "downsize."

Continue...

tatupu70 says

P2D2 says

That could be true for your area. But people near big metropolitan areas do rent homes

I think it’s more of a West Coast thing. I’ve lived in Midwest and East Coast cities and people don’t rent houses very often. But it does seem to be common in CA.

When I was living in Davenport, Iowa, many of my co-workers and friends were renting houses. I think it's more common than you think.

Great post, Linda. Prop 13 for non-owner-occupied property was one of the stupider things California has done. The fallout effects from this are truly immense. RE is one scum-suck sector of the economy and Ho Chi Minh in the mid-50s had the right idea if wrong implementation.

Therefore, to expect home prices to come down to 3x income in the fortress areas is highly unlikely IMHO.

Oh, I agree. Prop 13 (and 58) has locked away tons of inventory that will cash flow in any foreseeable future economy (even one without Google and Apple pumping billions into the local economy).

The 3X rule might hold, but it won't be over area median income but the median income of the new people who can afford to bid themselves into the fortress's tight supply.

simchaland says

When I was living in Davenport, Iowa, many of my co-workers and friends were renting houses. I think it’s more common than you think.

Maybe-but I've lived in several different areas and never seen rental housing like I did when I was in CA. I think it is at least partially due to prop 13...

The fact is someone is paying for the uninsured to have medical care. Either in taxes or higher premiums.

I can't decide which 3/2 rental in Concord offers the best value; perhaps this one (1550 sq.ft.) at 1069 Kaski Lane which is going for $1800/month. Hmmmm... owner's tax basis is less than $100k. How low can you go....