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Business Bytes

Prophecies are not housed in prices

If people could easily interpret the economy then “expertise in economics” would be redundant rather than a full-time profession.  In the attempt to gain insight, people, rather obsessively, watch different metrics as indications of whatever the economy seems to be doing and to predict its next move.  Housing prices provide one data point, where rising prices indicate greater prosperity.

Of late, whenever housing prices seem disappointingly low, financial indicators fall and pundits profess that  the economy has still not yet recovered from the 2008-09 recession.  Even so, GDP indicates growth; perhaps housing prices do not make the best proxy to understand the macroeconomy.

While GDP recognizes all final goods and services, by definition housing prices capture only on good.  Focusing on one good can be instructive if it is a commodity, like gold: each gold brick perfectly substitutes for another.  Homes, however, have unique values based on any number of factors like location or carpet vs. wood floors.

Remembering the initial goal: assess the state of the economy, suppose America finally achieved the dream: every family in the United States owns a home.  In the next year housing numbers would seem particularly bad, because, absent population growth, there is little room for new demand to raise prices.

Increasing housing prices would then depend either on a growing population or people wanting more than one home.  However, economic growth and population growth have an ambiguous relationship.  A growing population can indicate a robust economy: more wealth can support more people.  But, if population grows at the same rate as wealth, then the average person sees no improvement.  Also, demographic evidence suggests that wealthier people have fewer children.

While economics does assume people want more goods and services, it also assumes that the net benefit to having more of the same decreases.  The tenth piece of cake, for example, is never as good as the first.  Economics does not assume that all people prefer a certain good, like housing or cake.  It seems many people prefer other substantial purchases, like a car or an education, to another home.  The focus on housing prices indicates a bias towards one preference not necessarily indicative of actual economic activity.

An aggregative measure like GDP means that changes to one industry have little effect on the overall result.  Industry-wide policy means that any change will have a marked effect without the means to offset a change to policy.

Government policy distorts housing in favor of homeownership, with subsidies, tax deductions, and credits.  Absent government policy, all else equal, fewer people would demand homes and so the price of housing would fall.

The bias towards home ownership is hardly new.  Under FDR, the 30 year mortgage and the secondary mortgage market became standards, both of which eased the cost of taking a loan.  Thirty years to pay off a loan is a far more favorable timeline than the previous five or ten year loan standard.  With a secondary mortgage market, many mortgages will have some value to the bank because a buyer for the mortgage potentially exists.

Private industry also significantly encourages housing loans.  Financiers  figured out the potential value from many mortgages, bought and bound them together and to create Mortgage Backed Securities (MBS).  MBS made consumer debt more valuable to a bank because the bank that issued a loan could then sell it to others eager to securitize.  To finance even more homes required finding new homeowners.  Rather than wait for population growth, bankers accepted less stringent lending standards.  The subsequent change to lending standards suggests that housing prices across time will have little commonality; ownership now seems less a sign of good fortune and more a sign of financial liquidity.

Concurrent with financial innovation, in the years leading up to 2008, the economy seemed to experience unprecedented, legendary economic growth.  That is, if the price of homes provided the only measure.  But as the world discovered as 2009 unfolded with investigations and new information, housing prices certainly rose, not through increased value but increased borrowing.

Economic growth based on borrowing takes wealth from the future and moves it to the present.  This works as long as increases in wealth, that comes from gains beyond borrowing, keeps pace or exceeds payback obligations.  This growth comes at a cost: the added cost of borrowing and the risk of failing to meet obligations.

Instead of as a proxy for economic growth, housing prices should be used for what they are: an indication of demand relative to supply.  Yes, that’s dry but housing prices are hardly prophecies for economic booms or busts.



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