Housing: Ackman vs Shilling

By Felix Salmon
December 29, 2010
Bill Ackman and Gary Shilling in the wake of yesterday's dreadful home-price numbers.

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It’s Housing Day over at Business Insider today, which is running duelling slideshows from Bill Ackman and Gary Shilling in the wake of yesterday’s dreadful home-price numbers. Both of them are a little dated—Ackman’s is from November 3, while Shilling’s seems to be from October, although it’s not entirely clear. Since then, prices have fallen, which would do little to change either of the analyses, but also interest rates have risen significantly, which puts a substantial dent in Ackman’s math.

Ackman’s logic is pretty simple: you can get a lot of leverage in the housing market, and if you make a highly-leveraged bet and prices rise, then you can get enormous returns. At the heart of his thesis is the idea that valuations are low and will rise in future—but to my eyes at least, there are problems with both legs of that argument.

The “valuation” section of the slideshow is a relatively small part of the whole. It says that home prices are 28% off their peak; that houses are more affordable now than they have been in a long time; and that buy-vs-rent calculations work out in favor of buying with relatively low home-price appreciation rates between 4% and 6%.

The first one seems meaningless to me: why should home prices be low at 28% off the peak, as opposed to say 18% off or 38% off? In fact, a glance at the Case Shiller graph shows that prices are still roughly double what they were for most of the 1990s.* And more generally, when the first part of a valuation argument is percentage-off-highs, I always get suspicious, because that’s always a really stupid metric on which to base a buying decision.

The affordability calculations, too, are a temporary phenomenon related to artificially low mortgage rates and the fact that the US government is currently providing substantially all housing finance. What I’m not seeing is any analysis by Ackman showing that houses will remain affordable in a future of higher rates and private-sector financing—the future when, I assume, he’s looking to exit his residential-property position.

Finally, required appreciation rates of 4% to 6% seem high to me, not low: they say to me that buying is still more expensive than renting unless you assume capital gains on your purchase. Ackman, here, comes close to assuming the very thing he’s trying to demonstrate.

As for the reasons for future gains in house prices, there’s a bit of basic demographics, in that the number of households in the US is going to rise over time, and is going to outpace the amount of new homebuilding. That’s reasonable.

Ackman’s other main argument is based on the assumption that homeownership is going to bottom out at 66% and stay there, rather than continuing on the long cyclical decline which started in 2004. If he’s wrong by just a single percentage point, a lot of his mathematics starts looking very shaky. I suspect that as America moves out of the suburbs and exurbs and into denser forms of living, we’ll see a steady decline in homeownership, which in any case is now seen as being more of a liability than an asset. It’s no longer a road to riches: it’s a road to possible foreclosure, bankruptcy, and an inability to move to where the employment opportunities might be.

Ackman is a speculator, and he’s forecasting a return of his speculative mindset among the population at large—where people buy homes because they’re confident in the future and think that those homes will rise in value, and also because they fear not being able to afford a house in future. That mindset fuels housing bubbles, not sustainable home-price appreciation. And investing in bubbles is always very dangerous, and generally ends in tears. Maybe Ackman can make money doing it—but that certainly doesn’t mean that homes are a good buy right now for the rest of us.

Ackman does have one intriguing idea about what might drive house-price appreciation: institutional investment in single-family home rental properties. He’s right that such things barely exist as a financial asset class, and that even a small global allocation to them could change the demand dynamics substantially. But being a landlord is hard work, especially in suburban and exurban neighborhoods, and I’m not convinced that it scales well: my guess is that the cost of hiring a good rental agent is always going to wipe out returns, and that the only way to make money by renting out single-family homes is for the owner and the rental agent to be the same entity.

If you then turn to Shilling’s presentation, things start looking positively depressing: he brings up reasons for pessimism that many of us never even consider, along with the much more obvious ones. At the top of the list, of course, is unemployment, which poisons everything. No one wants to buy a house if they don’t feel secure in their job, and people don’t feel secure in their jobs if unemployment is over 9%, where it’s likely to stay for the foreseeable future. And these graphs just speak for themselves:





This last one is the most powerful, to me: for all the wheel-spinning that we’ve seen of late in the mortgage-refinance market, the number of people shopping for new homes has been declining steadily for the past five years. I’m sure that Bill Ackman would look at that chart and extrapolate all manner of fabulous mean-reversion, but I can’t see where the new demand is going to come from. Buying a home is no longer the American Dream; people are much more interested in being free of debt. And while Ackman might look at the enormous leverage in the housing market and see opportunity, most Americans I think are now much more aware of the downside risk.

No matter what happens in the housing market, Bill Ackman is always going to have more wealth than he can ever spend in his lifetime. But for those of us without his ability to make large speculative bets, housing is a very scary asset class, while renting is cheaper and much more flexible. I wouldn’t be at all surprised to see the US homeownership rate fall a lot in coming years, back down below even its long-term mean around 64%. And if that happens, prices—both to rent and to buy—are almost certain to fall from current levels.

*Update: Thanks to ckbryant, in the comments, who points out that this is true only in nominal terms, not in real terms.

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44 comments so far

>> . . . as America moves out of the suburbs and exurbs and into denser forms of living . . .

You keep waving that around in multiple posts as though it’s obvious, but to my knowledge have never offered any data to support it. There’s the whole rural-to-not rural thing if you look over 100 years or so, but you’re making a very different assertion. I believe it’s your own bias rather than anything supported by fact.

Nevertheless, Ackman is doing pretty much the same thing with his argument. There are people who will state that it’s always a good time to buy real estate, no matter what the state of the market. People like that are annoying, because there’s always a class of potential new home buyers (and eventually speculators) who are willing to swallow the line. It results in a bubble ever time. As I like to say, “Bullwinkle, that trick never works!”

Posted by Curmudgeon | Report as abusive

My fundamental macro expectation for the next decade:

(1) Weakening of the dollar index.

(2) Doubling of the CPI, driven primarily by commodities and imported consumer goods.

(3) Increase of 30% to 50% in wages, well short of the pace of inflation.

(4) Squeezed profit margins. The wealthy won’t be spared.

(5) Very tight credit conditions, as interest rates react to higher inflation. Corporate borrowing slows to a trickle (and leveraged companies have trouble rolling over their debt). Treasury borrowing continues, but the escalating coupons force dramatic budget cuts.

(6) Economy reacts to the tightened federal budget and reduced corporate expansion with a decade of stagnation. Unemployment/underemployment remains well above 10%.

Rents are influenced by both ownership cost and wages. I wouldn’t expect them to fall dramatically from the current level, but neither can they rise significantly in a recessionary environment. The resulting squeeze between rising financing costs and comparatively flat rents will depress new investment, and the limited supply will help keep upward pressure on rents. People won’t necessarily be paying more, since they won’t be able to afford it, but they may be paying the same and getting less.

This isn’t necessarily a bad time to own a home IF you can get one at a favorable cash flow (no worse than the rent you are paying), have a steady income, and have ample reserves. Investment returns are likely to be in the toilet (negative real returns for many investment classes), so owning real property becomes very attractive. As long as you can use the house as a residence, it is an excellent store of value.

Housing prices may drop further. Another 15% drop across the board could happen easily, but that doesn’t do you much good if the financing rates increase from 5% to 7%. Nor does it help you if your invested savings (which could have been used to pay cash for the property) drop by 30%. Since I firmly expect inflation to rise, financing costs to rise, and balanced investment strategies to lose large amounts of money over the next few years, I’m not sure that waiting on the housing decline makes any sense.

On the other hand, the housing market is moribund. Nor will it be resurrected any time soon, not in the face of double-digit mortgage rates and high unemployment. If you buy now, you are stuck with the property (either to live in or as a landlord) for at least another decade. Choose wisely.

Felix, I know you place great faith in these calculators. I’m not sure precisely what you would enter for the scenario I described above, BUT you might give it a try? And see what pops out?

All I know is that I’m trying my darndest to get the mortgage paid off before this whole thing blows up. Putting 20% of gross income towards mortgage payments, almost as much as I would be paying if I were renting!

If I can pull that off, then we can afford to lose 40% of our income (combined tax bracket of 50% on self-employment income) and still make ends meet. Couldn’t do that by renting, couldn’t assure that by investing the capital. I can’t think of any better way to prepare for the coming storm, can you?

Posted by TFF | Report as abusive

Excellent analysis TFF.

I usually side with Salmon in that I don’t believe in getting into the housing market right now. However, your case is different in that you talk about having a house not as an investment but as insurance, ie if all goes to hell you have a roof over your head. Not an investment thesis, since your scenario suggests no stopping off points to make capital gains at any stage in at least a decade.

If you looking to buy based on those reasons you should be ok, so long as you don’t overstretch.

In terms of overall home ownership levels bottoming out, that ignores immigration, demographics and widening income inequality that point towards a large lower class of US citizens who will be completely precluded from the housing market.

Posted by vk9141 | Report as abusive

“…[P]rices are still roughly double what they were for most of the 1990s…”

And WAY above what they were in the 1960s! But let’s keep it real, shall we:

http://cr4re.com/charts/charts.html?Home -Prices#category=Home-Prices&chart=RealH ousePricesOct2010.jpg

With a January 00 index of 100, real house prices in the 1990s were generally between 90 and 100, and today they are at about 115. For the record, I still think housing has a way to fall before the market stabilizes–but there is a mile of difference between “twenty one percent higher” and “double.”

Posted by ckbryant | Report as abusive

Yes, vk, I agree. Home ownership will continue to decline for a while. Too few households have the kind of capital and stability needed to purchase in the face of tightening credit standards. (And many of the people who DID purchase in the last decade probably should not have done so.)

One way to look at it… Would you be more comfortable with $400k invested in an IRA and a $25k/year rent bill? Or without the IRA and a $300k home instead. (These figures from one of the more expensive housing markets. A median house in a median community where I live.) Ongoing costs for taxes, insurance, and maintenance of $10k (if allowed to slowly deteriorate) to $15k (if you amortize major projects every 5-10 years).

In theory, that $400k IRA ought to support (after tax) 4% withdrawals of around $12k/year pretty much indefinitely. Add that to the fully amortized $15k cost of ownership and renting at $25k looks pretty good.

Now raise your hand if you are REALLY confident that you can draw against your IRA at a rate of 4% per year and still keep up with inflation. Felix himself (depending on the article) preaches an expected real return between 0% and 2%.

Best way to withstand a 40% loss of income is to prepare yourself to operate with 40% less cash coming in. Having an IRA with a large number isn’t nearly as comforting.

Posted by TFF | Report as abusive

Well, at least the Ackman slides didn’t take long to digest:

“A Low Valuation
Lowest valuation in at least a generation.”

Um, no. Just no. Unless we’re talking about generations of fruit flies here. We generally take human generations to be somewhere between twenty and thirty years. Housing is about where it was nine short years ago, which is to say: generally higher in real terms than it was at any point in the entire 20th Century. Ackman even includes charts in his presentation that give the lie to that bald statement.

I smell a no-good lousy salesman. The remainder of the presentation will be disregarded.

Posted by ckbryant | Report as abusive

“Finally, required appreciation rates of 4% to 6% seem high to me, not low…”

Think more about the buy-v-rent tradeoff (which economists don’t, because they are stupid enough to believe “Roofs Not Ceilings” is research instead of autoerotic asphyxiation).

Renters move less material (even counting unfurnished-to-unfurnished moves), tend to have smaller families (pending second child in Brooklyn means move to the Burbs), and–if they move frequently, downsize(cull) on a semi-regular basis.

What does Kevin Kline say in _The Boring Chill_? “I’m dug in here.” After several years in a stable neighborhood, homeowners have a gathering of non-economic factors as well as the “well, we never though we would use that room, but…” effect.

Sunk cost is one thing; sunk cost that adds to carrying cost and other expenses needs to be considered as part of the “costs” that arise on one side of the equation more often than the other.

He’s still wrong in concept, but requiring a higher return to make buy a rational decision in the first place isn’t the reason.

Posted by klhoughton | Report as abusive

TFF, excellent analysis.

Permit a few suggestions: first, that IF you have a good paying job, and are either self-employed or can obtain permission to create a home office, you can vastly change the economic dynamics.

Second, IF you maximize the interest/IRS deduction for the first years of your purchase or refi, and create all the permissible “Mary Kay” home/office deductions, you can maximize deductions against income. Including your property taxes. So, that whatever top tax bracket you are in, you make that percentage back on your “income”/money each year.

Third, IF you create, or re-create, all of the home office technology you can justify to the IRS, you can this year “expense” ALL of that cost. New computer, big screen Wifi connected TV, “IPad’s galore” for your cell phoneS, bad back required adjustable chair, et al. By also maximizing these expense deductions, you also make THAT percentage back on your money/income.

Fourth, note that since bedrooms & garages are the least expensive costs in building or renting or buying a “new” home, you should always buy/rent an extra office bedroom and a 2nd car garage, for your exclusively business used auto.

If you do maximize all the things that you can do, you will – until you reach the 6-8 year “cross over point”, when you need to refi and refresh all of your stuff – drastically reduce the costs of “ownership”.

And, then take ALL of the money you saved/earned and invest it wisely. Do NOT pay off the mortgage early. But, when you retire and/or no longer have income, buy a “retirement” home with the money you have saved/earned.

Posted by JGBell | Report as abusive

JGBell, your advice may be sound, but it runs opposite to our philosophy. I’d rather contribute my full share to Uncle Sam (no matter how incompetently he spends it) than devote my energies to shaving the tax bill.

We try to live simply, finding greater pleasure in the intellectual and spiritual aspects of life than in material wealth. (Excessive consumption as you describe causes me more stress than anything else.) Doesn’t hurt that this philosophy reduces our minimal cash needs to an amount that in theory could be satisfied by any one of our four jobs. Or sustained indefinitely off investment returns on the savings we’ve already accumulated over the years.

The question, “What is wealth?” comes up pretty frequently on this blog.

In my view, it means never having to take a job you don’t enjoy, never having to compromise ethics for money, never needing to worry about making next month’s rent or mortgage payment.

We almost certainly have less income than most of the people on this blog, but I’ll wager we enjoy it as much as anybody!

Posted by TFF | Report as abusive

@ckbyrant, the Case-Shiller Composite-10 series was in the 70s from Nov 1990 to June 1997. It’s now 157. And yes, Jan 2000 is set at 100. (Or 100.75, to be exact. Don’t ask me why.)

Posted by FelixSalmon | Report as abusive

I think TFF made some very strong points.

I do see housing as being at least fairly valued.

All around the world, the value of hard assets, ranging from gold to lumber to oil has all risen powerfully.

But for most people, isn’t the home the ultimate hard asset? Why should oil, gold, lumber, copper and all the rest be priced ever higher while such a crucial hard asset moves lower and lower?

It should be noted that a house is a kind of store of its inputs. All of the copper in the house, all of the metal appliances, all of the lumber, all of the oil for its paints, siding, shingles, insulation, and asphalt driveway and most of all, the enormous amount of fossil fuel that physically powered every stage of its construction.

I feel sure that the replacement cost for a house has risen sharply in the past decade.

Another dynamic is that desirable parcels in good school districts always get a major bid.

Posted by DanHess | Report as abusive

TFF – talking his book? Of course those who own homes will trumpet the vast benefits of home ownership. To do otherwise would undercut your need in order for your property value to recover. Good luck, but I’m not buying. Is the housing bubble in Japan a good model for the future here?

http://www.globalpropertyguide.com/Asia/ Japan/Price-History

Posted by silliness | Report as abusive

Silliness, that’s a fair question. There IS a natural human tendancy to post-justify their decisions, and I can’t pretend to be immune.

That said, we could still sell at a profit from where we bought if we were eager to get out. Even in the worst bubble markets, those who bought in 2000 are probably still above water. I just don’t see the point.

The reason I comment (repeatedly) on this topic is that I strongly believe people should STOP thinking about their home as an investment, and START thinking about their home as the second most expensive thing they will ever consume. (Education is the #1, at least for some families.) Evaluate it on a cash-flow basis, not as “expected total return”. (That latter figure depends heavily on assumptions of appreciation — assumptions that are a complete fantasy.) Maybe Felix will let me borrow his blog some day and I’ll write a more careful argument of my position.

Check out Megan McArdle’s blog today:
http://www.theatlantic.com/business/arch ive/2010/12/housing-prices-headed-furthe r-down/68677/#

Amazingly, I agree with almost every point of hers. To summarize, housing prices will likely drop further, and may take decades to recover, but that doesn’t by itself mean that buying is a bad decision. (Cash buyers probably ought to wait for the drop. Those who will depend on mortgage financing are at least as sensitive to mortgage rates as they are to the purchase price.)

I also believe that FEWER people should buy, especially compared to recent years. But a sensible buy/rent decision depends heavily on individual circumstances. It is NOT purely market-driven. The most important factors are financial stability and situational stability. If your job can be expected to keep you in one place for decades, if your need for space won’t be changing much, then buying becomes sensible. If your situation is unstable, then buying is foolish. My brother has been looking at buying for a few years now, however he can’t be certain that he will stay in one place (in fact more likely than not he will be moving). Thus FOR HIM, a home purchase only makes sense if it can be subsequently converted into a profitable rental. Maybe not even then, since it would tie up much of his capital.

Every situation is different. I try to define a paradigm that will lead to sensible choices, not tell people what they should do.

Posted by TFF | Report as abusive


The point I was trying to make was that a comparison across decades should use real, rather than nominal, prices. That’s why I linked to the inflation-adjusted version of the graph, although admittedly it doesn’t run the case-shiller series back before Jan 00 (using CoreLogic HPI instead). Here’s a pretty typical one running back to 1890 based C/S historical research:

http://www.multpl.com/case-shiller-home- price-index-inflation-adjusted/

It pegs 1890 to 100, gives a value of 133.1 for the start of the year, and lists values for the 1990′s in the region of 100-120.



Posted by ckbryant | Report as abusive

ckbryant, one question that you might have some insight on…

We know that home prices tend to be “sticky”, resisting decline more than other asset classes. Falling values is reflected by the market drying up as much as by the sales prices declining.

How is this tendency likely to play out in the current environment? Prices are already down ~30% from their peak (albeit a very brief peak), so while they might need to fall another ~15% to reach “normal” valuations, might the “stickiness” kick in to prevent them from falling that far? Or does the “stickiness” simply slow the rate of decline?

Either way, I can’t see a rebound coming any time in the near future. Too much inventory to unload, too few people with the resources and interest to buy.

That said, the real estate market is illiquid and inefficient. I suspect an astute investor can find some excellent deals if they are willing to put in the legwork (especially if they can afford the hassle of dealing with less-than-pristine properties and foreclosure situations).

Posted by TFF | Report as abusive

Struck by Chart 12 and Chart 13. There is no sign that the spike in delinquencies (9.9%!!) and houses in foreclosure (4.6%!!) is easing. And especially at this point in the cycle, with so many mortgages underwater, how likely is a delinquency NOT to end up in foreclosure? Or, at best, in a short sale?

Bank of America has lost money over the last nine quarters, is facing large repurchase suits on the deals it brokered, and continuing heavy losses on its own loan portfolio. And that’s even without getting into the fact that its records are a mess, throwing each and every attempt at foreclosure in doubt. They’ve been collecting a fat profit on mortgage refinancing, but now that rates are rising again I would expect that to rapidly taper off. (Anybody who COULD refinance likely already has done so, at lower rates than are available today.)

Are they going to survive without further Treasury assistance? Can the Treasury politically afford to help them after all of these well-publicized problems? If not, what next? Nationalization, along the lines of AIG? Or an arms-length recapitalization such as Citigroup received?

Full disclosure: Was once invested in BAC, back when it seemed a boring/safe investment. Lost some money before the full extent of the crisis became known. Now happily NOT invested in banking.

Posted by TFF | Report as abusive

Raghuram Rajan’s latest book, Fault Lines, makes the point that much of the rise in housing prices for better than the last decade has been related to systemic changes in operating behavior by mortgage industry components like the Fed agencies. They dramatically eased credit standards (and that’s under both Clinton and Bush so let’s not start the finger pointing, shall we), and that lead to market inflation. Unless we’re headed down that particular hole again, the major price rise driver is gone.

Out here in the over-thrust belt we went through a massive boom and bust in the mid-80′s that persisted well into the ’90s’. That included an oil industry boom/bust at the same time as the whole savings and loan mess. Though technical details vary in correlation, the aesthetics of melt down feel somewhat the same. Except: my ‘crumbling suburb’ neighborhood (that none the less gets the snow plowed) is much more stable in this one. In ’86 we had probably a 20% repo rate. Now, low single digits. People learn, behaviors change, age brings caution, wisdom, and after 30 years in the house, a paid off mortgage :>> Though I have to say the thrill on that passes all too quickly. Also, kiss home equity increase good-by for at least ten.

Posted by ARJTurgot2 | Report as abusive

@ckbryant, my bad, I thought Case-Shiller *was* real.

Posted by FelixSalmon | Report as abusive

How can “real” housing values possibly go higher?

James Grant reminds us (“Money of the Mind,” p. 352.) that

“Mortgages with federal support of one kind or another, as a percentage of residential mortgages outstanding, rose from 7.7 percent in 1970 to 18.8 percent in 1980 to 38.2 percent in 1989.”

http://books.google.com/books?id=-6XUBdx y05UC

Today, the WSJ reports “The government continues to dominate the mortgage-lending landscape, with more than nine in 10 new loans backed by Fannie Mae, Freddie Mac or government agencies such as the Federal Housing Administration.”

http://blogs.wsj.com/developments/2010/1 2/29/four-housing-issues-to-watch-in-201 1/

If the federal crutch were removed, housing would plummet.

Posted by dedalus | Report as abusive

It seems to me that there are some other factors worthy of discussion:

1. Residential values depend much on location. Thus, areas of shrinking population, high regulation, high costs and aging boomers who want out (e.g. old industrial cities of the northeast and midwest) will fare poorly in any event.

2. Ever since the Feds decided to make “adults only” apartments illegal, many singles, couples and families have avoided apartments. They have a belly full of low income neighbors with unsupervised offspring and transient “boy friends”. No one wants to talk about this but it truly influences renting and owning patterns.

3. Over the decades we have seen steadily increasing “hedonic” attributes of housing (e.g. size, features, fancy finishes). This “value” is very often hard to capture when people have lower incomes. With rising problems of government debt at all levels (and the possibility of tax increases and spending cuts) and falling real incomes due to commodity inflation as well as high unemployment, it is hard for me to see a general return to high cost housing. Of necessity, people will opt for a more minimal abode. (Sort of like giving up SUV’s for smaller cars.)

4. Often it is said that housing is not liquid. I disagree. IF one is willing to take a big hair cut (as one often must do with stocks) you can sell quickly (though not in five seconds like electronic trading). The problem is that we kid ourselves about value and fail to understand the concept of a huge spread between the bid and the ask. In addition, with leverage, we are constrained in our ability to act, but this is self imposed and not inherent in the market.

5. I would rather rent and have cash or a 401K at any time since I can move the money WITHOUT the high transaction costs of real estate OR the risk of a low “bid” price in my market. Also, if I have bad neighbors or a failing local government then I can get out without getting clipped. An inflation upside is not assured with real estate since it depends so much on local conditions and real incomes. I can easily see us having higher commodity costs and falling rents.

6. Demographics will make much of the recently constructed housing stock functionally obsolete. What retired couple needs a 5000 square foot two story “McMansion” in the burbs? They will want to sell such a property and live in a single story smaller space with lower utility costs, lower taxes and proximity to medical services. In addition, the “safety” of the suburbs is no longer a given for the future. Reduction of local budgets will leave many citizens with the task of defending themselves and that is better done in planned retirement communities. Who will buy from them when they want to move?

Anyhow, these are my random thoughts. I truly expect a further deterioration of housing prices over time, but I do expect the gov’t will throw money at the problem to mask the insolvency of our financial industry. My prescription:

1. Cut budgets of all levels of government with a HUGE knife.
2. Cut entitlements for everyone now.
3. Actively recruit new citizens from abroad. Allow those with skills and $$ to join the American experiment.
4. Deregualte the economy…especially the financial institutions. This should begin with ending all deposit insurance. If you want a gov’t guarantee on your funds then buy savings bonds. Otherwise take the risk yourself.
5. Go to a flat tax AND a consumption tax but only after setting strong CONSTITUTIONAL limits on spending. I believe we should allow the President or Governors to “impound” funds that are passed by Congress or Legislatures. Impoundment authority will give the executive branch sufficient balance to offset the spending orgy.
6. Attack the health care/education and government complex at every turn. We squander $$ on these sectors with little payoff. This must cease.

PROBABILITY of positive outcome: Lower than 20% in my view. People simply cannot make hard decisions until there is no alternative. Presently, we still live the dreams.

Posted by bigbuilder | Report as abusive

As usual, when a trend is in place, the herd thinks the trend will continue forever. It’s the same with stocks, commodities, and now housing. Housing may well decline for the next few quarters, but eventually the inventory of foreclosures will decrease and the market will stabilize. The question is, is it better to buy now and save tens of thousands on interest with mortgage rates at around 4% or wait until prices stabilize but interest rates will be higher. It is easier to get great deals now and a lower rate. Renting is literally throwing away $1500 a month or more. If you like seeing $20,000 of your hard earned money pay someone else’s mortgage, year after year, be my guest. Anyone with a third grade level of arithmetic can see that after two or three years, whatever you thought you were going to save by renting is money down the drain. I’ve been a landlord for 20 years now and I welcome your cash. If I was a bit younger, I’d be snapping up more properties now. The time to buy is when there’s blood in the streets. That quote couldn’t be more appropriate for the conditions in the housing market today.

Posted by jdl51 | Report as abusive

Love those questions, bigbuilder!

(1) Residential values absolutely depend on location. There was a period a few years back when EVERY market was grossly overpriced, but the present situation is much more ambivalent. Felix writes that price/rent ratios in NYC are extreme (and rents may be falling). In contrast, there is a very nice new house down the street from me which is dual-listed for rent/buy with a ratio in the asking price of just over 14. (And it is likely easier to negotiate that purchase price than to lock in a substantially lower rent for a long period of time.) Those metropolitan areas with a recovering economy will pull out of this sooner than those that are still in collapse.

(2) Not sure I understand your comment on “adults only” apartments. Families with children have NEVER been able to live in “adults only” apartments, so banning them shouldn’t make renting any less attractive for families. If anything, the opposite is true.

(3) Excellent point on people opting for a “more minimal abode”. Where I live, there are almost no single-family houses on the market below the median for the town. Most of what is listed is either new construction (uniformly above the median) or larger/fancier properties.

(4) Housing is *not* liquid. It is extremely expensive to buy/sell, with turnaround transaction costs that push 10% (even if not forced to take a discount for a quick sale or carry an empty property while it waits for a buyer). In contrast, I can sell any $15k stock position in my portfolio for turnaround costs of 0.1%. That is a 100:1 ratio in the transaction costs. I carried my previous house for five years after moving out before I was able to find a buyer (at a steep discount). That ain’t liquid!!!

(5) Real estate provides a fixed supply of a useful commodity. The value you place on that commodity stream determines the price you ought to be willing to pay. In an environment where real returns are pushing zero, real estate becomes very attractive. Your comments on the “options” associated with renting are well taken, however there are also options associated with owning. The relative value you place on the options in each case significantly influences your choice to rent vs. own. Case in point — I have nine fruit trees on my property, a large vegetable garden that I’ve been working for ten years, and dozens of mature flower beds. These bring me great joy, yet require at LEAST five years (and a fair amount of back-breaking labor) to install on a new property. Hard to do that while renting.

(6) I wonder if some of those McMansions will end up housing extended families? We’re already seeing a reduction in the number of households as people consolidate. I can’t see why anybody would need 2000+ square feet if they don’t have at least five people living there.

Not sure I like all of your prescriptions, though. In particular, economic deregulation is part of what got us into this mess. Banking is naturally a boom-and-bust industry. Banks will make small amounts of money steadily for many years, then lose everything overnight. Their whole EXISTENCE is based on the concept of leverage, by at least a 10:1 factor. You could lose 10% of your income and net worth and shrug it off. If a bank’s assets depreciate by 10% it is bankrupt. (Note the stem of that word. Banks are more likely than any other large institution to go bankrupt.)

I also firmly believe in the value of quality education. And, contrary to public opinion, our educational system does roughly as well as you would expect given the demographics. Consider this study:
http://super-economy.blogspot.com/2010/1 2/amazing-truth-about-pisa-scores-usa.ht ml

To me that suggests we should dump the meme that “American education is overpriced and broken” and instead focus on how we can improve outcomes for those demographic segments that are NOT presently well served. Throwing money at the problem isn’t sufficient (though solutions may cost a bit more than we presently spend). You need a different paradigm to serve an immigrant population (or a population whose parents grew up under institutionalized racism) than to serve white suburban America.

Posted by TFF | Report as abusive

@jdl, I agree. Being a landlord can be an excellent investment if handled properly.

That said, the business is a little like banking. Think “Maturity Transformation”. Banks borrow short and lend long, and reap a natural profit for that service. Landlords own long and rent short, AGAIN profiting from the difference.

The natural ownership period for real estate is measured in decades. The transaction costs are too high for anything shorter to make sense. Yet as others have noted, the natural period for living in one place is (for many people) three years or less. Under normal market conditions (which we may be reaching in some areas of the country), it is economically sensible for some people to be landlords, it is economically sensible for other people to own their own home, and it is economically sensible for many people to rent.

Posted by TFF | Report as abusive

Response to TFF:

1. I think you use a different definition of “liquid” than I do. Your definition seems to involve an element of an “inherent” value that limits your willingness to sell at whatever you can get. If you consider transaction costs as well, then you are correct. However, I think IF you need cash, you can get it fairly fast but it won’t be what you want. The same is true of stocks if you have a very large position like the US holdings of stock in GM or Citibank.

2. With regard to “adults only” apartments, federal law prohibits it unless for senior citizens. That is why so many apartments are so unsavory to singles. This is a regulatory subsidy to single family home sales.

3. Use of the word “education” to describe what is going on today is very misleading. What we are getting is simply information transfer and credential selling. We build lavish facilities and extend huge loans to students who major in subjects with marginal utility. Perhaps if we really challenged students to master skills of language and computation we would be getting our moneys worth, but that is not what I believe we are getting. For more in depth analysis, please read anything written by Richard Mitchell. His works are available for free online. Google “Richard Mitchell Underground Grammarian”. His best work on education is “Graves of Academe” and it is free on the website.

4. You are correct regarding the fact that ownership gives more latitude than renting regarding what the property can do for your personal interests and desires. However, my point is that this comes at a price that many can no longer pay.

5. Blaming “deregulation” for our economic mess is a gross mistake. This is a long and involved argument. Essentially, as a libertarian, I oppose ANY government participation in the economy. Much of the housing bust was due to matters that were hardly “deregulated”. These include: banks with deposit insurance, accounting rules and conventions that hid reality, rating agencies with special status under laws and regulations, wall street firms that received “bailouts”, a tax system that encourages home ownership via tax deduction of mortgage interest, local regulations regarding zoning and housing size, public schools district lines that screw the poor and isolate those who have money behing a protective regulatory structure, federal agency participation in home lending, and so on. Read the Austrian economists for a more full discussion. Though I doubt we will change our system of “state capitalism” it remains a truth that we are not “deregulated”. More “regulation” will simply further distort the market and give elected officials a new group to “shake down” for contributions. Just consider the SEC/Bernie Madoff mess. They had him served up on a silver platter and that bunch of Whores and Fools at the SEC ignored it. SURE, let’s get some more regulation!!! It would be more fair if we told people they are simply on their own. The illusion of “protection” by regulation is what got us into this mess. Let’s stop the lies.

Posted by bigbuilder | Report as abusive


(1) The standard definition of a “liquid asset” is one that can be rapidly converted into cash with little or no loss of value. Generally speaking, a liquid asset is one that you can flip easily and quickly. It is absolutely true that large stock positions are also illiquid. They can be sold slowly with little loss of value or they can be sold rapidly at a steep discount. A little like houses.

(3) There is good education and bad education, often at the same institution. You can graduate with mere credentials or you can take advantage of the opportunities to learn, think, and communicate. I graduated from an Ivy League college many years ago, and can attest to the fact that a large number of my classmates were just there for the paper. They may have been plenty bright, they were certainly wealthy, but they didn’t put much effort into learning. I would like to think I approached college differently. Besides, the most significant education happens in grade school. As with college, you often have good and bad education occurring at the same school.

You get out of education no more than you put into it, something too few people on both sides of the debate recognize. The only way to improve educational outcomes is to do something that convinces students to make a greater effort. Anything else is window dressing.

(4) I agree that many people are not in a situation to buy a home. I hesitate to guess at an appropriate homeownership fraction, but I’m pretty certain it is lower than what we’ve seen in recent years. Especially given the mobility of our society today.

(5) I didn’t blame deregulation for our mess. I simply noted that banking is naturally exposed to cycles of boom and bust. This isn’t the first banking crisis we’ve seen, and it surely won’t be the last. In banking, you can lose money MUCH faster than you can make money.

As a libertarian, you should embrace periodic banking crises as a natural fact of life. (Perhaps one every 15-20 years?) Without governmental regulation and intervention, a sizable fraction of banks will wipe out each time around the merry-go-round. History proves that.

I have strong libertarian leanings myself, but I don’t pretend that regulation is the cause of ALL evil. In this case, banking regulation (and intervention) tends to soften crises at the expense of extending them and distorting the recovery process. And yes, my Austrian half has been screaming about some of the governmental attempts to “fix” this recession.

Posted by TFF | Report as abusive

I really appreciate thoughtful responses such as these.

A reasoned and respectful discussion can advance our mutual understanding. That is missing in much of government.

As to the banking issues, I suppose that I question several basic assumptions regarding the structure of that sector of the economy.

First, I don’t approve of the fundamental distinction between debt and equity in our tax laws. This distortion skews investments and is the fundamental basis of the banking industry since debt is favored by the tax code and equity is punished to a degree.

Bankers get the government subsidy of deposit insurance and every 15 or 20 years they dump all their losses on those of us who pay taxes. During good years they profit and later they leave us with the losses. Is this really good in the long run. I think not.

A better system is one where debt and equity are on a par and losses fall only on private investors. Bankers should be like restaurant owners, if they serve bad food (or make bad loans) they go out of business and their private investors take the hit and the tax payers are left alone.

I suspect, perhaps, that you are familiar with “Running on Empty” by Pete Peterson. His work summarizes our entitlements bubble and its threat to our democracy. Our current orgy of spending and growth of government regulation simply throw gasoline on this fire. The housing mess is just the first small fracture. The next crisis will probably be stagflation and international turmoil that bankrupts the nation.

Anyone who believes that more paper from Washington will remedy these ills simply does not comprehend reality.

I don’t detect such illusion on your part, but the popular media and general opinions expressed by the public certainly seem to pursue that mirage. I sure hope I am wrong, but the bottom line is that in order to “square up the books” we will need to declare national insolvency and pay off half of our debts with funny money and repudiate the rest. This will require telling people to work more, play less and die without requiring vast resources for medical treatment on the way out. Nothing else seem capable of working to me.

In that world, I don’t want to own anything that I cannot either reasonably defend or trade for something of utility like food or fuel. A large home with a media room and granite counter tops is not such an item. My own degrees from east coast schools are likewise of marginal utility. The sad truth is that our national debt levels are so out of line with history that we are doomed to either go bankrupt or change our wasteful ways and work our way out. Neither choice is easy and few of us can accept the reality that the party is over.

Just like the movie “Animal House” we are down and out and now we are going on a “road trip”. Too bad that road leads the wrong direction.

Posted by bigbuilder | Report as abusive

Same here, bigbuilder. I try to eschew political labels, partly for this reason. If I’m wrong, I want to be free to admit it (and change my opinion) rather than feeling like I have to “toe the party line”.

Could you please elaborate on the differences between debt and equity treatment in our tax law? I’m guessing you are referring to the fact that interest is paid before corporate taxation while dividends are paid after? This, however, is balanced by a couple factors, including the preferential treatment for dividends and capital gains in the personal income tax law and the ability to delay recognition of capital gains for many years. Think you will agree that the current system is an opaque mess, very difficult to understand. I would much prefer something more straightforward like a VAT or flat tax. (The income tax system is perhaps not the best mechanism for social engineering and wealth redistribution, even if one feels that is an essential role of government.)

The FDIC is supported by a tax on deposits, resulting in lower deposit rates than we would otherwise have available. The federal government does back the FDIC as needed, but the FDIC is expected to pay the money back. That might be difficult following THIS crisis. Is bank participation in the FDIC mandatory? I’m not sure, though there are plenty of non-banks that perform similar functions without the insurance. So I’m not sure it is a critical distinction.

“A better system is one where debt and equity are on a par and losses fall only on private investors.”

Do you lump *depositors* in with “private investors”? Because a bank failure is REALLY HARD on the depositors. I’m not saying that such a system is unworkable — banks have lacked deposit insurance for most of history — but I don’t see why that is preferable to the current system.

I actually haven’t read “Running on Empty”, though the thesis sounds familiar. Reminds me of “The Coming Generational Storm”, from which I took insight that helped to weather the latest bubble and crash (and highly profitable rebound).

My father puts it more simply. If you add up the claims on our national wealth over the next 30 years, and balance that against the wealth we are likely to produce, you end up with the claims outweighing the wealth by a pretty shocking margin. Somebody is going to be seriously disappointed, and the longer we delay the reckoning the more serious the disappointment is likely to be. The trick is figuring out which form of wealth is likely to collapse next, so you can step out of the way in time.

Personally, I believe that inflationary policies ARE likely to play a key role in the resolution (not “remedy”) of this imbalance. Among other things, it is the simplest way to devalue the debt that is strewn throughout society. Moreover, the other ways of destroying wealth either land heavily on a small segment of the population (e.g. entitlement cuts) or create deflation that leads to waves of defaults. A certain amount of inflation is necessary to balance the deflationary aspect of other policies.

Of course, as you say, none of this would be a problem if we weren’t drowning in debt. Right now this is a miserable time to be leveraging yourself too heavily (without a LARGE cushion) and an even worse time to be investing in debt.

I’m a little more hopeful about the future than you are. There will be pain and belt-tightening throughout society, but we can make do with FAR less than we have been doing. The real question is how to get there from here without the collapse of society.

Posted by TFF | Report as abusive

The problem I see regarding debt and equity is the tax distinction you identified. This distinction causes “over leverage” which places both corporations and individuals out on a limb when a “black swan” event happens. The ability to endure the storm is reduced and this causes destruction of productive enterprises and personal economic turmoil. When people are encourage to get out on a limb and the limb breaks, the society picks up the cost. If enough limbs break, we get systemic risk to our constitutional, capitalist democracy. Times of great damage and peril sow seeds of potential dictatorship.

With regard to housing, if one looks at all of the incentives to own housing it is easy to see how we got out on a limb. If you track the total value of housing as a percent of total assets in the economy, you will find that we still need another 5 trillion “hair cut” to simply revert to the mean. In the process, people will suffer terrible personal loss in terms beyond merely financial. Basically, the government caused us to place our capital into consumption rather than savings or investment into things that could generate positive future cash flows and serve our future needs. Instead, we served short term wants.

Regarding FDIC, it seems to me that the restoration of bank solvency is being achieved by low cost of federal funds. This subsidy is rebuilding bank balance sheets at the expense of savers who get nothing on their CD’s. This is because, the FDIC cannot begin to deal with the reality that the entire banking system is busted. We are kicking this can down the road with no end of kicking in sight. I just wonder what happens when interest rates rise.

Milton Friedman once recommended that deposit insurance be handled by allowing unlimited insurance in banks that invested only in US gov’t securities. Other banks could invest in anything, but would get no insurance. Depositors should be thinking like equity investors rather than looking for guaranteed but limited returns.

True, non banks are sources of funds, but we have bailed them out as well and the cost of that is huge as well as hidden.

The sad truth is that we must now do economic battle with not only our own debt, but with a lower cost, highly qualified world. In this engagement, we cannot expect past glory to substitute for lower costs and hard work. The book “The Coming General Storm” is similar to “Running on empty”. The balance sheet of future incomes and obligations, discounted to present value yields an negative “net present value” of about 60 trillion. That is about the total value of our private assets. We are insolvent as a nation.

Resolution of this mess will require more than a little “belt tightening” it will require sacrifice from a nation with little, if any, recent history sacrifice. I am of the opinion that only war will motivate people to do what is needed. This war may not be classical military conflict. It may be a war on greed or excess. Whatever the form, only the metaphor of war will stir our survival instincts and motivate extreme sacrifice.

By the way, I had to promise my eldest son to be more upbeat when speaking to my daughter-in-law. She doesn’t deal well with harsh news. I guess, the world around her will deliver the message over time.

I really think we have a chance to transcend this materialist orgy and grow as a nation, but it won’t be easy and we sure need new leaders to begin the journey.

Posted by bigbuilder | Report as abusive

bigbuilder, I agree that the government went too far in encouraging a reliance on debt. A decade ago, I was somewhat relieved by the recession as I hoped that some of the long-term economic imbalances would improve. Instead Bush and Greenspan tag-teamed a “solution” that made the problem twice as bad. We are now back to where we were a decade ago, but we’ve lost ten years of time in which we might have dealt with the problem. Ten years of time and many trillions of dollars of additional debt.

Encouraging debt can, to a certain degree, be healthy for an economy. Debt is simply an arrangement in which one person who doesn’t need their money immediately shares it with somebody else who does. The ability to borrow is a valuable resource in starting a business, obtaining an education, and (for those in appropriate circumstances) buying a home. In each case this allocates an appropriate amount of capital to a need that serves societal purpose.

The problem, as you observe, is that when debt is used to fuel consumption rather than investment, you end up SUPPRESSING growth rather than feeding it. This happens when the government borrows a trillion dollars and mails everybody an iPhone and a large-screen TV. This happens when people borrow against their home equity to go on an expensive vacation. This happens when people take advantage of low (and subsidized) mortgage rates to buy a 2500+ sq feet palace instead of contenting themselves with 1500 sq feet like their grandparents did. (I guess you need the extra 1000 sq feet to house the large-screen TV and the Xbox?) You read daily about how consumer spending is the critical element of economic growth. If we can just get people to SPEND more, then we’ll fix all our problems. Yet when that spending is done, what remains? An economy short on investment and drowning in debt.

You are correct that the restoration of bank solvency depends on ultra-low short-term interest rates and inflationary monetary policy. Recessions involve significant “wealth destruction”. While that can be a good thing, and is absolutely necessary in the current situation, it also makes debt repayment difficult unless accompanied by inflation. None of this directly connects to the FDIC, but rather the belief (hard to argue against) that a universal banking collapse would leave our economy in shambles.

“The Coming Generational Storm” tosses around that $60T figure, yet there are some large assumptions baked into that number. The formal debt (Treasury obligations held by the public) is comparatively small. Social Security is *easily* fixed by simply slashing payouts by roughly 25%. People might scream if they expected $40k in Social Security and end up receiving $30k, but they’ll find a way to survive. And Medicare? Those promises will simply be modified. Full-freight-no-questions-asked medical care will likely not survive another decade.

These “solutions” are going to be painful, but not unsupportable. If it makes anybody feel better, working-age families are also likely to be making do with much less. American workers (at forex conversions) are among the most expensive in the world, and we don’t NEARLY have the best educated population. That cannot be sustained. Thus the dollar will necessarily inflate, wages will stagnate, and people will be buying more expensive goods with the same (or less) money.

I don’t know that we’ve grown so far from our forefathers that “war” will be necessary. The riots in Greece (over relatively minor belt-tightening) don’t seem to fit with the American ethos. But I do agree that we won’t accept these changes easily, not without a crisis. And that’s a shame, because waiting for a crisis ALWAYS makes things worse.

Leaders? What leaders? I haven’t seen any leadership in this country for decades. Surely not referring to Clinton, Bush, Obama, or Palin?

Posted by TFF | Report as abusive

I agree with almost everything you said TFF. Our condition is acute and the cure will be painful. I will watch with great interest what new Governor Brown in California does with his budget mess. I sure hope there are large tax increases since that may run the jobs to other more worthy states.

A small breath of fresh air is Gov. Christie in NJ. He is locking horns with all vested interests and talking the talk. Jury is still out, but it sure has high entertainment value. Check him out on You tube.

New leaders will rise up when things get bad enough. I just hope the disease is still curable when they do.

Good luck with your inquiry into the causes and cures of what ails us. We need more citizens who question things.

Posted by bigbuilder | Report as abusive

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