I’ve been asked to take on stimulus and housing, so here you are:
I try to stay away from anything calling itself “business.” The “business pages,” “business news,” “business books,” and the like have always seemed like a smarmy refuge for the self-indulgent and self-absorbed who only knew Adam Smith third hand, thought Karl Marx was Harpo’s brother and had no idea that Joseph Schumpeter or W.Edwards Deming ever existed. The genre tends to divide itself into the Dale Carnegie “swindle your way to success” crowd and the Taylorist crowd of “produce more widgets by squeezing them out of the workers.” Economics, sociology, engineering, and philosophy are all legitimate areas of discussion – “business” is what falls between the cracks of rigor.
Beyond the perennial hobby of using equity markets as a casino, the thing that really seems to get this crowd excited is the buying, selling, and financing of residential real estate. First to take on a noun: It is not possible to buy, sell, steal, “flip,” or own a “home.” Home as a noun is a relational or state-of-being thing. (For instance, my home is either a bundle of legal rights, someone else’s property in another city, or 240 acres of barren farmland, depending on the definition used. That might say something . . . . .) What’s generally under discussion is a house, usually (except apparently in Florida,) a single-family detached residence, almost always with a fee simple form of ownership. (Those of you out there with a J.D., feel free to help me out on this.) Housing starts numbers and a constellation of other statistics and terms are based mostly around this category. This, of course, basically leaves out the island of Manhattan, the Gold Coast and lakefront of Chicago, and thousands of interesting and legitimate ways of living, including (as I understand it) the traditional family farm.
Starting from there, we can look at trends. When the technology bubble reset itself back to real numbers at the turn of the millennium, fear of a more general collapse led the central banks (specifically the U.S. Fed) to cut the loan rates of borrowing down to very low number. That is, they made borrowing money very cheap. One of the biggest factors in a real estate deal is the cost of money. (Where are you Tom Skuzinski?) Since almost all real estate is purchased with credit, the return on investment depends on how much of the income stream goes to servicing debt. The lower the interest rate, the higher profits from a particular income stream, and thus the more attractive it becomes. (This, in large part, is how the Fed stimulates the economy.) As investment capital fled the stock market, and the cost of money plunged, much of that money poured into real estate; traditionally seen as a “safe haven.” More money chasing fixed building and land stock led to both an increase in construction and a spike in prices across the board. So far not a problem – just normal business cycle stuff.
The problem came in with the numbers game. As “safe” property became more and more valuable, prices of even single-family homes went up and up, especially in certain areas. Historically house prices have more than kept pace with inflation, so buying a house, even to live in, has usually been a pretty safe thing; if you absolutely had to you could sell it and recover what was owed on the mortgage and then some. However, in a market ginned up by speculation, and multiplied by cheap money and freelance mortgage brokers that made money by originating, but not holding loans, the opportunities for mischief abounded. People were lured into the wishful thinking that an appraisal number represented lasting value, and offered debt tied to this artificial number instead of their proven income. The cycle fed up and up and up until, like technology stocks, someone came to their senses and realized the asking price wasn’t anywhere near the long-term value. (Yes, I know, exchange theory of value and all of that . . .)
Demand dropped for unnecessary and overpriced housing, and the guys the crooked mortgage brokers sold the loans to realized that much of what they were holding was worthless; and voila – credit crunch as people decided it was a good idea to only make loans that could actually be repaid. Meanwhile the mortgage brokers, securitizers, and real estate sales agents slipped quietly away.
Now for the psychology: Normal Americans that had mortgaged themselves up to the neck for a “sure thing” in housing (and also, apparently, forgetting that as an investment real estate is incredibly illiquid, and if they ever need to cash out their “investment,” they’d have no place to live,) suddenly found themselves deep in debt without equivalent collateral and a more expensive and suspicious credit environment that would no longer let them borrow their way out of debt. Add on top of this the thousands that were given temporarily low rates without understanding they were only temporary and you have a wave of foreclosures. Each foreclosure for fire sale prices further lowers that artificial appraisal number and the downward spiral continues.
Which brings us to stimulus: As the good people of the University of Michigan will tell you, much of buying selling is driven by confidence. People who are optimistic about the future invest, those who are not retrench. Optimism and pessimism can start virtuous and vicious cycles leading to peaks and troughs in the economy - one of the big reasons no one wants to report bad news. Half of the trick (possibly the only real effect) of something like a stimulus package is getting people to feel good about the economy again. This is where tactics like handing out checks and monkeying with mortgage rates make both economic and political sense. If people feel “hey, I’ve got a little money in my pocket and the feds are fixing this debt mess I’m in,” they’re more likely to keep up buying and selling and pull the economy back from the brink (and re-elect the guys in power.) It's psychology, really, but it can work.
The question is: did the debt orgy get so far out of hand that it can’t be fixed by perceptions?
Postscript: Anyone who tells you that “equity appreciation” is a real thing is probably selling something (most likely a home equity loan.) The idea that you lost out because crazies on the West Coast bid their tulip bulbs up to an even more irrational price that your area did is just silly. I think the technical term for this phenomenon is the “greater fool” theory. (No, I’m serious, it is.)
For the full version of the image see: The City on Autopilot
