Thursday, April 24, 2014

A Very Basic Housing Post

This is a very simple graph comparing the relative mortgage payment (based on the typical 30 year mortgage rate and the Case-Shiller 10 city home price index <blue> or the CPI median home price <purple>) to the level of rent approximated by the Owner's Equivalent Rent series in the CPI.  The CPI measure didn't show the same price increases in the 2000's that the Case-Shiller Indexes did.  I suspect that the Case-Shiller index reflects the experience of existing homeowners in major cities, and the CPI index reflects the experience of homebuilders and rural homeowners.  (The green line reflects the CPI Housing price index more generally, as an alternative to OE Rent.)

(As an aside, I wonder if the Case-Shiller/CPI disconnect is related to the difference between long-term expected price behavior for urban dwellings compared to rural locations.  At very low long term real interest rates, adding a small amount of excess expected returns can cause present value to skyrocket.  This is a problem when doing discounted cash flow valuations on stocks, where changing the long term growth rate by 1% can swamp the scale of all the work you might do in the short term cash flow forecast.  This is especially the case on very long-duration assets with very low discount rates.  So, if this divergence reflects an urban/rural split, I will suggest that this also is a sign of the power of low real rates on home values.)

As I have explained, many times, a house is a very long term inflation protected asset.  The intrinsic value of a home is no more dependent on the use of a mortgage than is the intrinsic value of a stock dependent on whether you buy it on margin or not.  (Of course, tax treatment of mortgage debt does provide a consistent boost to the value of an occupied home, but this is a relatively constant factor over time.)  I have explained that homes should be worth more, in nominal cash value, during times of low real long-term interest rates.  This means that even the ratio of mortgage payments to rent payments should increase, because the mortgage has a relatively short duration, while implied rent would grow and extend further into the future.  Low real interest rates inflate the value of those future rent values more than they inflate the value of the mortgage payments, so the equilibrium mortgage payment to rent payment ratio should increase when real rates decrease.

But, ignore all of that for now, and let's look at this simple chart taken on the most simplistic terms of the rent-vs-own comparison.  Even ignoring all of that, homes are still cheaper now than they had ever been before the crisis, relative to renting.  There is no bubble.  There is the opposite of a bubble.  There is a big, giant, wet blanket of a non-bubble.

If there is bubble talk now, I hate to think of how much pressure there will be on the Fed to cut off our nose to spite our face when home prices go up another 30%.  But, they need to go up that much just to get mortgage payments back to the relative level of rent payments.  Lord help us if housing prices actually get back up to where they should be in a low rate environment.  If that happens, there will be calls for Janet Yellen to literally walk down alleyways with Molotov cocktails, burning houses down to save us from ourselves.

We live in a time where finance is treated as suspect, a priori, at just the time where financial intermediation is especially needed.

It's interesting how many thoughts the average person can hold in their head.  For instance, everyone knows that the average mutual fund underperforms the market.  These finance guys - you know how they are - they try to convince you to pay them a bunch of fees because they'll supposedly beat the market for you.  It can't be done.  Everyone knows that.  They are scamming you.

And, also, everyone knows that housing in the 2000's was a bubble.  And everyone knows housing is getting all bubbly again.  It is clear. As. Day.

Everybody KNOWS both of these the same time.  Prices can't be predictably wrong, and, also, prices are predictably wrong.

And, when we manage to pop those bubbles, isn't it nice that we have the finance guys to blame.  They only care about one thing: money.  They don't even MAKE anything.  They just want profit.  And, they will destroy the whole country to try to get it.  They'll even finance a house for you, and stick it right there on their balance sheet, even when we all know it's a bubble.  And, it doesn't even hurt them, because villainy is magical.  Just slap the term "bailout" on a half-dozen different policies regarding thousands of different financial professionals, and ignore that list of banks in FDIC receivership - the details aren't important.

What a nice story.  Magical villains can really bring a narrative around.  It's just about the only thing Republicans and Democrats seem to agree on.  Even market-supporting economists can earn street cred by asserting that finance is all just a bunch of rent-seeking.  (Never mind that negligible trading fees and spreads and low-fee index-type funds are fairly recent and now-ubiquitous innovations.)

PS.  Speaking of which, here's an interesting interview of Stalin by H.G. Wells, from 80 years ago.  To me it is chilling to read this conversation between a mega-murderer and a Western intellectual impressed with men-of-system.

It's kind of funny that Wells says this of J.P. Morgan: "Take old [J P] Morgan, for example. He only thought about profit; he was a parasite on society, simply, he merely accumulated wealth." And, it takes Stalin to come to Morgan's defense, though noting that profit-seekers will never be friends of the revolution.

But, knowing what has happened in the world since then, how the world has changed, and what Stalin was up to, it's sad how much of that conversation could be right at home in many of today's publications and university campuses.  We live in a world of mind-boggling human innovation, yet it seems that we are incapable of learning anything.

In 1934, Wells could profess his confidence to Stalin that the profit-based system was collapsing, and New Statesman readers could nod in agreement.  In 2014, the end of the old system is still professed.  The system of profit-seekers and "1 percenters" is toppling by its own weight.  And blog readers and Facebook friends click "Like".  In another 80 years, knowing intellectuals will use their neurotransmitters to telepathically emote hatred for those slimy profiteers to their Mega Corp 2000 brand robot-butlers, and robot lights will gleefully blink in agreement, "Bleep, blop, are so right, master."

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