Column by John Mattingly
Economics – May 2008 – Colorado Central Magazine
THE FIRST TIME I made a little money farming — back in 1973 when pinto beans hit $60 a hundred and sugar beets were $50 a ton — several old farmers in my area came around to visit when they heard that my wife and I were planning to build a new home.
“Don’t do it,” Harlan said, companions nodding agreement. “We’ve seen it before. A young farmer hits a good crop year, builds himself a new house, and a year or two later he’s broke.”
“All you really need,” Jake added, his gnarly hand fitted over my shoulder as he winked at my wife, “is a place to get out of the wind and charge your batteries.”
I followed this advice, continuing to live in the remodeled saltbox barn that came with my first farm. In the years that followed, I was grateful for the advice given by the local elders, as crop prices dropped and I needed the savings.
This early experience shaped my attitude toward, and analysis of, houses, such that I look at the current housing crisis (or sub-prime mortgage crisis) as more a necessary adjustment than a tragedy. Though the situation has both villains and fools, the tap root of the problem is the popular perception in the U.S. that everyone has the right to home ownership, and that a home is an investment. I’ve heard it said often in promotions and political speeches that, “Every American is entitled to own their own home,” and “A home is probably the biggest investment most people will ever make.”
But is home ownership really an American birthright, and is it really an investment? Short answer: not always.
1. A house is shelter. While a house can be a wish list of features, a playground of indulgences, or a way to exhibit the excesses of one’s balance sheet, in the end, a house is shelter, a place to get out of the weather. Some live in mansions, others in shacks, but both are accomplishing the same objective. The simple, human entitlement to shelter doesn’t necessarily extend to ownership of the structure.
2. The buck doesn’t stop. A house requires repairs and maintenance, as entropy enjoys a special fondness for dwellings. A house should be insured, for both casualty and liability events, and finally, a house is taxed. Expenses don’t end when one buys a house. They are, in fact, just getting started. While owning a house, calling it my home, gives one a sensation of control, security, and satisfaction, it usually does so at a hefty annual cost.
3. Marginal appreciation. You often hear people say that paying rent is “throwing money down a rat hole,” while owning a home is “building equity.” But is this really true? Surprisingly, in any 20-year period in the last 60 years, an individual or family who rented a median home and invested their capital in a savings account, bonds and T-bills, or the stock market was able to pay the rent from the earnings off the invested capital and also accumulate capital, whereas homeowners haven’t consistently fared so well.
In the 20 years between 1980 and 2000, for example, the median price for a home in Colorado was $127,000 (U.S. Census Bureau, Historical Census of Home Values, in which Colorado ranks 4th in the highest value homes nationwide). Family A buys the house, while Family B puts the money in bonds and T-bills and rents the comparable $127,000 house across the street. Twenty years later, A and B compare balance sheets.
A’s house is now worth $166,000. (Ibid., U.S.C.B.) But A has paid taxes, insurance, and the cost of repairs and maintenance each year for 20 years, which group of expenses started at $1,000/year and escalated to $3,000/year, totaling $40,000 over the 20 year period. A’s net position in the house is thus break even ($127,000 purchase price plus $40,000 expenses). If A decides to sell the house, the net received will be reduced by about $12,000 to pay the real estate commission and title insurance, so A will have $154,000 with which to now buy a home in a $166,000 market.
B, on the other hand, paid the rent on a median home from the interest earned on the $127,000 in T-bills and bonds, and, the Bs now have a whopping $447,630 in additional interest earned (based on number streams of bond interest rates and average rental rates in Colorado; Ibid., U.S.C.B.). Even if the Bs invested their money in an ordinary savings account, they pay their rent and have over $250,000 on deposit, but if the Bs invested in stocks and mutual funds, they have over $3 million.
Of course, there are pockets of exception. Depending on location, timing, and circumstance, some folks have made a profit from houses, but they may have seen their fortune diminished a bit when they had to buy a house to replace the one they just sold (unless selling in a high median price region and moving to a low). Most of us aren’t in the business of “flip that house,” but most of us need a place to get out of the weather. In the end, the numbers indicate that, on average, nationwide, a house is just a house, and not necessarily a good investment. Even worse, from an international perspective, if Family A from the above example takes proceeds from the sale of their house and tries to buy a house abroad, they’ll find their dollars have only about 50 cents worth of comparable buying power.
4. So, what’s the deal? If the foregoing has merit, why is there such a pervasive perception that a house is a good investment? Shelter is a basic, primitive need. An ancient proverb says, “Wisdom starts when you get yourself a roof.” Ownership of property has long been equated with rationality. In the early years of the U.S., property ownership was a requisite for voting rights, the notion being that property owners were rational and thus best suited to decide the future. Jefferson heralded the incorruptible peasant who owned and farmed a small plot of land.
In more recent times, a bias favoring private ownership of a roof can be traced to the period after the end of World War II, when resources were relatively plentiful and a modest home could be had by all. This stimulated a boom in consumer goods, as each separate house needed a washing machine, a TV, furniture, etc. instead of many of these durable goods being shared in clustered housing units. This consumer-driven economy built industries whose stockholders demanded annual growth: manufacturing, housing, banking all had to get bigger, even if they didn’t really get better. To meet the demand of constant growth, these basic industries had to practice planned obsolescence, and regularly convince consumers that what they have isn’t as good as what they could have. The motto of a growing consumer economy is: People always have what they need, but never have all they want. Instead of a mere bathtub, Formica, and color TV, how about a jacuzzi , granite top, and a home entertainment center? New homes were “tricked up” to lure consumers into “something better.”
This knit nicely into the basic fabric of the consumer economy, which constantly promoted the illusion that consumers must think of themselves as somehow special, that their feelings and dreams should be met. This translates to many people believing they deserve a house that is ideally suited to their every desire. How often do we hear people talk about building their “dream home”? Seldom do we hear anyone say, “I’m looking for my dream rental.”
The real estate industry and the “Get Rich Flipping Houses” industry flourished in this environment. Many houses in the U.S. that have flipped seven or eight times in the last 20 years have generated more total revenue in real estate commissions than they now are worth in the market. The most consistent winners of the Home Ownership Game the last 30 years have been the brokers and promoters, not the home owners.
Too, the credit industry saw an opportunity to capitalize on the popular misconception that a house was an investment. In most cases, the typical Mr. and Mrs. A didn’t have $127,000 cash in 1980 and borrowed the money from a mortgage banker to buy that median house, and for 30 years have been paying mostly interest, such that the bank actually became a kind of surrogate landlord, essentially collecting rent disguised as “equity-building.” Mortgage bankers understood the compounding dynamic of capital that made the Bs the smart players by being home renters instead of “home owners” in years between 1980 and 2000.
I suspect the old farmers who advised me not to build a new home back in 1973 also understood this important principle, and thus gave me sterling advice. These farmers also came from a generation less influenced by the “You are so, so special” suggestions of the growth-oriented consumer economic machine that really got fired up in the 1980s.
5. Hearts of the crisis. Broad brush, the demographics of the U.S. are shifting to a preponderance of older folks, aka baby boomers, whose kids have left home, putting the demand for large homes on a steep decline curve at the same time U.S. manufacturing businesses are failing due to foreign competition, which means loss of jobs, and thus loss of ability to make payments. Topping these two factors, consumer temptation for tricked up homes is reaching a saturation tipping point — that is, who really needs zebra wood cabinets, a 2,000-square-foot Roman style bathroom, Italian marble countertops, and 8,000 square feet of living space per inhabitant? This cluster of demographics, job loss, and saturation are a triple wonk to the housing market.
More specifically, the U.S. consumer economy has become addicted to credit, on both sides of the equation. Mortgage bankers are hooked on the profits from lending, collecting about ten times the value of the house in interest payments over the 30 year life of a mortgage loan. And many borrowers are hooked on using their home as a source of spending money to purchase consumer goods that depreciate at the same rate that milk spoils in the sun.
In the beginning, mortgage bankers lent only to responsible, gainfully-employed people who had a high probability of making payments. But higher yields (read as “higher rent”) could be charged those folks with dubious credit scores and empty balance sheets. This brought more lenders into the game, increasing competition, which led to creative financing which resulted in loans being made to borrowers who had no business even looking at a promissory note, regardless of its complexity. For quite a while, the spread between borrower capacity and reality was taken up by the inflation of house prices driven up in large part by the increasing availability of credit.
When Wall Street saw mortgage bankers getting high yields (9-12% in many cases) in an economy that — with rising costs of food and housing conveniently excluded from the calculation — was operating with low inflation (2-3%) and thus low CD and savings rates, big investors wanted some of the high-yield action. Mortgage debt was packaged and securitized, but seldom scrutinized, before becoming Structured Investment Vehicles (SIVs) whose revenue stream was solely dependent on thousands of mortgagees making timely payments. When the mortgagees didn’t make those payments, the SIVs were helpless because, unlike the banker downtown, the SIVs were a mass of undivided interests, none of which had authority to sit down and try for a workout agreement with the mass of mortgagees.
Now that it appears the Federal Reserve intends to bail out the big SIV players such as Bears Stearns by selectively taking the default SIVs into government custody, many of us common taxpayers will become, in effect, non-profit-sharing absentee landlords.
John Mattingly is a recovering farmer who may be found near Moffat, Boulder, or Creede, or perhaps elsewhere.