Sunday, July 15, 2012

AN UPDATE on Housing, Investments and the Debt Obligations Involved


{NOTE; After the updated summary of today, following that is what was initially posted on June 1, 2011. The basic story hasn't changed and won't for at least a few more centuries. It's about debt, real prices, housing as an investment and bubbles bursting. The concept of "reversion to the mean" is something we all need to understand and internalize about markets---housing, stocks, inflation and interest rates included.

The 2011 post is still timely and we'll be updating the home price data and home equity debt related problems in subsequent writings. For now it's important to understand the concept of reversion to the mean. That simply means that prices tend to follow inflation and real growth over a long period. In the case of housing, despite what many people still believe, it's never been a good investment.

It sometimes is a speculative winner, as the years between 1996 and 2005 were. But taken as a whole, home prices don't reveal a solid investment result, especially when debt is factored into the equation, even excluding the now burdensome home equity loans.

Buy a house to live in that you can afford when the time is right, but don't look at your home as an inflation adjusted profitable investment. It's a place to live.

I hope you enjoy the "oldie but goodie" below. And more important, I hope you will take the time to help educate others about the truth behind home ownership and making or losing money, as the case may be.


The concept of "reversion to the mean" applies to all markets, including stock prices. Yea! Home Prices Hitting Bottom. Now the Bad News has the updated story:

"This is a great time to buy a home in many parts of the country. There are signs that the downward price spiral is bottoming out. Mortgage rates are at historic lows.

The next few years could well be remembered as the best opportunity for Americans to buy homes since the postwar baby boom.

But one group's opportunity is another group's problem. Tens of millions of baby boomers and other home owners have seen their equity shrunken or wiped out completely. Many were counting on their homes to help finance their retirements. Often they have been waiting for years for the market to turn. Now they find themselves on the short end of the deal, sellers into the buyer's market of the century.

"It's a really challenging environment to be a seller," says Lawrence Glazer, wealth adviser at Mayflower Advisors in Boston. "Unfortunately, many people planning to retire may have no choice."

So what if you are on the wrong side of the trade? As ever, there isn't a single, simple answer, but if you're in this situation, here's a checklist to help you out.

1. Don't hold your breath.

Yes, house prices nationwide have stabilized. Of the 20 cities tracked by the Standard & Poor's/Case-Shiller Home Price index, 16 are in the black for this year. But the housing market isn't like the stock market. Bouncebacks are typically slow.

The last crash took more than a decade to work through—and this market could take an especially long time because the huge accumulation of empty, foreclosed houses will hold down prices for all properties.

When adjusted for inflation, the Case-Shiller index didn't return to its 1989 peak until 2000. Some markets, such as New York and Los Angeles, didn't hit new highs until 2002. This time may be even worse because the bubble was much, much bigger. Some locations may not recover their inflation-adjusted peak in our lifetimes.

Harvard's Joint Center for Housing Studies calculates that there is a backlog of around two million home loans in foreclosure, waiting to come onto the market. Some estimates put the number much higher, especially when you include "shadow inventory" held back by banks.

Unless you are willing to wait for a long time, you may not want to get too hung up waiting for a big rebound. . . ."



The recent "bad news" is in large part about the 'double dip' in housing and its effects on unemployment and future economic growth (Bottom May Be Near For Slide In Housing). Pardon me, but I missed the first rise and subsequent dip. It seems like it hasn't risen at all to this point.

Unfortunately, this type of a continuous stream of bad news may very well continue for several more years, assuming that what the pundits would label good news means reverting to the kind of activity we enjoyed during the years between 1996 and 2006. Let's review a few historical facts cited in a chart on page 207 in the book "This Time Is Different" by Reinhardt and Rogoff. Real (inflation adjusted) housing prices rose a total of 27% from 1890 to 1996. The next ten years generated a real increase of 92%. At the peak in 2005, real prices increased a whopping 12%. Since then home prices have fallen 34% from that peak.

That's right; up 27% in 106 years, then up 92% in 10 years, including 12% in 2005 alone, and most recently a fall of 34% during these past 6 years.

So the rough math says that a house selling for 100 in 1890 sold for 127 in 1995, then increased to ~244 by 2005, after which it fell to 161 today. The historical trendline suggests that what sold for 127 in 1995 should sell for ~130 or so today. Using 161 for today's market price (peak of 244 less 34%, or 161) suggests that a final further adjusting trendline reversion to the mean yields a fair market value of some 20% less than today's selling price. That, or something close thereto, may well be what's ahead.

Whether that's in fact the way it turns out or not, we really shouldn't be surprised at how far prices have fallen thus far in the past several years. We've simply been reverting to the historical mean.

What we should consider carefully and fully is how house prices rose so far so fast in the ten years ended 2005 or so. And why it happened? And what does this teach us about the staggering larger societal issues concerning home ownership, unemployment, economic growth and the like? In other words, what does this means for the future decades ahead of us?

Our problem, pure and simple, is debt in relation to income. We borrowed too much to buy homes and other things which we couldn't afford based on income, wealth, and so forth. As more of us bought on cheap credit, prices went up. So more of us borrowed more money on more cheap credit and we bought some more "good stuff". And as that happened, prices went up some more. The cheap credit bubble continued to build until finally it burst, as all bubbles do.

So prices started falling fast and the result is that the trendline of inflation adjusted home pricing over a very long period of time is being reestablished, albeit painfully. Cheap credit was offered to virtually all takers, and lots and lots of people availed themselves of the opportunity for what appeared to be "can't miss free lunches all around".

Lenders accepted collateral for loans in the form of the house "bought". When the bubble burst, prices fell. Then the happy home owners became sad, and many couldn't pay off the loans or even the interest on the loans. They also couldn't sell the house for the purchase price, so they were stuck. Thus, although the value of their asset had declined, their debt obligation remained unaltered. As a result, banks and other lenders had lots of bad debt on their hands. And they still do. And consumers had lots of problematical debt on their hands. And they still do.

So spending slowed. And new loans slowed. And demand for products slowed. And demand for loans slowed.

So unemployment grew. And grew.

So we asked the government to "stimulate" the economy, whatever that means. So the government "stimulated" the economy, and that meant even more debt owed by the government.

And less income came to the government since unemployment grew despite the "stimulus" spending. So the government issued more checks to the unemployed and other unfortunate people, along with the elderly and others deemed to be deserving souls.

Except the government had no money. So it had to borrow the money to "stimulate" the economy and so forth. So the debt continued to grow. And grow. And it's still growing.

What a sad story. All about debt.

Today if the federal government spends $1, it has to borrow 40 cents thereof. Not enough income. Not a pretty picture. And the debt grows and grows and grows.

Eventually we will come to grips with our debt problems. Maybe even much sooner than eventually, depending upon what the lenders and "We the People" choose to do and when we choose to do it. Both in our roles as individuals and as citizens, too.

Sadly, we've done this to ourselves. We'll have to solve it together. And solve it we will. Because we must. and because it's the right thing to do.

Debt is not always bad, but too much debt never has a happy ending. Not in the short term.

But I'm a committed optimist, and I sincerely believe we now have a valuable teachable moment at present ........ about living within our means both as individuals and through our governments as well.

Stay tuned. Bob.

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