Worry Not Over Falling Home Prices
A ways back in an interview on NBC's Meet the Press, former Federal Reserve Chairman Alan Greenspan suggested that a new economic contraction would be possible "if home prices go down." The following day USA Today reported that the rate of homeownership in the U.S. had declined to 66.9%, down from 69.4% in 2004. The article's author noted that, with millions of houses on the verge of foreclosure, the rate of homeownership could fall to "its lowest level in 50 years."
This expression of concern dovetails nicely with Greenspan's assertion that "right under this current price level, mainly 5, 7 or 8 percent below, is a very large block of mortgages, which are under water so to speak, or could be under water. And that would induce a major increase in foreclosures; foreclosures would feed on the weakness in prices, and it would create a problem."
The consensus here seems to be that if housing prices decline, the resulting increase in foreclosures will weaken already shaky banks. These, in turn, will either fall into insolvency, tighten lending standards or both.
Reduced lending would then strangle a nascent economic recovery in concert with reduced individual consumption thanks to the increasing inability of consumers to borrow against their houses. As for the many Americans employed in the homebuilding industry, their jobs would be further imperiled, thus driving up unemployment.
Scary stuff for sure, but also wildly overdone. The greater truth about housing is that it's a sink of wealth that neither opens up new markets, nor enhances the true stock of productive capacity in the U.S. or the world. The U.S. economy's problem at present is decidedly not centered on flat to declining home prices. Indeed, the unwillingness of Washington to let home prices move downward is restraining real, wealth-enhancing production.
Housing is a consumptive sink for wealth that de-mobilizes the economy. Wealth is neither money nor jobs. Real wealth consists instead of goods or resources of intrinsic value.
Without a doubt, the creation of the computer, phone and ATM destroyed countless jobs. But the efficiencies wrought by all three freed up secretaries, messengers and bank tellers to enhance their work product on the way to even more wealth creation. The shedding of work is what drives the profits which attract the investment for increased production. There will be no jobs and no investment without profit.
Admittedly we would be less productive if housing didn't exist at all. But housing does not measure up when it comes to generating economic activity. It is merely the consumptive result of the truly productive activity that gives homeowners the means to make their purchase.
The purchase of a home isn't economically stimulative in the same way as an investment in (for example) a mutual fund. When one family buys a home from another, there's merely an exchange of wealth between them. This is quite different from the purchase of shares in a company, or the deposit of funds in a bank. There an individual is making capital available to existing and future businesses eager to expand. To produce housing is to invest in the ground, providing no ongoing capital flow to entrepreneurs.
This is an important distinction in light of the housing boom that the U.S. and the rest of the world recently experienced. Mr. Greenspan states that a decline in prices from what remain historically high levels would be economically harmful. But price signals can retard investment. It is more accurate to say that advances in home prices implied a recession for capital flowing into unproductive assets of the earth instead of productive assets of the mind.
House prices, the dollar and overbuilding. A number of H.C. Wainwright publications over the last few years have made it plain that housing does best when currencies are weakening. To put it very simply, housing prices tend to do well during inflationary periods because housing is a physical asset. It's not been historically vulnerable to currency debasements that otherwise invariably end in tears.
The above is best illustrated by comparing the price of housing since 1890 with the price of gold. The parallel is rough, but it's clear that house prices tend to rise to offset the depreciation in the dollar relative to gold. According to these data, the ratio between house prices and gold has been little different in the current decade from what it was in the 1890s.
Some argue that rising prices in the housing space increase consumption for individuals borrowing against a domicile's appreciation. But to make this borrowing possible, someone else must be saving. It could also be argued that during housing booms the seller is suddenly flush, and that the seller's proceeds must go somewhere. Actually, one individual has just shifted consumptive ability to another.
Indeed, rising home prices that are more the result of money depreciation than simple demand mean that limited investment is funding unnecessary homebuilding during inflationary periods. The wealth creating portions of the economy are casualties of these money-driven price signals on the way to housing gluts.
Evidence of overbuilding is everywhere at present, with unsold and uninhabited homes dotting the suburban landscapes of Florida, Nevada and Arizona. As the Wall Street Journal recently reported, "overbuilding during the housing boom has left so many homes available that landlords, desperate for renters, are wooing Section 8 recipients" (i.e., low-income individuals who qualify for federal rent subsidies).
Lower home ownership in the U.S. overall is far from an economic negative. Indeed, it could serve as an economic stimulant. We live in a global economy that is increasingly characterized by mobile capital that can be moved to all points in the world with a click of a computer mouse. In that sense broad homeownership creates a less mobile society; one that is less able to pursue attractive work opportunities irrespective of locale.
Do foreclosures threaten the economy? There's a growing fear that if home prices correct downward that this would foster a great deal more mortgage foreclosures. This clearly worries many, including Mr. Greenspan, given that banks which are slowly coming back to life would fail if the mortgage assets on their books took another dive.
Here too the worries are greatly overdone. Foreclosures are closely associated with falling home prices. But it's not so clear that they tend to reduce the supply of credit. To understand this, another frequent Wainwright theme concerning the "substitution effect" must be considered. Though most perhaps think of all lending as something that originates from what we've come to term "banks," the reality is that the lending industry long ago evolved far beyond the traditional banking system.
As Secrets of the Temple author William Greider has observed, in the early part of the 20th century "ascendant industrial corporations increasingly decided that they could finance their expansion projects from their own growing profits." Greider went on to point out that, from 1900 to 1910, "70 percent of the new funds for manufacturing were generated internally, making the corporations more independent of finance capital."
Fast forward to the present, and the evolution of finance away from traditional banking continues. As Mises Institute senior fellow Thomas Woods revealed in his book, Meltdown, as of October 8, 2008, when credit by all media accounts had disappeared, "data showed no decline in business and consumer loans."
How could lending have remained stable amid a banking crisis that commentators and politicians were saying was the worst since the Great Depression? The answer to this is simple, and goes back to Greider's observation about the evolution of finance back in 1900. As Woods noted, by 2008 "about 80 percent of business borrowing took place outside the banking system."
David Ranson has almost uniquely made this point right from the beginning of the financial crisis. Not only is it illogical to presume that banking failures caused the Great Depression, but the hysteria revealed by both left and right over the supposed impact of bank failures on the recent crisis was much ado about nothing. Finance is nothing if not fungible, and as the practice of lending evolved well beyond the purview of what we call banks, there was no reason to fear that their failure would have any lasting economic impact.
In the event of another round of foreclosures and another dive in home prices, it's a fair bet that more than a few banks will go under. But with most lending occurring outside the banking system, this would not be a recessionary event. Probably the opposite.
One other factor that could cause a further substantial decline in home prices is a rise in the value of the dollar. This in and of itself would be a growth signal. When housing is less attractive to investors, the appeal of productive, wealth-creating concepts of the mind is increased.
In this sense, far from something we should fear, a housing decline could serve as rocket fuel for the growth parts of the economy given the near certain reorientation of capital away from tangible assets. A weak dollar has historically boosted nominal home prices. But a weak dollar means inflation, and the latter bats 1,000 when it comes to fostering periods of economic hardship.
Conclusion. There remains a fear within the commentariat that if government simply stands aside in order to allow the economy to heal itself, that much worse lies ahead. This is faulty thinking.
The greater truth is that economies are quite resilient, and a prime deterrent to their continued growth is artificial supports that disallow the natural migration of capital to its highest use. At present, Washington is doing everything it can to delay prices reaching their natural, market-clearing level.
The unfortunate result of all this intervention is that a large fraction of the nation's limited capital is locked up in housing. This holds back a more natural reorientation of investment away from sinks of wealth and into the productive economy. A natural housing correction, far from an economic retardant, would unlock capital needed to fund real wealth production. The sooner we allow this, the sooner the economy can begin growing again.