The Fourteenth Banker Blog

August 23, 2010

Rethinking Homeownership

Filed under: Running Commentary — thefourteenthbanker @ 1:11 AM

It has been a rough three years. Most Americans have lost a lot of their financial security. Small investors are abandoning the stock market. The assumption that homeownership is a great investment is out the window for now. Regardless of whether home prices resume their upward climb, Americans may choose to be more conservative in how much house they choose to buy. These are perfectly rational choices to make given recent history. However, people should think twice before choosing to be long-term renters. Why? First, the Federal Government has pushed interest rates to multi decade lows. The Federal Reserve is actively buying bonds out the yield curve in order to push borrowing costs down even further. Home prices had adjusted sharply downward and these two things combined have made homeownership more affordable. But that is not the prime reason to own a house today.

Here is my fear. I fear that the people who were really hurt in this stock market and housing bust will end up getting hammered again. Choosing not to invest in stocks may be wise. However, anyone who piles into bonds at this point risks really losing a lot of value when rates rise again. Note this NYT piece about a potential bond bubble, like the bubble or the housing bubble. Bubbles burst. If you are buying bonds you are basically betting that either the US is going into Japanese style long-term stagnation or that you can outsmart Wall Street and sell the bonds again before they do. That is playing with a loaded gun. When they sell their bonds, you will lose.

From the article:

Those who are now crowding into bonds and bond funds are courting disaster. The last time interest rates on Treasury bonds were as low as they are today was in 1955. The subsequent 10-year annual return to bonds was 1.9%, or just slightly above inflation, and the 30-year annual return was 4.6% per year, less than the rate of inflation.

Furthermore, the possibility of substantial capital losses on bonds looms large. If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4% as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?

This does not project what will happen if we move into a dollar devaluation scenario or if buyers quit purchasing the mass issuance of government debt. Rates can move much more dramatically.

Renting is a pretty good deal right now and may be for several years. But, if inflation comes, renters will not be spared. Many economists, and I trust the bloggers the most, believe we will suffer a period of deflationary pressures and then the debt burden on the US Government will become so large and the structural deficits so uncontrollable that there will effectively be a devaluation of the dollar through money supply creation and inflation in prices. If this happens, it will drive up interest rates as well as  home prices. Rents will follow. If, on the other hand, the deficit is not as large as expected, that will primarily result from an economy that is stronger than expected and therefore has driven tax revenues up. In either case, interest rates rise. In either case, bond investors take capital losses from today’s levels and the price of either home ownership or rent goes up, perhaps dramatically.

So what to do? If you are in that group that was already in bond funds prior to the last few weeks, you have some profit built-in. For those investing in bonds today, beware. The math does not work in your favor unless economic growth stays down long-term and the government can negotiate through its high debt levels without the markets reacting. To me those combined scenarios are low probability. Not impossible, but low probability.

From a housing standpoint, if you are one that currently does not own and has lost confidence in home prices, and would be a long-term occupant in your particular circumstances, think about the range of possibilities. What if inflation was 5% per year, mortgage rates went back to the 6-8% historical range, and the cost of your rent (probably artificially low in most places right now, went up 10% then 5% per year. Then five years from now you were looking at buying a house. How much would your payment be compared to if you bought today? How much would your future rent be compared to a payment locked in at today’s low interest rates. How much would having your long term cost locked be worth to you in a day of fiat currencies? Try to assign probabilities to the different scenarios and make your decisions. Maybe it is still worth staying flexible. Just know the risks.

Don’t just go with the flow.



  1. The margin for error is “incredibly thin,” said Derrick Wulf, a portfolio manager at Dwight Asset Management Co. in Burlington, Vermont, which oversees $64.3 billion. “A lot of investors have become complacent about being long” in Treasuries.

    Comment by Amos — August 23, 2010 @ 7:56 AM | Reply

  2. I’m am not at all sure that ‘if’ we have a bout of monetary inflation after this deflationary period that it will cause an increase in either rents or home prices. Rising rates will do the inverse to house prices that they did when rates were declining by decreasing the approved mortgage size….and….the mean house affordability of around 3 – 3.5 times the average wage will take a long time to be rectified. IMHO, only a period of increasing wage inflation will start to turn house prices up….and that is a long ways away when analysts like David Rosenberg expect unemployment to be at 11% in 2 years thus we’d likely have a double whammy of declining wages and rising rates reducing the maximum mortgage sizes eligible buyers can secure. As always….’volume always precedes price’.

    Comment by iceobar — August 23, 2010 @ 8:37 AM | Reply

    • You make good points that all apply to one degree or another to both decisions and the timing of decisions. Ideally a home run would be to purchase an affordable home when prices are at the bottom and interest rates are at the bottom. Some folks will do that, if only by pure luck. My thought is that the assumptions that underlie high unemployment and lack of demand will be somewhat changed at an inflection point. Perhaps unemployment stays high but behavior changes. Not everyone will fly to gold. I question whether rising rates and falling demand go hand in hand. Rates affect affordability, but may reflect rosier assumptions about future nominal home prices. If investors buy homes at higher rates, they will do so based on the expectation of higher rents. We all know expectations drive the future as much as present reality. Expectations can change quickly. I tend to be contrarian and when everyone says houses must be lousy purchases, I tend to think it is approaching a time to look at buying if your circumstances are right. Please note I am not saying to buy for investment, I am saying to buy for affordability and to mitigate risks a few years out if you intend to live in the home.

      Comment by thefourteenthbanker — August 23, 2010 @ 5:05 PM | Reply

  3. If you change the headline to “Do” rather than “Don’t” I might be able to take you, and your blog’s mission a little more seriously.

    My fear is that your fear is(are)nothing but crocodile tears.

    Homeownership as an aspiration is dead. Period. Adequate housing stock exists for every American worker who can find a job. Since no housing shortage exists, encouraging ownership in the face of the coming deflationary storm is unconcionable. (heartless really, and raises serious questions about the motives of this blog).

    Your ‘fear’ that the losers in this round (middle class citizens) will get screwed again if they miss this opportunity of a lifetime ( to invest in RE stocks/bonds) is appalling and more than a bit disingenuous. And hardly sounds more clever than your thirteen predecessors.(precedents?)

    I thought you guys were legit. Now’s as good a time as any for Mr.Johnson to acknowlege that he’s been conned and disassociate from this site. You sound like the 14th banker indeed, the one who wasn’t invited to the meeting with the original thirteen, not the rebel outsiders you’ve pretended to be so far.

    Since you’ve idendified yourself as a banker I suppose you can be forgiven for thinking like a banker. But posturing yourself as the 14th, contrary to the previous 13, is a fraud.

    Shame on you. Or shame on me for being a sucker. Please rebut,or identify who you really represent.

    Since I know many bankers who are genuinely appalled at what they saw, I was naive enough to believe that this might be a legit forum to challenge conventional wisdom. How in the world did you get Simon Johnson to endorse this?

    Did you really think you could coopt the bloggers you pretend to endorse?

    Comment by anon — August 24, 2010 @ 12:34 AM | Reply

    • I have nothing to gain from this post. I am also not an investments guy or a housing guy. I’m aware that the consensus is that housing is dead. I have not endorsed housing as an investment but as a necessity, whether you own or rent. Today in the city where I live, your house payment in a good school district is less than the rent for a comparable house. You also can deduct the interest and taxes. And, you can lock P & I in for a very long time. The price of your residence is relevant when you buy it and when you sell it. Granted, if you lose your job in the meantime, you can have to sell it or lose it against your original intent. Please understand that I am not predicting sales price increases anytime in the next several years. Nor am I predicting that we have hit the bottom. There is probably another leg down. But when the bond bubble busts, so do the mortgage rates. When hyperinflation hits, if it does, there will not be much we have control over. A roof might be nice. I have several intents on this blog and one is to provide an opinion that is independent of anyone else and is from my unique perspective. I can’t just always go with other’s opinions. I have to use my intuition. It won’t always be error free but it will be with the right intent.

      Deflationary storm? Maybe. Not a certainty.

      Heartless? Come on.

      Comment by thefourteenthbanker — August 24, 2010 @ 8:14 AM | Reply

    • You will get some of the same tone from James Kwak below. I agree completely with his post. He is also reacting to shifting “conventional wisdom”.

      The Baseline Scenario

      Housing in Ten Words
      Posted: 23 Aug 2010 07:04 AM PDT
      By James Kwak

      “Housing Fades as a Means to Build Wealth, Analysts Say.” That’s the title of a New York Times article by David Streitfeld. Here’s most of the lead:

      “Many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century, when houses not only provided shelter but also a plump nest egg.

      “The wealth generated by housing in those decades, particularly on the coasts, did more than assure the owners a comfortable retirement. It powered the economy, paying for the education of children and grandchildren, keeping the cruise ships and golf courses full and the restaurants humming.

      “More than likely, that era is gone for good.”

      I’ve been telling my friends for a decade that housing is a bad investment. These are real housing prices over the past century, based on data collected by Robert Shiller:

      Housing is generally a worse investment than either stocks or simple U.S. Treasury bonds. Then why do so many people think it’s such a great investment?

      Leverage. Let’s say inflation is 2% and housing returns 3% (1% real return). If you put 10% down, now your house is returning 30%, or a 28% real return; subtract a 6% fixed-rate mortgage, and you’re making about 22%–or twenty-two times the real return of the underlying asset. Of course, we all know the dangers of leverage.
      Price illusion. People remember the nominal price they paid for their houses. When they sell them thirty years later, they look at the difference between the nominal purchase and sale prices and think they made a ton of money. This is especially true of the generation that bought houses in the 1960s and early 1970s before inflation hit; they saw their home prices go up by a factor of ten and thought it was due to high real returns.
      Bubbles and optimism bias. Every now and then we have a huge bubble like the one at the right-hand end of the chart above. For a while, people think that’s the new normal. For a while after that, they continue to think it’s the new normal, because they are biased toward optimistic expectations about the world. (Note that during the first half of the decade that I was advising friends that housing was a bad investment, housing was actually a great investment, assuming you could get out in time.)
      OK, so now we all now the real story. Or do we? “In an annual survey conducted by the economists Robert J. Shiller and Karl E. Case, hundreds of new owners in four communities — Alameda County near San Francisco, Boston, Orange County south of Los Angeles, and Milwaukee — once again said they believed prices would rise about 10 percent a year for the next decade.” There’s that optimism bias.

      But I don’t think it’s correct to say that an era is over–an era when housing appreciation was the key to the economy. The chart above shows simply that that era never existed; housing was flat for a long time, and then there was a bubble. Instead, we had the illusion of an era of housing appreciation, produced mainly by leverage and price illusion. For every homeowner who made a killing because she got a fixed-rate mortgage in 1970, there was a new family that couldn’t afford a house in 1980 because interest rates were too high, or a savings and loan that failed because it was weighed down by those fixed-rate mortgages. That whole phenomenon was just a transfer of wealth within society.

      One last caveat, however. When “analysts say” one thing, they are usually wrong. Remember back in 1999-2000, when most analysts were saying that stocks were the best investment for everyone, all the time? Generally the best time to buy an asset class is when conventional wisdom has shifted against it. So while I still think housing is overpriced–and we should slowly remove the props on that price, like the mortgage interest tax deduction–maybe in the long term it’s not such a bad idea after all.

      Comment by thefourteenthbanker — August 24, 2010 @ 9:04 AM | Reply

  4. Market trends don’t usually happen until there is some form of capitulation or panic at which point the balance of buyers and sellers reverse. I think that has not yet occurred in the housing market. The supply of buyers is decreasing and the supply of sellers is increasing. The buyers are disappearing due to baby boomer retirement, repairing very damaged household balance sheets (we’re apparently only $600 Billion into a $6 Trillion credit contraction), continuing job losses, paycuts, increased taxes, and job insecurity (fear). The sellers are increasing because of their desire to liquidate for all the same reasons as the buyers plus 62% of house purchases since 2005/6 were apparently 2nd homes resulting in some having 2 sets balls and chains dragging them down. As Richard Russell says, operating expenses are 10% of the home’s value per year, either through direct or indirect costs and that does NOT include any capital losses.. There are $1.5 Trillion in residential mortgage resets between spring 2010 and Q3 of 2012 (Credit Suisse), $1.4 Trillion in Commercial mortgage resets in the next several years. Banks are sitting with a huge shadow inventory of houses. Strategic walk-aways are increasing and might possibly bring the endpoint closer. 10% of the huge rental stock sits vacant, family units are contracting, etc, etc. As you can tell I believe there are still lots of ongoing downside pressures. IMHO, we have, at a minimum, another 35-50% decrease in house prices before there will be any serious renewed interest in housing. Simply look at the amount of OVERvaluation of the assets on the banks’ books that the FDIC has taken over. I believe that same number represents the approximate current housing market overvaluation and that is before any further shocks. Banks are reportedly ‘not lending’, and yes, some of the reasons are that “the people that can borrow don’t want to and the people that want to, can’t”, plus. the banks are getting a risk free return on their reserves…..but, my guess is that they are holding the extra reserves for the possibility of the above price drop…. Hey, this is only my short opinion on a very complicated and interconnected, but significant portion of the old economy. The major problem is that …I can wait, sellers usually can’t…..Silver lining is ….I wasn’t part of this problem, but I do plan on being part of the solution…..

    Comment by iceobar — August 24, 2010 @ 10:46 AM | Reply

  5. I work in what’s called the “Wealth Group” at a TBTF and it is right now the busiest of any other groups within banking, know why? Because rich folks are gobbling up these houses in record numbers and they are doing it per wealth advisers advices. I can tell you they are not investing one bit in bonds.

    I can see the point that for us non-rich folks it is risky to invest in a market that still has some potential downside risk to it, but the point 14th has tried to make in several posts is that rich always get richer from this sort of carnage, so guess what maybe we need to think like them.

    Bashing the blog! That’s a little too much Anon.

    14th is not a mortgage broker.

    Comment by Vocalbanker — August 26, 2010 @ 11:24 AM | Reply

  6. Correct me if I’m wrong, and I’m not trying to be sarcastic…..Is it not the TBTF’s that have the huge inventories that they are trying to distribute? I do however understand your point, but I believe that buying a house right now is akin to catching a falling knife. Also, how many people including wealth managers have much experience dealing with a credit contraction the size of the current one? History tells us that it is at such times that there is a major transfer of wealth. About a year or so ago, wealthy investors took at stab at the inventory down in Cape Coral, ….so far, I don’t think they are faring that well… One question that you might be able to answer, what general type of discount are they seeing on these properties??….My guess would be about 35%+….

    Comment by iceobar — August 26, 2010 @ 2:45 PM | Reply

    • The TBTFs service most mortgages, so in that sense yes. Every market is different but 35% is probably a good average.

      Comment by thefourteenthbanker — August 26, 2010 @ 9:03 PM | Reply

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