Why housing bears are wrong (Part 1)
September 18, 2007
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All right, now it's time to talk about the misconceptions that cause otherwise intelligent people to talk blatant nonsense when it comes to housing. In doing so, I'm also taking the opportunity to respond to all the flak I've got on floridabuilder's blog. I'm not going to go into details such as balance sheet of one builder vs. another because floridabuilder and others will surely do it better than I ever could hope to. I will just focus on the big picture, because corporate bookkeeping is tricky but the big picture is simple.
Part 1: The reality of a rigged game
The primary reason why people fail to grasp the simple truth that prices will only go up has to do with idealistic crap that was stuffed into their heads in High School. That is to say, they still believe that the Federal Government is an impartial player concerned with social justice and affordable housing for all Americans. How about instead making sure that the landlords get richer and that the renters never get a chance to break free from their rental payments? -No, you must be wrong here, surely they can't operate on such a mean agenda! These people are ready to ignore any empirical evidence that comes into conflict with their faith in the kind tsar. No, I'm not suggesting that they are all supporting Bush and Bernanke. Far from that. They are perfectly comfortable admitting that this or that official can be incompetent, greedy, corrupt, and engaged by special interest groups. They can say that about any individual mayor, governor, senator, or president. But when they need to admit that the whole system is corrupt, and the entire market is manipulated, the whole set of notions they were taught to believe in gets in the way. So when they see the government methodically executing a consistent strategy intended to boost the net worth of owners and crush renters, they still handle the "own vs. rent" debate as if it were a purely academic discussion. This is the equivalent of analyzing a stock based on its PE ratio and ignoring competetive moats and future prospects - presisely the way to rob yourself of capital gains enjoyed by investors like Buffett. That's why we have people like Roubini on www.rgemonitor.com/blog/roubini illustrating with graphs, numbers, and affordability indexes that current prices are unsustainable. Yes, they are unsustainable if the governement doesn't interfere. But the bears forget that guessing what would happen if we had a free housing market is a fruitless exercise in abstract thinking. The fact is that when these prices appear unsustainable, the government will most surely interfere, and after this interference the prices will become sustainable again. No, I'm not against the asset bubble talk when we're in a free market situation (that means stocks and bonds). But I'm not interested in the kind of analysis that attempts to call a bubble burst on a controlled market where you can't put a brick on the ground without a permit.
The reality of a controlled market is hard to grasp for the intellectuals who were taught in school that the market is free. Yes, your Economics 101 textbook which introduced you to the subject in your freshman year in college will not tell you that the Fed will lower the rates any time when housing is in danger. For that, you need to apply that rare commodity known as common sense. You are taught that prices and interest rates are closely related, but you are led to believe that interest rates is the independent variable, of which price is the function. Armed with this little knowledge (always a dangerous thing), you naturally conclude that the game of changing housing prices has two possible outcomes. Which means you've missed the boat entirely. A simple-minded Texan farmer who tells you "Look, man, there a'int no drops, them prices will just keep growing" has a much better understanding of the dynamics of prices and interest rates. He doesn't know what "Federal Reserve" means, however, he has observed his empirical facts and made the right conclusion: the dynamics of prices and interest rates is the one that will make prices grow.
That's why we can read posts like the one by devoish: "Mr. Bernanke, please. Do what you know needs to be done. Cheap credit has caused ridiculous housing overpricing. Everyone earning minimum wage realizes that everything people need to survive has inflated in price and is continuing to do so...Do what needs to be done. Take care of the people whose jobs earn them more than their stocks... Raise the rate .50 and warn that more raises might be coming."
This poster shows an understanding of theoretical economics, and zero understanding of the social reality. 70% of the population are homeowners. If you try to suggest a policy that will make houses any cheaper, these 70% will outvote you in a democratic election. If you suggest the opposite policy, you can always count on a solid majority support. But wait, it gets even better. The people who make decisions come from the segment of the population who own their houses. Which part of the population - homeowners or renters - have more reason to expect sympathy from them? (Not to mention that their personal wealth is at stake).
But wait, it gets even better than that. After all, it's not just about money. Once you're in charge of the government, you get other concerns that have to do with Ideology and Political Expediency. For instance, upholding the American Dream. You want America to be a successful country showing the way to the rest of the world. Well, you know it's not true, but at least you have to keep up the appearance. Can you allow the truth to come out that all these wonderful "opportunities" the American economy offers its workers boil down to a simple thing: a roof over your head? Certainly not. It can't be just a roof over your head. It has to be "a roof over your head that costs a million dollars". That sounds cool and sends a message to the world that America is rich. And it also makes the American people believe that they indeed are rich. Well, most of them, anyway. But if you remove the artificially inflated price of this "asset", the American people will realize that they are getting from their economy essentially the same things as people anywhere else in the world: a roof over your head, a morning hamburger, a boring TV, and, with any luck, some mediocre medical care. What will the government say to the 70% of the population as their equity turns into dust? "Sorry, ladies and gentlemen, what we presented to you as the American Dream was a hoax, and that equity was never real anyway, so grin and bear it and and be glad you still have a roof over your head"?
But even aside from these considerations, you must realize that the government has absolutely no freedom to let prices drop. To expect that from the government is about as realistic as expecting them to abolish the income tax. Theoretically possible, but will never happen. Because the entire financial system that was built on the foundation of constantly appreciating real estate will go belly up as soon as prices retreat merely 10%. Remember how they droped 1.5% this year, and then mortgage companies collapsed, the stock market almost crashed, and Ben had to call in his helicopter? Make no mistake, folks: the government will fight the bearish scenario more vigorously than it fought Saddam, and this alone is sufficient to assign this scenario a probability of zero. What steps it will take when and if necessary - impose a moratorium on sales, ban all construction, bring in 100-year mortgages, drop rates to -2%, impose death penalty for not buing a house - I cannot tell. But I can tell you for sure that it's not going to sit and watch that 20-trillion dollar "funny money" equity fall off a cliff.
Betting against the government is a bad investment thesis. That's why it never succeeded. A free market would take house prices up and down, but there is always the Federal government, the Federal Reserve, the state governments, the city councils and the endless bureaucracy of building, planning, and urban development departments, whose job is to intercept any downward trend. Today's bearish arguments are hardly new. There was never a time when housing did not appear overvalued. Ten, twenty, and thirty years ago people were talking about a bubble as much as they are talking about it today, and every time they were proven dramatically wrong. For the last fifty years, the story of the Housing Bear has been a heart-warming story of a man who gets repeatedly punched in the face. So, to conclude the first lesson,
Reason #1: Bears are wrong because they apply standard valuation metrics to a controlled market.
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