12 April 2009

Housing is Toxic

There are lies, then there are really big lies. The Obamanauts are off and running with one of those really big lies: home mortgages are a really Good Thing. Well, no. There is a story here, I sense.

When I was in econ grad school, it was common knowledge in the profession that USofA's worship of home ownership as "the family's major investment" was not just wrong but downright dangerous. The reasoning goes like this: there exist two types of investment, financial and real. Financial investment is stocks, insurance policies, and, well, residential housing. Real investment is things like a plant to build widgets or buy a widget forge. Real in this case meaning physical, of this corporeal world.

The Obamanauts were out encouraging folks to refinance, and "put money in their pockets". This is just the behavior, bait and switch, that caused the mess in the first place and was the mantra of the wingnuts. While reducing real median income/wages in the name of free market capitalism, the wingnuts encouraged a Ponzi scheme in the residential housing market. The price of housing will increase by double digits year after year, so live off this unearned equity. Neat trick, but it doesn't work. In due time, the house of cards collapses. The Obamanauts serving it up too is in line with their secrecy moves.

We were hosed. Obushama.

Now, as to why housing is toxic. Financial capital can be used to create real capital, plant and equipment. Or it can be used to bet on pyramid schemes, like the stock market. A topic for another essay, but the 401(k) bait and switch is from this same bolt of cloth used to sew the Emperor's new clothes. In can be argued that, from the point of view of the individual, it matters not whether $1,000 is put into XYZ, Inc. stock bought on the market or into a $1,000 widget forge for XYZ, Inc. The individual just wants to get back $1,100 at some point in the future. But from a macro-economic point of view, it makes a hell of a difference. A widget forge has real return: it allows XYZ, Inc. to make widgets more efficiently. So, society as a whole benefits when fiduciary (financial) capital is directed to real capital. There is no economic benefit to society from the trading in financial capital, this is just a zero sum game.

Residential housing as investment vehicle is the toxin. It was no coincidence that this scam finally collapsed during the Bush years. But it had its start in 1973, with the first oil embargo, and stagflation. It is a truth that housing prices and interest rates are inversely correlated. With the Volker disinflation in full force, interest rates soared. It is also a truth, recently revisited with the subprime and alt-A and similar scams, that the net cost of housing is fixed by median income. If you make $1,000/month, then $333 dollars/month is about the max you can pay for housing. The exact percentage waffles a bit, and was further fiddled a bit during the Bush years, but for the short and medium term in a location, the median mortgage payment is a fixed percentage of the median income in the location.

So, in the 1970's interest rates soared, median income didn't move much, so house prices declined to meet the arithmetic. People who bought then saw ridiculous unearned capital gains as time went on when interest rates declined. As interest rates decline, then house price rises to consume the median mortgage payment. The notion that housing prices always rise was born in the brains of the feeble minded and evil minded. The two groups overlapped a bit.

In the current drama, Greenspan aided and abetted the scam with his insistence that interest rates would be held low. When that stimulus began to wane (as it will when time moves from the short term to medium term), the mortgage companies invented new and interesting ways to inflate house prices with an essentially stagnant median mortgage payment. Make no mistake, it was not banks that originated the scams and the bulk of the mortgages; banks came to the game later and generally in an attempt to maintain market share. (The Fannie and Freddie messes were market share artefacts.) This is not an intelligent excuse for being stupid. But merely an explanation. It is also another reason why the micro-economic analysis fails when applied to macro-economic policy issues.

While the USofA has been dumping financial capital into McMansions for decades, other countries, notably China of course, have been putting their financial capital into real investment. Guess who is winning the game?

The USofA is among only a few countries that allows the deduction of mortgage interest from income taxes, and the one of two (the other is the Netherlands) that doesn't otherwise balance that benefit.

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