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Home Publications Blogs Beat the Press People Who Were Alive Through the Housing Bubble Do Not Consider Homeownership "a Way of Obtaining a Firm Financial Foothold"

People Who Were Alive Through the Housing Bubble Do Not Consider Homeownership "a Way of Obtaining a Firm Financial Foothold"

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Wednesday, 15 January 2014 06:00

The NYT had a piece on mortgage financing that was written as though the housing bubble and crash never occurred. It includes the incredible assertion that homeownership is considered a way to get a firm financial foothold as though there were not overwhelming evidence that this is often not the case. Even before the bubble, housing was often a volatile asset.

There are many markets where people have seen their house prices crash along with their local economy. For example many people in Detroit saw the value of their homes plummet even as job opportunities disappeared. This means that at the same time that their prospects for a good paying job were vanishing, they saw their life's savings also disappear. It was not clever to tell people in Detroit to invest in a home in the 1970s or 1980s.

In the bubble years house prices became much more volatile making the risks of homeownership far greater. Since housing is always a highly leveraged asset, the potential loss of wealth is enormous. If someone buys a home putting 20 percent down and it loses 10 percent of its value, they have lost almost half of their investment. If they just put 10 percent down, they will have lost almost all of their investment with a 10 percent price decline.

In addition, there are large transaction costs associated with homeownership. The round-trip cost of buying and selling a home are around 10 percent of the sales price. This means that if a house is selling for roughly 15 times what the annual rent would be, a homebuyer would throw away 1.5 years' worth of rent in transactions costs. (If the price-to-rent ratio is 25, as was the case in many bubble markets, the transactions costs would be 2.5 years' worth of rent.) In an economy where people often have to move to get a job, many homeowners will be forced to sell their homes much earlier than they expected.

For these reasons, people who paid attention to the housing market over the last decade generally think of homebuying as a way to make the financial sector rich. Its benefits to homeowners are far more questionable.

Comments (24)Add Comment
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written by foosion, January 15, 2014 5:41
Higher home prices tend to make costs higher for buyers. This is often ignored in discussions of housing.
A "firm financial foothold"?
written by Chris G, January 15, 2014 6:10
> It includes the incredible assertion that homeownership is considered a way to get a firm financial foothold as though there were not overwhelming evidence that this is often not the case.

In this neck of the woods (Boston suburbs) single-family home ownership now means a $400k+ mortgage - that's figuring 20 pct down, 10 pct down is probably more realistic so I bet $500k+ mortgages are more typical. Doing the math and knowing a fair number of recent homeowners, paying off a mortgage like that requires two solid incomes two pay off every month. At the risk of stating the obvious, if you need two middle- to upper-middle-class incomes to pay your bills every month then you're one bad break away from deep $#!%. That's hardly a "firm financial foothold".
Homeownership: It's All About Private Property
written by Last Mover, January 15, 2014 6:49

Exactly. And to secure a real financial foothold in America, be sure to buy into a property managed by a homeowner association after government services were privatized.

One day you may discover to find alongside a huge fine for leaving the lawn mower on the lawn too long, a lien and foreclosure notice against a $300k dwelling for hanging handwashed laundry outside to dry during an electrical outage.

All issued by a flunkie property manager who gets a cut of the take at the bottom of the economic predator chain.

Homeownership in America. If the servicers and lenders don't get you, the homeowner associations will, through the fine print, carefully written by the predators to assure you never did really own the property you thought you did.

You have been unprivatized America ... in the name of privatization.
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written by sherparick, January 15, 2014 7:00
Scott Summer has an interesting post which he points out that barriers to the creation of new assets (whether copyright, patent, rent control, zoning, and land use rules) leads to higher asset prices and rent seeking (and although he claims he does not believe in "bubbles") are the starting point for both bubbles and greater inequality in the economy. Summer is an iconoclastic conservative economist, so it is interesting that he agrees with you on some points. http://econlog.econlib.org/arc...s_cre.html
Diversification
written by Jay, January 15, 2014 7:03
You mean having more than 50% of one's assets tied up in a single piece of real estate that is relatively illiquid with higher transaction costs than alternative assets (stocks/bonds) is a terrible idea? The government has done a great job at edumacting the financially illiterate American sheeple.
home ownership is a hedge against future housing costs
written by pete, January 15, 2014 9:48
It is a rather simple argument really. That is why most economists discount housing "wealth" as a source of a wealth effect. There is no wealth created when housing prices go up, simply a reevaluation of the property. E.g., mom's home price went up 10X from 1976-2010. If she sold the house and rented something, her rent would have been huge. She was certainly not wealthy.
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written by liberal, January 15, 2014 9:57
sherparick wrote,
Scott Summer has an interesting post which he points out that barriers to the creation of new assets (whether copyright, patent, rent control, zoning, and land use rules)...


Yes, things like zoning and land use rules often work to keep the supply of housing lower than what it should be.

However, the biggest "barrier to creation" is that they're not making any more land. Of course, there's plenty of unsettled land in the US, but very little of that is adjacent to places with good jobs.

The reason why there are land bubbles and why there always will be (in the absence of high ad valorem taxes on land) is that it's an asset in fixed supply.

This understanding strangely eludes most modern economists, even smart ones like Dean, who doesn't seem to understand the distinct nature of land as a purely (economic) rent-generating asset.

It's also the reason that the person who was the earliest to predict the housing bubble---even beating Dean, who was one of the earliest---is an advocate of land value taxation. Imbued with an understanding of the political economy surrounding land rent, he observed the cyclical nature of real estate booms and busts and predicted the bubble about 17 years in advance.
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written by liberal, January 15, 2014 10:06
pete
wrote,
There is no wealth created when housing prices go up, simply a reevaluation of the property.


Yawn. There's no wealth created when stocks or bonds go up, either.
House Prices Diverge Sharply from Rents
written by Dean, January 15, 2014 11:05
Pete,

There have been very sharp divergences between houses and rent over the last 15 years. This is why most economists who have any familiarity with the issue do treat housing as wealth. There is also the fact that people often move between metro areas. This means that if housing prices plummet in the metro area where you live and and rise in the metro area to which you move to find a job, you will be screwed if you were a homeowner rather than a renter.
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written by AlanInAZ, January 15, 2014 11:18
There's no wealth created when stocks or bonds go up, either


It is a question of liquidity. I can sell my stocks/bonds at a moments notice - not so the house.
excuse me...you mean that the bubble is wealth...I see
written by pete, January 15, 2014 12:06
If house prices rise above rent equivalent, this is a bubble, and I should consider this bubble to be wealth. So this is another irrationality. Could be, probably is true for some people. Thanks for clarifying. I would think most economists would not think of irrational prices as wealth.
For the economy it matters what actors in the economy think, not what economists think
written by Dean, January 15, 2014 12:17
Pete,

you're making economists out to be much stupider than I ever word. If people think that a bubble-inflated house price is real and act accordingly, then economists better take that into account in assessing the economy or they are going to miss the whole story, which of course they did.
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written by skeptonomist, January 15, 2014 12:45
Dean omits the effect of inflation. He and some other economists are currently recommending that inflation be much higher than at present, while interest rates be kept low. This would make keeping your money in bonds or CD's a badly losing proposition. In the long run stocks keep up with inflation, but their prices are much more volatile than those of houses and there are many more ways to make bad decisions. Stock P/E is currently well above the long-term average. When inflation is high, holding real property is good, the more so if it can be leveraged at low interest rates, and mortage rates are still at a historically low level. Inflation has only very rarely been negative since the Depression. Buying a house is a form of hedging against inflation and rent-collection from those who would otherwise own the land. Suppose all the land and buildings were owned by Goldman Sachs - what would you be paying for rent?

You have to be careful about investing in any kind of bubble, but housing is not in a bubble now (overall - there are almost always local bubbles). The way things are now, with the financial sector running wild, they're going to get some of your money no matter what you do.
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written by djt, January 15, 2014 2:16
Somebody's really got to do something about those transaction costs. Shouldn't cost more than a flat fee of a few thousand dollars to do everything including inspections and appraisals. A uniform process and forms across all jurisdictions would do wonders. Then it could be completely electronic, and a few companies could create software, tools, and document management systems to make it work.
Some bonds are inflation-adjusted, and primary residences are NOT good investments.
written by Squeezed Turnip, January 15, 2014 5:30
Skepto, don't forget about inflation-protected securities such as TIPS . It is indeed very possible to invest in bonds that won't come out behind inflation.

The data shows that a house purchase barely beats inflation, not as much as TIPS, and that's before taking into account maintenance costs. (see for example this WSJ article from two years ago)

Primary residences are not investments, they are not (definitely should not be) purchased as hedges against inflation. Buying a primary residence is (or, for a rational person, should be) a life-style choice, nothing less, nothing more.

Listen folks, do not listen to anyone telling you that purchasing a primary residence is an investment. After closing costs on the front and back end, and years of maintenance and repair costs, you will be lucky to break even. Whether housing is in a bubble or not, you're just not going to do as well as you would with inflation-protected bonds like TIPS. If you're a bigger risk taker, do a total market stock index fund. Stop giving your money to economic predators in exchange for nothing.
typo correction
written by Squeezed Turnip, January 15, 2014 5:50
Scratch the word 'account' from the previous post. And don't think of your house as an investment: it's a cost source, not a wealth source.

The data shows that a house purchase barely beats inflation, not as much as TIPS, and that's before taking into account maintenance costs. (see for example this WSJ article from two years ago)
NYT Assertion of Housing Bubble
written by CBeck, January 15, 2014 6:59
After reading the NYT article, I am again struck by Dean's propensity to take off on a tangent that has little or no relevancy to the theme of the article. The NYT article had a single mention of other's common perception, not the NYT's assertion, that home ownership is a source of wealth. I agree with Dean's views on home ownership, but don't use the NYT as a jumping off point to pontificate.
ethical journalism
written by Squeezed Turnip, January 15, 2014 8:20
NYT Assertion of Housing Bubble
written by CBeck, January 15, 2014 7:59
... The NYT article had a single mention of other's common perception, not the NYT's assertion, that home ownership is a source of wealth.


Well, CBeck, in the world of people who believe in ethical journalism, the fact that the single most widely read newspaper for english speakers on the planet said this:

Much is riding on the appetite of large banks to make mortgages, both for the broader economic recovery and for Americans looking to own a home — long considered a way of obtaining a firm financial foothold.

… is downright sloppy if not unethical, as it continues the propaganda of Big Finance that home ownership should be considered for its finance aspects such as tax breaks and (nearly non-existent in real terms) capital appreciation. While technically the NYT does not make the assertion itself, the fact that it is in the times and not questioned gives the assertion credence. As a matter of fact, why is the parenthetical phrase "— long considered a way of obtaining a firm financial foothold" even in that sentence? What function does it serve? I can tell you one function it serves: perpetuating a myth that is not based in empirical reality and a myth that was one of the underlying causes for the current deep damage to the economy, but a myth that magically serves the interest of the big banks just down the street from NYT office, big banks that take out big ads in the NYT. As CBeck says himself, that phrase is not relevant to the article: so why did the reporters/editors put it there, using up valuable ink and paper?

So, hell yeah, Dean, use the NYT as your jumping off point, because they are indeed perpetuating crap thinking, even if, by clever wordplay, the reporter manages to make it not sound like an editorial comment. We're not all rubes, like CBeck. We know that if we give them an inch, they're gonna take a mile. So don't give them that inch.
...
written by liberal, January 16, 2014 8:22
skeptonomist wrote,
Buying a house is a form of hedging against inflation and rent-collection from those who would otherwise own the land. Suppose all the land and buildings were owned by Goldman Sachs - what would you be paying for rent?


You nail it.

That doesn't always make housing a good investment. But...

There are multiple components to any real estate asset. One is the rental value of the land. The other is the use of the structure/improvements. The last is the fact that improvements depreciate.

While rental value could decrease (e.g., it's found out there's a superfund site next door), in aggregate land rents should rise in step with the economic force that generate them. In many places, that means they will rise with GDP growth. In a simple model, you'd expect that, because otherwise land rent would decrease asymptotically to zero as a fraction of the economy, which is preposterous.

Of course, structures do depreciate. But they also throw off an enormous amount of value.

Squeezed Turnip wrote,
The data shows that a house purchase barely beats inflation...


Yawn. There's a balance here---the structure depreciates, the land appreciates (usually). Where it all falls out depends. But the "statistics" are likely flawed. What happens when a house is knocked down and a bigger one is put up in its place? If the stats start that over as a new data point, they wipe out all the gain in rental value of the land, likely accumulated over decades, perhaps centuries.

Again, this isn't to say that land is always a good investment. But nor are bonds or stocks.

AlanInAZ wrote,

It is a question of liquidity. I can sell my stocks/bonds at a moments notice - not so the house.


That's true. I was addressing Pete's claim that no wealth is created by home prices going up, merely pointing out that the increase in the price of any already extant asset represents no gain in true wealth.
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written by PeonInChief, January 16, 2014 12:47
Whether or not it's a good financial investment is irrelevant to a lot of people who buy houses. If you compare it to the alternative--renting--it can be preferable to extend yourself to buy a house. Then you don't have to worry about having to find a new unit and move in 30 days, putting out $5K in moving costs, facing an unlimited rent increase the next month, and so on. The burden of the alternative has a lot more to do with it than the financial rewards.
missed the point ...
written by Squeezed Turnip, January 16, 2014 9:36
liberal, the point is not to make your primary residence an investment. I'm not saying people don't invest successfully in land or shouldn't. Some people do well with that. But most families should not consider their primary residence as an investment, it's a shelter and a home. Stocks and bonds are highly liquid and thus a better choice of investment for most people (who have change of life circumstances such as job change, change in marital status, health issues).

Land is highly illiquid. So, yes, stocks and bonds are definitely better investment vehicles for the vast vast majority of Americans who can afford to invest.

Value-based traders with deep pockets will always outperform the unwashed masses of uninformed traders who try to beat the real estate market.

Of course, liquidity costs money to obtain when your money is tied up in illiquid assets (re: pawn shops, pay check loans, etc.). Bonds and stocks are more cheaply liquidated than land/homes.

TIPS have for all intents and purposes risk-free inflation-adjusted return, but land does not. So your claim that bonds aren't good investments may be true in general, but I wasn't talking about bonds in general, I was talking about TIPS.
...
written by liberal, January 17, 2014 7:08
Squeezed Turnip wrote,
liberal, the point is not to make your primary residence an investment.


Huh? There's so much money at stake that it doesn't make sense to view it as not an investment.

But most families should not consider their primary residence as an investment, it's a shelter and a home.


That doesn't contradict the idea of it being an investment. Far from it; everyone needs shelter, and if you're diligent, you have to compare it against renting. Those are investment decisions, like it or not.

TIPS have for all intents and purposes risk-free inflation-adjusted return, but land does not.


The government guarantees an inflation adjustment, but there's still interest rate risk. I've invested in TIPS myself. At some points, they were a great investment, if for no other reason that they've sold at a discount. IIRC in the past few years they've (at some points, anyway) been a poor investment, selling at a premium. I'm guessing because of all the idiots out there who don't understand how our monetary system works and thought that government spending/Fed QE would somehow cause hyperinflation, but I'm not sure.

Finally, if you don't understand why land rents should rise roughly in tune with GDP, then you don't understand land economics. Over the long hall, well-sited land is probably the best investment there is. Given that considerable time has to be taken to pick parcels, etc, I'm not saying it's for everyone (myself, I've got better things to do), but like other rental assets, it's a great way to make money without making any actual contribution to production.

Me, I'd institute a land value tax and be done with this pernicious assault on liberty and economic efficiency, but sadly it's pretty difficult to convince people. The fact that almost no one, even people who understand a lot else about economics, understands the nature of land rent makes it a pretty tall order.
...
written by liberal, January 17, 2014 7:16
PeonInChief wrote,
If you compare it to the alternative--renting--it can be preferable to extend yourself to buy a house. Then you don't have to worry about having to find a new unit and move in 30 days, putting out $5K in moving costs, facing an unlimited rent increase the next month, and so on. The burden of the alternative has a lot more to do with it than the financial rewards.


Those are still investment issues. "Investment" means a lot more than "what kind of capital gain/loss can I expect when I sell an asset."

People often invest in stocks with relatively high dividends and low growth because of the economic value of the dividends; buying a house is similar---instead of "dividends", they throw off other things of economic value (place to live, which has direct monetary value; even things like reducing time spent dealing with hassles has economic value, since time is money; though I'll be the first to agree that owning has its own hassles).
Cause and effect, they're doing it wrong.
written by Jim A., January 17, 2014 9:49
In a normal, non bubble economy, high transaction costs meant that home ownership was only economically advantageous if you stayed in one place for a long peeriod of time. And banks were careful enough in lending that mortgages were only available to those with a good chance of paying the mortgage according to the terms. So homeownership was a mark of those who whose jobs were stable and who were reasonably prosperous and able to save up a down payment. But some decided that homeownership was a cause rather than an effect.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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