On Sat, 29 Jan 2005, Jordan Hayes wrote:
> Ok, we're way off track here. I'm NOT saying that the housing market
> isn't frothy; I never did, and I won't be misconstrued to be "against" it.
I'm sorry, Jordan. I'm not trying to nail you on anything. I don't know about other people, but I thought your discussion was very good, you prevailed in many of your points, and now I'm moving on to something else and asking what you think of that.
I think you made a very good case that an investment in a house is fundamentally different than an investment in stock because:
1) There is so much use-value involved that you can break even, or even lose money from an investment point of view, but still make out great from a paying for housing point of view compared to where you might have rented during the same period.
And you have a subargument, as I understand it, that in some ways these lowball backloaded mortgages increase the odds that a person could have a good time in their house from a rental point of view for five or ten years even in a worst case scenario, precisely because so little is at stake for them, whereas in an old fashioned fixed rate high money down mortgage, there was much more to lose if it all went south.
2) Precisely because there is this housing calculus involved, when there are bad consequences, they often tend to be worked out in nonfinancial ways -- people simply stay put instead moving until market rises again in a way they don't with stocks.
You might also have added (but I don't think you have yet) that the housing market has a true feature that sounds like bubbleheaded nonsense but isn't: during the postwar period in America, it has never gone down in nominal terms. Never, not even for a year, on a national basis. And the few times it's gone down in real terms, it wasn't very much and it wasn't very long, only a year at a time, not a problem at all to sit tight and wait out.
Now if anyone said of the stock market that it never went down, they would be marked as a loon. But in housing, you can say that, and you're not wrong. And since the market has been overheated many times before, the fact that this overheating has never led to a crash before on a national level means that it is quite possible it won't now either. Past practice is no guarantee of future results, but still, this clearly isn't like the stock market, where overvaluation always does eventually result in correction and downturn.
So those of us who feel the housing market is bubbilicious have the burden of proof to show why this time is different. And even then we can't be sure until it happens. There is no "sure sign," because, unlike the stock market, it doesn't have to happen. Mere unprecedentedness is not enough to prove anything. Because there have been newnesses before that looked absolutely nuts and so far haven't done south, like low or no-money down mortgages. That violated decades of iron wisdom. Maybe it will still lead to a massive banking crisis someday. But so far its been going on for so long that it just possible that it simply enlarged the market rationally to people who were being unnecessarily excluded.
3) Lastly, as I understand it, you argue that backloading makes sense because almost everyone who has ever bought a house is making a calculation that is reasonable in the aggregate: that they will be closer to the peak of their lifetime earning cycle in 10 or 15 years than they are now. And in the aggregate, most of them will. So not only does backloading often make financial sense, the bulk of the major risk is thus being pushed to the bank -- which, from an individual's point of view as a homeowner, is jake.
Is that fair so far?
So now let's move onto two points where I think we disagree.
> [ I'm "against" the idea that this is a "bubble" -- I think that word should
> be reserved for situations where, when it pops, it's gone ... like a bubble.
> Housing isn't like that
Here I think you are mispresenting what a bubble is. A bubble is when value is inflated far beyond the value it should have. When it pops, value returns to the correct level -- it doesn't disappear. Stock in Ebay, Amazon and Yahoo all still have value, as does most of the other stock in the market. It's just much less than it was at the height of the bubble. If you could live in your stock, most of it will probably eventually rise to the same level again -- just like with a house.
When value disappears entirely, like with Worldcom or Enron, that's not a bubble. That's fraud.
So on this definition of a bubble, it's perfectly possible for there to be a bubble in housing. The price of houses could be bid up much higher than the value they ought to have, with the value they ought to have being determined by how much people can afford to pay. Specs can have driven the market up in the same way as daytraders drove up the NASDAQ. The difference here, though, would be that normal people who still need houses would feel compelled to buy at prices far beyond what they can afford over their lifetime earning cycle, simply because they are convinced of the basic postulate that housing prices always rise over the long term. On the push side, such a postulate entails that waiting will always cost them more so everyone should get in sooner rather than later, or maybe they won't be able to get in at all. And on the pull side, it means they can pretty much count on either making money or at worst it being a wash, so if they can just get in, they really don't have anything to worry about.
Now previously, many people who might have wanted to make this choice couldn't have because the price of admission was too much. They didn't have a downpayment and they couldn't meet the monthly nut. But now, thanks to a great number of financial innovations, almost anybody can swing it one way or another, at least in the beginning. So following these postulates, lots of people may be making a totally wrong calculation and not knowing it.
So the bubble argument is that there are lots of these people who are in over their head and don't know it. And that if interest rates turn adverse, they might be shocked to find that not only can't they afford their mortgage, but massive numbers of people can't. And that when all of them feel compelled to sell their houses because they can't meet their nut, they will all lose big.
And I think it's possible to make this argument even when one understands and accepts the points that which you've made very well. Yes, this hasn't happened before on a national scale; and Yes, many Henny-Pennies have said it was going to and they've always been wrong before; and Yes, New York apartment dwellers have a certain schadenfreudliche ressentiment against home buyers because we're tired of them smugly telling us our whole lives that we're stupid for renting :o)
But even though it hasn't happened before, it could happen now. And one reason to think now is different than it's ever been before is precisely because there has been so much unprecedented financial innovation. We agree on that fact, that it's been unprecedent and its been huge. So it is certainly it is possible that over time this has changed the underlying structure of the housing market from what it's ever been before. So that it could crash in a way it never has before. We won't know 'til it happens. But it's possible.
But you quite right -- it's certainly possible that it won't. In that way, it's different than stocks.
On your last point, that if banks say you qualify, you probably do -- that is true on an individual basis. But the whole point about systemic risk is that it's off the charts. Banks are quite capable of collectively missing a huge risk. They did it when they gave everyone 30 year fixed rate loans as if inflation would never soar. So they can do it again. They are not infallible on this point. They are not even really relevant. It's just not part of their framework to worry about the unprecedented. Their calculations are based on a continually rising housing market just as much as the buyers. The risks of an unprecedented crash have not been factored in anywhere.
Michael