Chuck Ponzi October 28th, 2009
Much of the last 4-5 months has seen a veritable frenzy of activity in the housing market throughout Southern California and throughout the rest of the US. What does this mean? Have we hit a bottom? Is it a dead cat bounce? Or, was the last year a bump across the bottom before an explosion upwards?
Well, if you’re looking for easy answers, I don’t have a crystal ball, any better than anyone else, so it’s nearly impossible to tell you where its going. But, I can tell you the basics of the Long, Medium, and Short term. Much of this is common sense, but must be repeated constantly to remain tethered.
Long Term Prediction
Eventually, though, it’s an argument about inflation or deflation. Housing prices relative to incomes, rents, and inflation have moderated, but at a much higher level than historically, as pointed out by Dr. Shiller above. If this is indeed a bottom, the ramifications of higher home prices are profound. Consider for a moment, the beginning of this thought expounded in the WAPO yesterday regarding the housing stimulus:
Putting cash in pockets does have a stimulative effect because some of that cash will turn into consumption. But as far as stimulus measures go, it has a low multiplier (the ratio of new economic activity to stimulus spending). By contrast, we could take the same cash and hire more teachers, police officers or soldiers to fight in Afghanistan. We would get more economic activity, and the government would get something for its money.
But the tax credit stabilizes the housing market, people say. What does this mean? It means that the credit keeps housing prices artificially high. But housing is something that all people need. Why do we want it to be expensive? Would we want government policies that artificially push up the price of food?
To take it a step further, is there anything in this world that we consume that we would cheer when it goes up in price? Nevertheless, even knowing how wasteful, inefficient, and stupid the measure is, our congress seems intent on passing an extension of the home buyer credit. Even worse, it appears to be expanding to existing homeowners, completely negating the originally intended purpose of clearing inventory. Of course that could be in large part because inventory in many areas has dramatically decreased, and it’s simply a matter of pork and pork products for the housing industry.
Currently, housing prices receive the largest subsidy of any asset class, and for what? To make our neighborhoods better in some way?
But isn’t it just better for more people to own their homes? The conventional wisdom is that homeownership has positive externalities: Homeowners are more likely to invest in their communities, and it is the best way to build household wealth. But the evidence for this is mixed. In “Our Lot,” Alyssa Katz cites three academic studies and concludes: “Scholars found that once they set aside the various traits that tend to determine whether someone chooses to own or rent one’s home, homeowners and tenants really aren’t that different. . . . Often the new homebuyers were purchasing the worst housing in the worst neighborhoods with the worst schools — hardly a solid investment.”
So, to recap, we’re giving money to people to do what they were going to do anyway, and thereby increasing our own costs and driving malinvestment into residential housing instead of manufacturing capacity or research and development reducing our country’s competitiveness. We’re taking money away from firefighters, teachers, and policemen so that your neighbor can afford a larger SUV or better furniture, and this entire premise is built on the disproved theory that won’t improve our neighborhoods in any way?
As I mentioned earlier, the real fight is about inflation or deflation. There is no doubt that inflation is a monetary phenomenon. At the present time, the deflationary forces of deleveraging are stronger than the inflationary forces of the stimulus packages and absurd monetary policy.
Make no mistake about it, in the long run, our currency will be devalued through inflation to nothing. This is the fate of every fiat currency, and given the political stupidity that occurs when large numbers of people vote conmen and shamsters into political office. This is the state of the US, and there is no indication that this will ever change. Just look at the last 30 years. In this environment, you will want to hold assets, not cash in the long run.
Medium Term Prediction
However, in the long run, we’re all dead, so we need to know what’s going to happen in the next 3-5 years. What we can expect are the following in the medium term.
1. Higher taxes. This is true of both state and federal taxes. We are on an unsustainable path. While most Americans would rather make do with smaller government, the fox guarding the henhouses will never allow themselves to be kicked out. This means less money to be spent on food, housing, healthcare, education, etc.
2. Low interest rates. Financing will stay very loose as long as interest rates are held down. This is the latest salvo on the war against savers. Banks, governments, and every company is doing everything it can to separate you from your money. Most Americans will simply give up because they know nothing else. Saving will come from outside the US, and not inside. American’s balance sheets are beyond repair. Nothing can save the average consumer now.
3. Commodities Bubble. Expect the next bubble to be in hard assets. Perhaps this is oil, gold, natural gas, copper, lumber, corn, porkbellies, wheat, etc, etc, etc. The government DOES want prices to go up, and will do anything to make it. It would rather destroy Americans in its quest to save them than to admit that they don’t know and just let the world sort it out. Most commonly, those who think they understand economics are far more dangerous than those who study it.
To be sure, there are no easy answers, even in the medium term. And, beware that many of the above issues work against each other, so it will all be relative. For example, low interest rates will drive a weaker dollar, rising prices on products which will improve export industries that may end up increasing jobs and demand and moderate the decline of the dollar. Such paradoxes routinely exist, and help prevent the currency of a diversified economy such as the USD from declining too quickly too fast. But make no mistake, the endgame of the fiat currency is to fall to zero value. Eventually, houses will hold their value, even if prices are still too high. This just means that they will endure long periods of poor returns relative to other assets.
If housing prices stabilize here, there will be no free lunch that returns us to high returns. That can only come if they fall below intrinsic value, something I feel supremely assured in saying has not happened in Coastal California (not true of deep inland Cali such as the Victor Valley or Palm Springs). Orange County, San Diego Coastal, Los Angeles Coastal, and Ventura and Santa Barbara Counties are still painfully overvalued in relation to their alternatives.
The medium term case to own a home in Coastal California is uncertain. I predict that we will have a clearer picture in the short-term predictions, but there are no certainties with this much malinvestment.
Short Term Prediction
There has been a significant shift from foreclosures. Various reasons abound as to the cause, but there is no clear reason that the Notice of Defaults has continued to rise to record astronomical levels while foreclosures have remained relatively low.
The Big Picture takes up part of that story with “Strategic Non-Foreclosure” and the Piggington site details some of the statistics in the recent past for SoCal.
Do not be misled, there is a serious imbalance that has grown between defaults and foreclosures. Foreclosures are dramatically lower than they should be given the incidence of defaults. There are 2 possible reasons for this imbalance:
1. Banks are having difficulty foreclosing. Numerous possiblities exist for this reason such as poorly equipped staff, moratoriums, trepidation of foreclosure while on government dole, stated contradictory policies, and many more. The general perception is that this will eventually result in higher foreclosures once the problems are dealt with. Noone knows when that historical balance will return.
2. Banks are actually working out modifications and they are sticking. This could mean that a dramatically higher number of modifications are being approved and they are having the intended effect of reducing the market’s fall. This would be difficult to explain. Never in history has this happened, but never in history have we been this indebted before either.
While it’s entirely possible that #2 is happening, the risk is much higher that #1 is the actual case. The table is clearly tilted on a risk/reward basis that #1 is happening. Smart money should hold out at this time until the trend is clear. While the past 4 months is the first indication of stabilization, an unbroken 1 year trend will be the clear signal. The soonest that could happen is next spring. That is the earliest BUY signal that the housing bubble could give us since Summer 2005. We will simply have to see if that buy signal is confirmed for early entrants. Purchasing now is highly speculative and likely to result in knife-catching.
According to Occam’s Razor, it is beter to attribute the latest moves to #1. I cannot stress this enough that the risk/reward ratio still favors waiting for much of Southern California. The exceptions to this are areas where buying is at a significant discount to renting (some exist). It doesn’t preclude the possibility of failure, but it does give options for medium term and longer term trends to mitigate the risks of buying a home now. For coastal california, any purchase now can only be seen as speculative and imprudent.
The Final Wrap
The basis of any bubble is a speculative frenzy. Recognizing the attributes of a speculative frenzy and the stages bubbles go through is critical to timing any asset purchase.
Remember, there is nothing more fundamental to investing than timing. Anyone who tells you otherwise is a fool. Timing your purchases of stocks, bonds, commodities, housing, or any other asset is critical to success.
My hope was that this country and its leaders could see the value of letting housing prices fall to their intrinsic demand value, but leadership is nearly absent in US politics today. There does not appear to be an opportunity for this to happen any time soon.
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I have nothing against Donny. Love him to death.
