tag:blogger.com,1999:blog-582368152716771238.post3847592322598753737..comments2024-03-28T14:41:03.793-05:00Comments on The Grumpy Economist: Benn Steil and I debate house pricesJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger14125tag:blogger.com,1999:blog-582368152716771238.post-61490305384868098592012-03-08T04:08:59.559-06:002012-03-08T04:08:59.559-06:00Quoting from the post: "Even those that lost ...Quoting from the post: "Even those that lost money in one house will still want to live in houses for a long time, so they can buy a new house for the same low price that they sell their old houses for."<br /><br />This is the simple, key point that most "lay" people miss. And it's an excellent point, of course. However, I think it's more tricky than it appears. This argument assumes that you know the difference between the high price (in 2006, say) and the low price (in 2012, say) for BOTH the old house you sell and the new one you buy.<br /><br />Now, for sure you know the former: you know the price you paid in 2006, and you know the price you are selling for 2012. But the latter is uncertain: you know the price you are paying in 2012 but you don't know how much you would have paid that *specific* house in 2006.<br /><br />This can make a big difference if people are risk-averse, don't you think?Giulio Zanellahttps://www.blogger.com/profile/07342115048531367498noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-89817703350409676352012-03-06T10:18:37.131-06:002012-03-06T10:18:37.131-06:00This comment has been removed by the author.RMhttps://www.blogger.com/profile/14169718180681043601noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-75460533751502707542012-03-03T17:08:32.962-06:002012-03-03T17:08:32.962-06:00National real estate busts in modern economies are...National real estate busts in modern economies are terrible events, regardless of age groups. The obvious reason is that real estate is leveraged (banks get hurt bad), and residential real estate is a large part of household wealth. See Japan for real estate busts that were never reflated. Down 80 percent in last 20 years and still falling. The nation is shrinking.<br /><br />For the USA, the immediate response to a real estate bust should be 1) stop them from happening in the first place, then 2) reflate as quickly as possible. <br /><br />Fannie and Freddie and CRA may be bad ideas; lop 'em off if you want to. But remember, there was an equal bust in commercial real estate, and no Fannie or Freddie. Why?<br /><br />Fed policy was too tight. The Fed tightened in in 2008 in a Quixotic and ill-timed venture to quash global commodities inflation. They dented commodities prices (since largely reflated) but put a torpedo into the side of the USA economy from which we have not yet recovered. <br /><br />Lesson learned, I hope. <br /><br />What to do now? As Milton Friedman advised (http://www.hoover.org/publications/hoover-digest/article/6549), print money until we get robust growth (the Fed has failed) and the keep printing until you get past certain annual inflation levels (I would suggest five percent). Alan Meltzer and John Taylor also advised this course of action for Japan. As did Ben Bernanke. <br /><br />Yes, it is so, so wrong, except everybody has recommended this course of action. <br /><br />A long sustained dose of real estate appreciation and inflation, and several years of robust growth and moderate general inflation, is the tonic we need. Would help the nation delevarge too--and the wealthy pay the income taxes, which is how we will pay down the national debt.<br /><br />Thus, using QE to monetize the debt, and inflation to reduce the debt might allow for the cutting of income taxes on the wealthy, which is evidently the point of life for many.Benjamin Colehttps://www.blogger.com/profile/14001038338873263877noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-60999107273443550692012-03-03T12:42:28.405-06:002012-03-03T12:42:28.405-06:00Perhaps a better perspective is to stop using doll...Perhaps a better perspective is to stop using dollars as the measure of wealth and start using things. If house prices decline 50%, that does not change the number of houses or the "services" they can provide one bit.<br /><br />A related issue is a decline in stocks. That does not change the number of material things, hence does not change aggregate wealth.<br /><br />The problem with both scenarios is the change in behavior that occurs that effects future output.TOGhttps://www.blogger.com/profile/17026819141512109918noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-11183994378432668342012-03-02T21:43:40.666-06:002012-03-02T21:43:40.666-06:00John - First, glad I found your blog. Well done t...John - First, glad I found your blog. Well done thus far. I'm only an armchair economist (be gentle) so I'm hoping you can help me connect the dots here:<br /><br />Let's say I'm young (33 is still young, right?), gainfully employed, and intend to live in my current home (which I bought 5 years ago) for a while (say 15+ years). I bought it at X and now it's market value is 1/2x. Interest rates aside (due to ability to refinance), I'm still paying for an asset at 2x its market value; this isn't just an unrealized gain/loss, it's a real cash flow savings that I would have if I were able to transact in today's market. This potential cash could be directed anywhere (durable goods, investments, etc).<br /><br />Said differently, to Benn's point, if feels that in the long run I will be worse off because there is cash I could have redirected to investments (let's say in companies with high dividends) but instead have tied up in an asset that may never be worth the amount I am paying for it. Considering this, I can't say I'm sold on your closing paragraph.<br /><br />Also, it seems that the subset of people that you single out (young, employed, etc) are exactly the type of folks who you want to be market makers in the long run, but now they're a group that are not able to participate in the market because they can't abandon their current positions in underwater mortgages (if they could, then I'd agree that you're selling low and buying low, so no big deal there). Perhaps the group is statistically insignificant, but I can't understand why tying the hands of that group is unimportant.<br /><br />From a macroecon perspective, do you just consider this household cash flow this a net zero transfer in the same way that job creation (unless it's a new to the world job) is not or economic benefit to society? Color me confused.<br /><br />Thanks for your time,<br /><br />RyanRyanhttps://www.blogger.com/profile/06416742806389611100noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-41487950789011209972012-03-02T15:03:12.707-06:002012-03-02T15:03:12.707-06:00“So, yes. If you lose 90% on a stock, but the str...“So, yes. If you lose 90% on a stock, but the stream of dividends is completely unchanged, then yes, you’re just as well off as before. If before you were planning to live off that stream of dividends, you can still do so. If before you were going to exchange the stock for a different one that gave a similar stream of dividends, you can still do so.”<br /><br />I think this is interesting to think about because houses and stocks as investments seem different to me. You buy the stock up front (we are not assuming most young people are buying stocks on borrowed money) and your investment then increases or decreases, but the worst it can go to is zero. You own the asset outright, you expect the dividend streams, you take the risk. <br /><br />Your comparison of a house to a stock is direct if a young person bought the house fully, with cash. You can rent the house out to someone in the future- these are your dividends. And if the underlying value appreciates, even better. It’s like buying a stock whose price appreciates and who continuously increases its dividend.<br /><br />But most young house buyers didn’t do this. Most borrowed to buy a house.<br /><br />Let’s say you borrowed a fixed rate mortgage. And the value of the house goes down. Your stream of (monetary) dividends is not the same. Your only hope of meaningful dividends in any scenario where you borrow to buy a house is through the house appreciating in price at a rate greater than inflation, or the ability to rent the house at a greater price than your monthly payments, which is usually not the case (but we may be approaching this scenario soon, which is interesting to think about). <br /><br />In fact, you, the buyer, are the stream of dividends to the bank who is holding the mortgage. You are essentially “the stock” for the bank. The bank can lose 90% of the value of the house, but your income to them is the same, so they benefit from the dividend stream, not you. Essentially, the bank is buying your ability to pay dividends when it gives you a mortgage, they could care less about the value of the property, except as a piece of collateral.<br /><br />Further, let’s assume a buyer buys a floating rate mortgage. The buyer is still “the stock” in the eyes of the bank. Let’s say the property value falls 90%. Now, with an adjustable rate mortgage, you are more like a derivative to the bank. The property value decreases, but your interest rate resets higher, so the bank makes an even greater dividend off you. True, their cost of funding might change as well, but with the good old Federal Reserve stepping in to help them keep it as low as possible, this shouldn’t be a problem.<br /><br />The more I think about it, the true investor in the purchase of a house is the bank, and the house buyer’s ability to pay is the true asset being valued. The monthly mortgage payments are dividends to the bank. The piece of property is only collateral in the case of default. <br /><br />So your statement about losing 90% of a stock but dividends staying he same is true for only two categories that I can see: Someone who owns a house with no mortgage, or the bank who provides the mortgage. Weird.GVhttps://www.blogger.com/profile/10345593335092007147noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-87596936296396913172012-03-02T13:52:59.771-06:002012-03-02T13:52:59.771-06:00One of the main points i think we are forgetting i...One of the main points i think we are forgetting is many young households didn't buy with 20% down into fixed rate mortgages. So when their mortgage "resets" they can't make the payment. And as prices drop,they can't refinance because they don't have enough (any equity). So even if, to your point, your 2006 "wages haven't shrunk" your mortgage payments have increased and therefore you are worse off, and you have less spending power (unless your wages have increased at a greater nominal amount than the increase in your monthly mortgage payment, which I doubt is the case for most young people).<br /><br />Now i am not going to get into a moral argument as to whose fault it is for getting an adjustable rate mortgage with little equity. Mostly it is the borrower's fault for not being educated. And financial education among young people in this country is abysmal. But, precisely because they are young, they also have little "other assets to sell" to pay off their debt. <br /><br />So, basically, the problem is leverage, and we all unfortunately feel the effect as people wind down their debt because they spend less which leads to slower economic growth. Debt service payments eat up larger parts of their income even if their 2006 wages haven't shrunk. And so all those older people who want to sell and "downsize" will also feel the effects in that there wil be less younger buyers for their homes, and the prices will be lower. <br /><br />So really the only people who win were younger people who didn't buy houses during the boom, which is a small population compared to those who did, and compared to thoses older owners who now want to sell. And, as mentioned above, it is much harder even for these younger people who sat on the sidelines, to buy anything now.GVhttps://www.blogger.com/profile/10345593335092007147noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-44980822790770536742012-03-02T09:28:15.421-06:002012-03-02T09:28:15.421-06:00Yes. Houses are terrible savings vehicles, but peo...Yes. Houses are terrible savings vehicles, but people do look at them that way. <br />This is interesting though because it's much less relevant for young people, the subject of Benn's post. Old people are closed to cashing in the big house, downsizing, and living off the difference. Young people are mostly buying a house for the "dividends," the value of living in it, and by definition didn't have much equity to start with.John H. Cochranehttps://www.blogger.com/profile/04842601651429471525noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-28954489934544679332012-03-02T09:25:59.559-06:002012-03-02T09:25:59.559-06:00He can sell the house for less than the mortgage a...He can sell the house for less than the mortgage and pay off the mortgage principal from other assets. It was debt after all, which you are supposed to repay.<br /><br />If you borrow money to buy stocks and the stocks go down, we don't all take it for granted that you call up your broker and default on the debt ("short sale" of the stock portfolio and only pay back half the margin loan.) <br /><br />I know many people don't do this, but it's worth remembering that it is physically possible to pay your debts!John H. Cochranehttps://www.blogger.com/profile/04842601651429471525noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-54128273002219051472012-03-02T07:14:23.291-06:002012-03-02T07:14:23.291-06:00What about the savings aspect to owning a house. ...What about the savings aspect to owning a house. I pay my $1,000 a month mortgage (on my house worth $100,000), but I am hopeful that I am building some equity in the process. Enter the bust, and now my house is worth $10,000. Yes, I can still pay my mortgage (I still have a job), but the notion that I am building any equity (savings) is gone... its like I am renting. So now I realize I have to save extra on top of my mortgage, so my disposable monthly income goes down because I feel I need to save more. Isn't this relevant.Dan Megeshttps://www.blogger.com/profile/11740514522924633060noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-84974209671915902512012-03-01T23:24:14.706-06:002012-03-01T23:24:14.706-06:00What I mean is say that in scenario 2 all the hous...What I mean is say that in scenario 2 all the houses stayed at $100. He sells the house, pays back the $90, and is left with $10. He still needs access to a credit market to buy that $100 house. i.e. he has to borrow $90 again. So it is the credit market that makes the difference here.LALhttps://www.blogger.com/profile/08196675112184615614noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-62047838687903022702012-03-01T23:16:06.030-06:002012-03-01T23:16:06.030-06:00Only if he can't borrow $90, which he was able...Only if he can't borrow $90, which he was able to access beforeLALhttps://www.blogger.com/profile/08196675112184615614noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-45826191027683370192012-03-01T22:59:51.306-06:002012-03-01T22:59:51.306-06:00The credit hit cannot be overstated. A person who ...The credit hit cannot be overstated. A person who now owes more on his mortgage than his house is worth cannot move and buy another house. He either has to sell short, damaging his credit and ability to obtain a new loan for the cheaper house, or stay put and watch his new neighbors buy his same model across the street at half the price he paid. True, there is a benefit to those lucky enough to have stayed out of the frenzy who can now jump in with lower prices. But we can't say those who bought at the peak enjoy the same utility by staying in their house. Overall, my view as a real estate lawyer at ground zero Las Vegas, is that this was a net loss.Pathttps://www.blogger.com/profile/16257987064390227383noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-80005945784443089382012-03-01T17:48:58.535-06:002012-03-01T17:48:58.535-06:00Prof Cochrane -
Is there a leverage effect to be ...Prof Cochrane -<br /><br />Is there a leverage effect to be accounted for here? For example:<br /><br />Scenario 1: all houses cost $100. Person A buys a house with cash. Now all houses drop to 90. I agree with you he's no worse off. He can sell the house for 90 and buy another house if he wants. <br /><br />Scenario 2: all houses cost $100. Person A buys a house but only puts 10 down (borrowing the other 90). All houses go to 90. He sells his house, repays his mortgage, and has nothing left. He can't buy another house. <br /><br />Seems like the deflation hurts him on the second case, even if all he buys is equivalent houses his whole life.Mike Nigrohttps://www.blogger.com/profile/02368658239396400715noreply@blogger.com