Are we in the midst of another real estate bubble? Who’s to blame? We wade through the lies and give you some answers.
New York Times Op/Ed columnist, Peter Wallison, has declared the real estate bubble is back.
While he ultimately reaches the right conclusion, nearly all of his assertions are either patently false or misleading. In fact, New York Times Op/Ed columnist, Jo Nocera has termed Wallison’s take on the housing bubble “the Big Lie”.
It’s imperative to understand the housing bubble and financial crisis of 2008 to ensure we do not repeat the same folly that brought our economy to its knees. Home prices of late have been artificially inflated by certain market factors (read: overbidding from real estate speculators). However, the current situation bears zero resemblance to the previous bubble, despite Mr. Wallison’s most earnest exhortations.
Follow along as we critique his premises one-by-one.
Premise one: “Housing bubbles [. . .] become visible — and can legitimately be called bubbles — when housing prices diverge significantly from rents.”
All good lies start with a grain of truth.
Rents historically appreciate at the rate of consumer inflation since wages follow consumer inflation and rents are equilibrated by the population’s ability to pay.
Real estate’s mean price also proceeds at the rate of inflation, with peaks and troughs depending on the market’s “cycles.” Thus, according to Mr. Wallison, rents act as a standard against which real estate prices ought to be measured.
While this logic basically works for determining long-term price stability, it is not a useful indicator of a housing bubble on its own. When home price inflation greatly outpaces rent inflation it is a basic truism that would-be buyers opt to rent instead, which in turn places downward pressure on prices since homebuyer demand falls.
Thus, in order to properly link price/rent divergence to a housing bubble, one needs to claim that a bubble is apparent when home prices vastly outpace rents and buyer demand continues to rise. This clearly occurred during the last bubble.
In 2006 the California homeownership rate peaked at 60.7%. Despite the fact that California was experiencing near 100% price appreciation, we were adding more bona fide, end-user homeowners during the bubble years. This occurred, as is now well known, due to the wide availability of NINJA loans (no income, no job or assets).
Today, prices are appreciating at unsustainable rates while the homeownership rate continues to fall — it registered an anemic 54.4% as of November 2013. So, while price appreciation is outpacing rents, the market is behaving normally as more individuals are renting rather than buying at unsustainable prices.
Premise two: “Both this bubble and the last one were caused by the government’s housing policies, which made it possible for many people to purchase homes with very little or no money down.”
Wallison is well known as the progenitor of this myth. Study after study have all propounded that low income and equal opportunity housing policies were not to blame for the mortgage meltdown and financial crisis of 2008. Here is the landmark Federal Reserve study on the topic.
But one doesn’t need a double blind, Fed-commissioned study to understand this. The policies being slighted by folks like Wallison started in the Carter-era. That’s right, we’re talking 1970s. Fannie Mae and Freddie Mac’s mandate to purchase low-income loans was laid out in 1992, after which followed a period of weak home price appreciation. That’s a fair rebuttal to the specious argument that these policies caused the bubble.
No, the government’s low-income and equal housing programs had nothing to do with the housing bubble, current or past. The bubble was engineered in one place and one place only: Wall Street. Wall Street developed the liar loans, packaged them up and sold them to suckers, plain and simple. Fannie Mae and Freddie Mac did get caught-up in buying these loans, but only after they began losing market share to private investors.
Premise three: “Today, the same forces are operating.”
This just ain’t true.
Fannie Mae and Freddie Mac, while still integral to the housing market, are well under control and shrinking. The FHA’s footprint is also getting smaller. Mortgage originations in general are down across the board. Interest rates are rising. The Dodd-Frank Wall Street Reform and Consumer Protection Act has its troubles, but it has effectively outlawed the NINJA loans of the millennium boom.
The 2000s real estate bubble was driven by sub-prime loans created and pushed by Wall Street bankers. Very different forces are operating in today’s mini-bubble. As is now widely accepted, speculators artificially drove up asset prices throughout 2012 and 2013. This means prices were inflated with cash, not financing, which eliminates the possibility of the widespread default that popped the last bubble.
The reality of new mortgage rules and old-fashioned risk aversion on behalf of lenders has kept the current bubble from taking off. Investors have priced end users out of the market, which means the general consumer is protected from the bone-crushing losses they suffered in 2008.
Since this is not a debt bubble it will not implode. Instead it will slowly fizzle as investors either collect rents or sell at a loss. Either way, prices will slowly return to equilibrium.
So yes, the bubble is back, but it’s a far cry from the nuclear event of a few years ago.
I’d like to add a longer perspective to this than that of the seven to ten year real estate “Cycle”. Consider the huge appreciation in real estate that benefited The Greatest Generation. That boom led to a typical “nice” tract home in my area, suburban Los Angeles San Fernando Valley, going from $30,000 to $150,000. All within an eight year stretch in the 60’s.
Have values crashed to these Vietnam-era highs? No. They far surpassed them. Even the recent crash only returned these home values from a peak of $700,000 to a “trough” of $400,000. There are clearly extant factors that influence property values beyond the economy and supply and demand. Yet I never read about these in the “bubble” articles. Buy what you can comfortably afford and live in your home. Let your heirs sort out the rest.
SHOULD AN INVESTOR HOLD HIS PROPERTIES OR SELL?
Probably most agents and the general public would agree that Southern California has entered bubble territory again. Price appreciations have been quite noticeable in the various cities of the Greater Los Angeles region, more so in some than in others of course.
And, as the old saying goes, “What goes up must come down,” one might assume that at some future time—be it sooner or later—prices will again drop.
The article gives various convoluted and technical reasoning as to why that might happen, but it seems a simpler answer may be the case: If economic hard times intensify, with less income in the hands of potential end buyers, and investors not willing to pony up the cash for properties any long fearing a decline in sales prices, and with interest rates set to rise soon, it seems only logical that those simple factors would exert a downward pressure on home prices.
With less potential end-buyers able to qualify for enough money to buy the homes they desire, they will remain as renters. One might believe the rental rates thus would continue to rise or at least not decline at all. So, the investors will not be “stuck” after all, but will be able to rent out properties (rather than flip them) for substantial rental fees. Even now, in places like Santa Monica, a one-bedroom apartment can go for $2500 a month or more. Even in the plebian neighborhoods of Long Beach, one bedrooms are going for $800-$900 a month or more. Tiny studio apartments in Hollywood and the Westside rent out for $1200-$1500 per month. And, in the most undesirable parts of Echo Park or Silverlake an “efficiency” apartment of less than 300 square feet can be an outrageous $700 a month.
So, it seems, purchasing real estate still has its benefits. The tax write offs remain substantial. The rents are rising. And, with less persons being able to purchase homes, there will be more and more people in the “rental pool” to rent to. Supply and demand will dictate the rents. As more persons flow into California, as is historically true, rents will keep going up, as little new construction has occurred since the early 2000’s for the rental market in case you haven’t noticed.
This all precludes some Black Swan event, like another big quake or a tsunami hitting our shores, which would cause a population outflow and further economic decline for a while, till reconstruction boosted local incomes a bit. But, typically, we do not figure such events into our calculations of real estate trends.
Our conclusion would be for investors to hold their properties. Look at past history and you will see that the majority of those persons holding great wealth always also held much land and property. The “landless peasants” ended up as perennial serfs and financial slaves of the “landed gentry.”
The wealthy have traditionally built their wealth through land and property. And the super-wealthy have always been able to manipulate the real estate markets to their own benefit (as the article states, it was Wall Street bankers who caused the last bubble). That was all done purposefully and with full knowledge of its consequences. As in the historical past, the premeditated goal was to transfer wealth and property from the common people to the ruling gentry.
Most persons live with the belief that what happens in our economy and in various financial markets, including real estate, is purely happenstance and subject to chance. In reality, the exact opposite is true. Those in control know full well which way they will next steer the ship and why…………….and the answer to the why question is always the same: To diminish the wealth of the masses and increase the wealth of the ruling gentry. Look at every nation in history, and you will find that to be so.
Great article !!!!