patrick.net

Also, there is a good reason why asset prices are not in the domain of CPI. Asset prices are very sensitive to monetary, as opposed ot macro-economical conditions, and therefore are not innate characteristics of the economical development.

I think this is the basis of the bubble.
BUT, what about the people who have bought these assets at high prices.
As a consumer they have locked in high holding (or consumption) costs.
The builders have also generated profits and therefore this should reflect in economic indicators.

What’s the “fluff” that those people are buying? Are we talking about cars? Ultimately, there’s only so much space in a house which puts a natural limit on the amount of furniture, TVs, etc. that you can have…

I don't know..... people seem to have an amazing ability to accumulate stuff. Clothing and jewelry don't require that much space, and women looooooove that. I bet people are entertaining more, so I'd love to see what liquor and food profits are like nowadays. Just a thought.

What’s the “fluff” that those people are buying? Are we talking about cars? Ultimately, there’s only so much space in a house which puts a natural limit on the amount of furniture, TVs, etc. that you can have…

See? A cycle! Once you have exhausted the space of your house because of all the stuff/fluff you need a bigger house. Once you get a bigger house, you need more fluff to fill it up. Sigh...

Crashes in equities are much worse, IMHO.
From what I've read about crashes in the past, equity crashes aren't that bad, where RE crashes are worst.

Reason is that equity crashes tend to hurt the higher income demographic, who can mostly withstand the fallout.

RE crash hurts a broader demographic will alot more people who can't withstand the fallout.

Let's see:

62" Plasma TV: $10000
Escalade SUV: $60000
Lexus Sedan: $50000
Kitchen Remodel: $30000

150K of "middle class" stuff that can fit nicely into any house with a two car garage.

He drove an old Cavalier that he had purchased used. Quite a different story than your average Santa Clara County Realtor in his Acura RL or Escalade.

In Silly Valley, I saw a parked brand-new MB S500 with a open house sign stuck in the leather backseat.

Max, I thought all bubbles represent expectations.

Farther into history, tulip-mania did not crash Dutch Kindom.

I'm not sure if tulip's ever reach the price of a home though.

Equities however represent real income-generating economy, and they represent the most important part of a capitalist economy - expectations.
The price of an equity, both up and down, actually don't control the prosperity of the underlying company. (Except for mergers and takeovers of course).

I am talking about earnings. Equities are the “real thing” because they generate earnings and wealth. Their valuations is the market expectation of the earnings.

Assets, IN GENERAL, do not generate earnings.

I understand that. But an asset bubble forms only when there is expectation of price gains irrespective to the associated cashflow. (rent or earnings)

Price of a bulb routinely reached prices of whole estates at the end of the bubble.

I agree... from what I have read.

Max, what do you think of Joseph Stignitz?

When my son-in-law asks all that, I just tell him to raise his right hand. Things get quiet fast.

Huh

I have often pondered the linkage between equities (companies) and RE.

For somebody to earn an income, a company usually has to be profitable.
The equity would rise. The employee would get part of the profit (wage) and usually put that towards their house. It seems logical to me that equities should out perform the RE market as the primary income producer would be recognised as the bedrock of future RE growth.

I think I read somewhere that generally (In OZ) that shares on average, outperform RE.

Thoughts?

And this is why I believe, asset prices are irrelevant to the real economy.

What about people who have used leverage to buy these assets?

And this is why I believe, asset prices are irrelevant to the real economy. Basically, when asset prices inflate the money is created in the financial sector, when asset prices deflate, the money is destroyed in the financial sector

Second law of thermodynamics:-
Money is neither created nor destroyed.

... Once the money has been printed it is out there, only being brought home by the FED's interest rate.

I have a couple of friends who are DINK's, but are thinking about the children issue. Fact is, they could afford to have kids quite easily. They earn about $250,000 collectively each year. They bought their house well before the market got moving. So what's the problem. Let's see. Jet ski's, BMW SUV, BMW sedan, Oh wait! They decided to sell the SUV and get a mini cooper. They take probably 4 vacations a year, Europe Hawaii-- like that. Now they could have a kid if the wife keeps working, but the wife doesn't want to work. But the wife also doesn't want to give up the lifestyle, so kids keep getting put on hold. See the vicious cycle? They're still going round and round on the issue and ultimately it's going to come down to kids or stuff.

“Money is neither created nor destroyed.”

How about "money as purchasing power is neither created nor destroyed, ceteris paribus"?

“Money is neither created nor destroyed.”
I was only kidding that money can't be created. BTW , they actually print it.

When somebody borrows money to buy a house, the seller gets a fat wad of money. When the asset declines in value, the seller still has the money.

Unfortunately, the leak in the boat here is when people, or companies go broke, the debt is effectlively waived. BUT the original money is still out there though.

Unfortunately, the leak in the boat here is when people, or companies go broke, the debt is effectlively waived.

Does the bad debt get "waived" or does it just cascade through the system, getting absorbed in the process.

Incorrect as well. For example, government deficit spending is a direct enforcement of making certain purchases - for example - infrastructure, labor for building highways, military and high-technology developments. This debt will be monetized at some later point. So, you can actually increase your purchasing power by borrowing, that is - creating new money at THIS point in time.

Ok, you have point. Not going to argue with you. :)

Incorrect as well. For example, government deficit spending is a direct enforcement of making certain purchases - for example - infrastructure, labor for building highways, military and high-technology developments. This debt will be monetized at some later point. So, you can actually increase your purchasing power by borrowing, that is - creating new money at THIS point in time.

What if government spends money in a non productive way producing deficits.

Does the bad debt get “waived” or does it just cascade through the system, getting absorbed in the process.

Does the FED ever have a bad loan?

Will the FED ( or government) bail out Fannie Mae (hope I spelt it right)?

I was reading in The Economist this week that the average European home costs 10X the average income in Western Europe and England.

This is why I am very careful in NOT using affordability in our bubble arguments. Rental yield is a much better indicator.

In the Bay Area, it is getting very close to 10X. Also, I think homeownership rate is lower in Europe. Please correct me if I am wrong.

By the way, I’m not being sexist - the person staying at home could be the husband instead of the wife.

I agree.

BTW, the effect of losing one income is not that bad. The marginal tax rate will be lower. There will be less need for hired help. More eating-in. Less gasoline consumption. Less car depreciation.

Face Reality, where is your bio? :)

Yes, but what happens to the career of the person who stays at home? That can potentially be a huge long-term sacrifice. Also, relying on one bread earner in today’s job market is scary, especially when you have kids.

Not being sexist. If women left the work force, wages might increase as companies compete for the fewer workers.

Yes, but what happens to the career of the person who stays at home? That can potentially be a huge long-term sacrifice. Also, relying on one bread earner in today’s job market is scary, especially when you have kids.

Not necessarily. If one is entrepreneurial enough he/she can always start a home-based business. That is by no means stable income, but there can be an upside.

It is scary, I agree.

I do think that whenever there is a chance, one should seek to build a stream of passive income.

“KURT S: AMERICAN ODDITY”

(It’s catchy, dont you think?)

--I suppose it could be worse, such as "KURT S: AMERICAN PSYCHO"

it’s insanity, especially around here (Marin) right? This county used to be a very laid back, decently well to do, unpretentious place.

Yeah--that's what I used to like about California in general! Perhaps a new ethic will return; something needs to give way. And, despite what I save personally, we live modestly (although comfortably). Certainly the environment here lends to a lifestyle that's unrelated to money, and I enjoy that. It doesn't take mad dollars here to enjoy kayaking every day, enjoying the scenery and wildlife. Ok, enough about moi...

You’re basically saying that the middle class should scale down its expectations in terms of housing and other things. It’s hard to see this is a positive development
Well, I think the housing angle is currently overvalued--and will adjust. However, if Americans learned to enjoy life with less, it would do them a lot of good. Obviously something's wrong, given the stats on credit card debt, etc. By contrast, American's should check out how the "middle class" lives in Europe--that would be an eye opener, at least by my experience. But of course, here we're entitled to the "good life"--whatever that means. ;)

In the Bay Area, it is getting very close to 10X. Also, I think homeownership rate is lower in Europe. Please correct me if I am wrong.

Peter P-
All I can provide is scant anecdotal information, but very few friend's families in Switzerland own homes, unless they're farmers or financiers. It's much more common for the middle class to live in apartments. I'm sure P.Tiemann has more info to share.

Max, Krugman has been saying for 2+ years precisely what he is saying now, that re is overpriced and that the rate of appreciation is unsustainable. Eventually he’ll be right, yet it has not been a pretty sight to see him ignore his past inaccuracies.

Technically, Krugman has not been inaccurate unless he was specific about the timing.

But if the wife stops working, the $250K will be cut in half or so which makes it hard to afford kids (at least in the Bay Area) even if you are frugal and your mortgage is relatively low (say $500K instead of $1M). Also, it’s not easy to resume an interrupted career, so this may be a long-term financial damage. Even if all these aren’t concerns, how secure is the husband’s position?

I should further explain. She currently works at home but has to travel frequently. And even if they go to one income, they would still earn 6 figures and could easily afford to go to one income if they were willing to give up some of their more lavish spending. The thing is, the wife wants to be a stay at home mom AND continue to live the lifestyle she's become accustomed to. So far the lifestyle is winning out.

On a recent visit I asked her ‘why do you prefer to pay 600 in rent over 500 in a mortgage?’. She is looking at purchasing now.

So why would an investor want to buy in Bay Area, when there are better oppurtunities to be found?

How does one go about financing something like that, if you are an American investor? Do you have to pay all cash?

This might be a good investment, if you can get your sister to do the property management for you. It might be okay even if you cannot.

It is pretty funny: I was spurred by your post to start researching property in Europe. The Craigslist postings in Europe are all trying to sell crappy condos in Florida.

The Craigslist postings in Europe are all trying to sell crappy condos in Florida.
LOL, can there be that much sun in Florida, or are flippers trying to find buyers that far away.

Lots of issues to cover:-
1) Tax implications for rent collected.
2) Foreign ownership.
3)Currency hedging (might be good timing vs USD.)
4) Financing. (Are you foreign national?, as this can help in some euro countries.)

There is no correlation between interest rates and equities (real sector).

Unless you are a value based investor, where interest rates determine a suitable price of the equity based on company dividend / equity price.

I am still not very sure about having kids. It is not a lifestyle issue. Well, perhaps kinda. It is easier to take career and financial risks without kids.

Hopefully, we can have the means to participate in philanphy when we retire, thus filling the void of old age.

Face

I am very impressed at your ability to express the possitive intangibles of having children. ;)

Having 2 kids of my own, I can speak from experience on the kids vs. money/stuff issue. I wouldn't trade parenthood in for all the Escalades and McMansions in the world. Of course there are going to be trade-off's financially and yes, you worry. But there is unbelievable joy as well. Those late nite's up with the baby may sound hard, but when I get to hold that child next to my heart and smell his hair and cuddle him close... let me tell you, there isn't a pet in the world that can evoke the kind of love a parent has for their child.

My husband has a partner who elected to never have kids. He and the wife are still happily married after 25 years or so. They're both successful, millionaires in fact. They have a beautiful home, they go on fabulous vacations, donate huge sums of money to various charities. In short, they have a really great life. But when you go to their house you notice some things. Their place is spectacular, chandeliers from Yugoslavia-- stuff like that. But there are no family photo's on the wall. There are a few pictures of neices and nephews around, but nothing really prominent. The house is always perfectly in order but not really lived in; in fact it's a little sterile. While other people their age are enjoying the grandchildren and having family over during the holidays, they spend much of that time alone. Retirement isn't even on the agenda, even though they could easily afford it because work has filled up the void in their lives that living childless has left. I'm not saying they're unhappy, but I have to say that from where I'm standing, it doesn't look like that much fun to me. My parents don't have the money they do, but they have a home that's filled with activity and grandchildren on a regular basis. And my parents would have a comfortable retirement despite having children if they had planned better-- but that's another story.

When I was in my 20's I was sure I was never going to have kids. My 30's arrived and God only knows why, but kids seemed like a good idea. We definitely have less $$, but who cares? In the long run I still can't take it with me, but when I die I will have lived a full and happy life with the up's and down's of raising a family and that is something I can take with me.

Max,

First of all I want to thanks for your treatment above on Monetarism vs Keynesianism. Very useful for using as a model/reference point for the debate at hand.

You've made a large number of posts this evening on a variety of subjects, but the core of your argument seems to be advocating the position that asset bubble corrections are relatively harmless to the "real" economy (defined as the profit-generating business sectors) vs. equity bubble corrections. To make things simpler reference-wise, I've assembled what I think are your key points here from your various posts, with bold-face added for emphasis:

You’ve just unleashed a can of “real-vs-financial sector” model. It is probably the most complex junction of modern economy, and nobody really knows how the two behave, with exception of the IS-LM model. Crashes in asset prices I believe are not that deadly, US has withstood a lot of them. Crashes in equities are much worse…

...Assets, IN GENERAL, do not generate earnings. A single-family home is an inefficient, high-maintenance and fragile asset, located in remote suburbs, and poorly designed for generating income - and solely designed for people to live in it.

I think you’ve made some excellent and well argued points here. However, I’m not sure I agree with all of your conclusions with regards to the RE (asset) bubble’s impact ultimately being “relatively harmless” and any fallout “contained and short-term”.

For starters, I wouldn’t be so quick to dismiss the very “real” impact (both economist and layman definitions) of the current RE bubble on consumer spending, which constitutes some 67% of the total U.S. economy. This by itself has generated a huge number of new jobs, and has increased both equity profits and values (the “real economy”), especially those equities which are related to housing. Right now, we have a situation where some 50-70% of job gains since the tech bubble recession are directly or indirectly related to RE gains (new housing construction, cash-out refis, HELOCs, the “wealth effect”, etc.). Even if RE traditionally accounts for only 11-13% of the overall economy, imagine where the Dow & Nasdaq might be right now if the monetarists (Fed) hadn’t started the RE bubble in the first place? I don’t see the “financial” and “real” markets as being that disassociated from one another.

I would like to believe when the easy lending & speculation ends, and housing (non-productive asset) prices revert to the historic mean vs. rents & incomes (as I believe they will –call me crazy if you want) that “the money is destroyed in the financial sector”, but “the spillover is contained and short-term.” When you have an asset class held by 70% of the population --whether it’s “productive” or not— driving so much in the greater consumer economy (including corporate earnings & profits), then it’s bound to have a very nasty and measurable impact when it falls.

And when it falls, I just don’t see what sector in the “real economy” is supposed to pick up the slack in terms of job growth and stimulating (or even sustaining current) consumer spending. There was a time not-so-long ago when America was a net-producer and net-exporter nation, which sustained its growth in real wages and consumption by selling its industrial products around the globe. No longer. It’s difficult to even call the U.S. an “industrialized nation” anymore, when most of the jobs now are service-sector based.

The Fed/Treasury does have the ability to create money out of thin air, and destroy it just as easily, this is true. However, I think it’s a mistake to assume that the repercussions from deflating this particular asset bubble will not be “real” to a great many consumer-dependent businesses and job-dependent consumers.