Comments (25)

• Mike

  Mr. French, good article, but there seems to be spelling and grammatical mistakes in the 3rd to last paragraph. I think you meant "falling" instead of "failing", and "12 times greater" versus "12 greater".

  Published: June 22, 2009 8:16 AM

• greg

  There is more to real estate and housing than interest rate levels. Consider the following:

  700,000+ housing units are lost each year to demolition,fire, floods and other natural disasters.

  The demand for over 500,000 units a year due to population increases.

  We are currently building on an annualized level about 535,000 housing units a year.

  All real estate is localized. Anyone that talks about the state of real estate on a national level shows what little they know about real estate investment. I can carry this further by pointing out that in any given subdivision, I can tell you the lots you will make money on and the ones you will loose.

  What happen in our boom, people bought real estate in stupid areas because they felt the need to buy and had to stay within a certain budget. It is these over priced houses purchased on the fringe that are our problems. And yes, those bought outside the fringe need to be torn down.

  But those that bought in the right areas have not seen their prices fall that much. And now we are seeing prices start to edge up in these areas. Even the right areas in CA, DC, FL and NC are showing price increases.

  Existing home sales will be out tomorrow which has been showing signs of support. The housing starts was a great number considering the number of builders that have dropped out of the market. The Case-Schiller index has been a problem, but that number is always 2 months old when it hits. Plus that number is to generalized and was basically used as an index for investment funds.

  Bottom line, supply and demand will trump interest rate levels.

  Published: June 22, 2009 8:29 AM

• Spideyv

  Great article! Thank you for sharing.

  Published: June 22, 2009 8:59 AM

• ralph h

  I left the commercial real estate business about 5 years ago because the deals did not make sense to me. Very simply, I could not identify the end user even though the money was available for the development. In hindsight, my observations were correct and now I witness numerous developments with never occupied space, excess land and an increasing vacancy rate from existing projects.
  My residential experience was limited to following the rooftops and now I see
  subdivisions that are struggling, existing homes that stay on the market forever along with an abundance of "for sale" signs everywhere. I believe you could call this a cluster of errors from intelligent people reacting to the abundance of credit.
  

  Published: June 22, 2009 9:38 AM

• gene

  I have to agree with Greg that all real estate is basically a localized market. We have barely experienced a downturn in real estate even though we have the second highest unemployment in the nation. To throw another fly in the ointment, we have some of the most rigid, albeit general in scope, statewide zoning regulations in the country. So, assumptions don't always hold true.

  What is true is that the interest rate, what capital sells for, influences the financial markets on a national and worldwide level. So, messing with the natural rate upsets all markets.

  Another area that is rarely mentioned is the "transitory" nature of our housing stock. We basically build "inexpensive" in terms of quality but "expensive" in terms of price, housing. This insures that we will need to replace or repair housing at regular intervals and requires a larger industry, much like many of our products.

  Published: June 22, 2009 9:55 AM

• Craig

  "There is reportedly a million-house overhang in the market nationwide"

  A few months back, "60 Minutes" ran a special on the housing market. They covered subprime, and how people are defaulting on the loans. A gentleman on the show predicted basically what you stated above. There are still non-subprime mortgages that are not having their payments met. .

  Anyone else see the special?

  Published: June 22, 2009 11:08 AM

• David Spellman

  Great picture. Mises.org has a lot of great pictures with the articles. Sometimes the pictures transmit the message better than the article. :).

  Published: June 22, 2009 11:37 AM

• Old Hop

  @ Greg:

  I'm a real property appraiser and agree with your notion that real estate (like politics) is local. However, your conclusions do not discredit Mr. French's thesis, which reasons soundly from Rothbard's discussion of malinvestment.

  When the adjusted housing numbers come out they will indeed demonstrate, as you say, changes in supply and demand; but the "support" you anticipate will reflect a spike in purchases made by savers who waited until prices fell. I think the numbers will be particularly robust in the sub-$150,000 range. One has to read between the lines: those are properties previously appraised and selling near the $200's during the bubble.

  Moreover, around the Charlotte, NC area we are witnessing a precipitous drop in building permits, which demonstrates that the shift from the production of higher- to lower-level goods and service is well underway.

  Published: June 22, 2009 2:32 PM

• Dick Fox

  Good article.

  A comment, when all you have is a hammer everything looks like a nail. Rothbard goes through tortuous reasoning to get things to fit neatly into the ABCT. He should just accept that not all economic events are ABCT events.

  Mises understood that if bad policy is reversed recover begins almost immediately.

  Because Rothbard misunderstands he attributes the length of the Great Depression to the length of the "boom" he imagines in the 1920s. Actually the 1920s were simply a time of growth and prosperity and the length of the Great Depression was because the government simply would not allow the economy to recover. Had the government changed its policies recovery would have began immediately. The same is true today. If the government was to reverse its disastrous policies recovery would begin immediately.

  Published: June 22, 2009 3:55 PM

• Greg

  Old Hop,

  You are seeing a drop in building permits in the Charlotte area because a large percentage of the small builders (50 or less homes per year) have left the market. Also, the fringe areas of Charlotte was over developed as people moved to the affordable areas of Statesville, south of Ft. Mill and to the far eastern parts of Union County. This overdevelopment of the fringe has put downward pressure on prices on all real estate.

  On Lake Norman, huge houses were built on marginal lots during the boom. These are the houses that are putting pressure on prices around the lake. This lake has over 500 miles of shoreline and only about 5% of the lots are truly great lots that have seen the best appreciation over the last 5 years.

  People forget, all houses depreciate! If you are really interested in making money, you need to make sure your lot can appreciate faster than the house depreciates with age.

  On the recovery it is a normal cycle for it to start with the lower end and move through to the mid range and finally the upper end. And that is another reason the building permits are down as only the low end production builders are pulling permits. Add to that, builders without $5 million in equity cannot get financing as the banks have pulled in their existing credit lines and cannot pull permits. These builders tend to be the mid to high range custom builders that have been forced out of the market.

  As a builder for 25 years, and yes, for the last 10 years in the Charlotte area, my decision to build or not to build was never based on the interest rates. It was always based on my ability to buy a unique and valuable lot at a fair market price. In any given subdivision, 20% of the lots are total junk and it these locations that are sitting in inventory pulling prices down. And anyone that purchases them at any price is still making a poor investment at any price.

  Remember one thing, there have been many downturns in the past and every one of them have recovered. Most on the back of supply and demand.

  Published: June 22, 2009 4:20 PM

• Old Hop

  "People forget, all houses depreciate! If you are really interested in making money, you need to make sure your lot can appreciate faster than the house depreciates with age."

  Houses do sustain physical deterioration due to age; however, because of the subjectivity of value, the measurable amount of depreciation in terms of dollars (for example) varies according to buyer tastes and preferences. A desirable neighborhood of older homes may show less real depreciation than a subdivision of newer homes with lower curb appeal and/or a less desirable location.

  I'm glad you brought this up, because measuring appreciation and depreciation in real property are perfect examples of how Menger's theory of subjective value is proven correct. They are not objects of mere accounting procedures; they are based on buyers' value scales.

  Published: June 22, 2009 5:27 PM

• gene

  Houses definately depreciate, but they don't necessarily cost less to build! Thanks to our wonderful monetary policy, inflation drives the price of replacing homes up constantly. This works against real depreciation, since the cost of replacement inflates the "depreciated" value.

  The land is also a great store of value. Much of the phoney baloney capital the Fed puts out gets stored in land value and stocks. Plus, land is always "absorbing" the value of others. Improvements around land by both the private sector and the government raise the value of bare land [and land under improvements]. thus, location, location. this is the logic behind the "land fee" as replacement for other "product" and labor fee taxes.

  Published: June 22, 2009 5:38 PM

• greg

  Gene,

  Thanks for a point that I left off. In today's market, it does cost less to build a new house than it did a couple years ago, about 15% less. And that is another problem for the resale market that bought at those elevated levels. They can't sell their homes for more than the cost of new construction, so they have to mark them down below the current cost of construction.

  Thanks to the overspeculation in housing, oil and almost every commodity out there, the prices of everything jumped more than 40%. And thanks to seasonally adjusting prices, we didn't have inflation, yet we were paying double for a gallon of milk and $4 a gallon for gas. Today the speculation is to the short side and the prices are falling and now we have deflation which gives the Fed a free pass to print money.

  Thanks to ETF's, REIT's and hedge funds, the world of housing and real estate has joined the commodity exchange world. In this world, prices will fluctuate and if you are a buyer or seller, timing and product quality is going to be important. And because of the size of the investment, a change of 1% on the value will impact you much more than a change of 1% on your loan amount. Remember, in the commodity market, it is all about leverage, not the cost of money.

  Over the last 30 years I have paid as high as 17% and as low as 3% for housing and that was during good and bad times. What makes this current boom and bust different is the increased access to investing in real estate. And this access is open to both sides of the trade, long and short. Whereas before, investing in real estate was like gold, you just bought and held, real estate will always go up. Introduce the short play on these ETF's and REIT's, then they are force to sell to rebalance their funds and the prices for real estate will fall.

  The point I am trying to make is if you are trying to find the cause of over speculation in the market, try blaming it on the act of speculation. Interest rates play a role, but it is a small part of the action. Really, there is a lot more to this market than the cost of money.

  Published: June 22, 2009 6:51 PM

• newson

  dick fox says:
  "Actually the 1920s were simply a time of growth and prosperity and the length of the Great Depression was because the government simply would not allow the economy to recover."

  this does not explain the asset boom prior to the '29 bust. as fritz machlup says:

  "... continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply."

  (The Stock Market, Credit and Capital Formation, William Hodge and Company Limited, 1940, p. 290).

  Published: June 22, 2009 6:55 PM

• gene

  anytime you can control the credit market by lowering the cost of captial, increasing the supply, you increase the return to the creditor by the difference between the natural cost of capital and the subsidized cost.

  more return means people take greater proportional risk.

  but, you can't leave out Greg's point that speculation has a big part in it all. I think the manipulation amplifies the action but doesn't cause it. people malinvest because of human nature, not because of the Fed. The Fed certainly doesn't help matters and really the Fed actions can be also called "malinvestment". Printing money that doesn't represent anything certainly isn't a "good" investment!

  Published: June 22, 2009 7:15 PM

• Gil

  Since when was the 1920's a time of prosperity? I believe only small sectors of the U.S.A. were 'roaring', other sectors, such as agriculture, were stuck in a rut. Plenty of other countries were still reeling from WW1. Besides doesn't a 'roaring' stock market in the presence of a mediocre economy mean there's plenty of inflation behind the scenes?

  Published: June 23, 2009 12:59 AM

• thesprot

  Greg wrote :"Remember one thing, there have been many downturns in the past and every one of them have recovered. Most on the back of supply and demand."

  You state that all real estate is "local". While it is true, it is on the other hand, meaningless, and serves no purpose. the term is very loose and in general means nothing.

  In every asset class one may find localized assets whose performance exceeds others in the same category for whatever reason, in this there is nothing special about property and housing. There are property that performs far better in some areas than others, but as i said it is nothing "special". You can actually make the same point of "local" about stocks, commodities etc.

  Back to the quote. It is not true that property always recover, to be sure many do not in real terms, whereas they might trade above bubble levels after decades, only nominally. Let me quote for you from a Fred Sheehan article writen some 3 years ago and posted in Marc Faber's site at gloomboomdoom.com. :

  "Florida is merely the most benighted of the 1920s property speculation – the building
  spree crossed the nation. Losses were much greater than from the stock market crash. Prices in
  many cities have never recovered. Nominal prices of Baltimore residential property prices are still
  lower than in the 1920s. Prime commercial property prices in Omaha still trade at a discount to
  Jazz Age highs. In Boston, a lot on Boylston Street near Copley Square sold for $2.12 a square
  foot in 1873, $35.30 in 1912 and $3.00 in 1939. A building on Boston’s Arch Street sold for $33
  a square foot in 1881 and traded for $5.13 sq. ft. in 1940. A lot between Summer and Essex
  Streets sold for $2.50 in 1831, for $32.16 in 1916 and $1.80 sq. ft. in 1940.

  Real Estate and Property are no different than other asset classes, they are not immune from booms and busts. And there is no law in the nature of economics that states that prices will be sure to trade higher than the previous high always and every time, one widely known example is the tulip seeds and bulbs, once their high was reached during the boom, that was it, they never reached their highs again.
  Such is the case with many properties around the world also, once the crash becomes reality, many do not recover, at least not in real terms, and some fail to even reach previous nominal highs.

  Published: June 23, 2009 3:09 AM

• Dick Fox

  this does not explain the asset boom prior to the '29 bust. as fritz machlup says:

  "... continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply."

  (The Stock Market, Credit and Capital Formation, William Hodge and Company Limited, 1940, p. 290).

  newson,

  Machlup is wrong. There are many reasons the stock market will rise totally separate from an inflationary credit supply. Here Machlup is imagining a totally mechanical series of economic events by saying "only," but economics is a behavioral science not a mechanical science.

  Now an increase in the money supply can facilitate a boom - I agree that is part of the cause of the current credit crisis - but even with a stable currency people may choose to shift their spending preference to what they perceive is a profit opportunity with no increase in the money supply.

  But an increase in the money supply will not always immediately generate a boom. Roosevelt desparately attempted to use an increasing money supply to pull us our of the depression but people simply would not cooperate. They were afraid the government would take their investments, and so their consumption preferences did not include spending or investing the additional money.

  The same is true today. Bernanke has been desparately attempting to pull us out of our current crisis by expanding the money supply but people simply do not trust the government and so banks will not lend and investors will not borrow.

  But what happens when people do allow the increased money supply to change their behavior. Well, the ABCT for one. Often this will come as the recovery begins. The additional liquidity begins to ooze out into the economy and malinvestment is the result with a crack up boom/bust cycle to repeat again. I fear that will happen with our current situation. So much money has been forced into the economy that when it comes out there will be a serious inflationary problem.

  But we can also see stagflation as happened in the late 1970s. People still fear the government will confiscate their investments but they are willing to consume what does exist especially assets that will protect them from inflation, and so prices are bid up. Stagnation with inflation.

  Like I said, when all you have is a hammer everything looks like a nail. Broaden your tool box. I suggest listening to Roger Garrison on the Great Depression. He is much more balanced.
  

  Published: June 23, 2009 7:17 AM

• gene

  Gil is right about the "roaring twenties". There was lots of money around, like there is lots of money now in China. Some people have it and the rest are destitute.

  We were basically a third world country [although we've always had the advantage of being governed by our own elites rather than some other country's] beginning to form the semblance of a middle class. Poverty was everywhere, even though Wall Street was thriving.

  The stock market has always been a better indicator of inflation and credit extension than fundamental economics. Likewise, housing. If given the choice, most investors would choose easy money over actual labor.

  Published: June 23, 2009 10:15 AM

• newson

  to dick fox:
  i see no coherent explanation from you as to why aggregate price/earnings ratios would increase, absent monetary factors.

  as machlup is talking about the stock market as a whole ("prices"), your reasoning that people shifting purchasing preferences makes no sense. how can they buy more of everything, without an expansion of money and credit? you've got to fall back on psychological factors ("animal spirits") to explain why the entire market rises and falls. cutting back on consumption to fund investment doesn't cut it either, as that could in no way explain the cluster of errors.

  what is your answer to the very high p/e's of the roaring twenties?

  yes, i'm familiar with garrison, and here's an excerpt from "contra krugman" which shows how different your view is from his on the 1920's:

  "The Austrian theory is not a theory of depressions per se; it is instead a theory of the unsustainable boom. In 1929 the Federal Reserve had "a tiger by the tail"–to use F. A. Hayek's apt metaphor. Whether the central bank held on or let go, the boom was over. Good times were about to turn bad. The Austrians have had lots to say about the government policies that made the bad situation worse (the propping up of prices and wages, the cartelization of industry, the Smoot-Hawley tariff, further bungling by the federal Reserve), but they have something unique to say about how the situation turned bad in the first place. The capital theory featured by the Austrians and, more pointedly, the policy-induced discoordination of the capital structure are not to be dismissed lightly."

  Published: June 23, 2009 10:47 AM

• Gil

  "The stock market has always been a better indicator of inflation and credit extension than fundamental economics." - Gene.

  I was wondering that too. Would the stock market be a place for investment in a true free market?

  Published: June 23, 2009 11:41 AM

• gene

  In a true, free market, there wouldn't be corporations. Incorporation is a privlege granted by the State.

  The "limited liability" that is granted with it, socializes any excess liability. That is totally obvious right now, as we speak, with all the trillions of dollars of bailouts. We are doing nothing but funding the "excess" liability of limited liability corporations with taxpayer funds. Corporate Socialism.

  So, we might not recognize the stock market if it existed in a true, free market.

  The other complication would be any investment in stock would be extending the shareholder's liability through ownership. Investing would change as a result. Think local might not be just a slogan! Being able to really "watch" your investment would have greater importance.

  Published: June 23, 2009 2:37 PM

• Abhilash Nambiar

  This is a very well written article. I especially like the way quotes from Rothbard and Mises are placed so properly within context that they speak to our time so perfectly.

  Published: June 23, 2009 6:20 PM

• David Hillary

  Gene, how about the concept of personal bankruptcy as a legal form of limited liability for individuals? You reckon its legit or not for individuals to wipe their debts and have a fresh start?

  I've noticed the concept of limited liability and limited responsibility for things to be a quite libertarian concept. You're not liable for anything unless you've done a wrong, so if someone else has a loss because of you, it is not your liability unless a recognised legal wrong (e.g. a tort) is found. If your wrong causes no loss, no liability to bear. If you kills someone by accident, then you're not guilty of that either. If you do cause someone else's loss by your wrong, your liability is limited to their loss.

  It seems a small legal move to allow limited liability to investors in a partnership or unincorporated company: why can't they trade on a limited recourse basis? this avoids the need for incorporation. Alternatively, why can't trustees act as trustees on a limited recourse basis? already trust assets are isolated from personal assets and liabilities of the trustee, why not the other way around too? Again, it seems like a small legal move to enable some to act as directors or fiduciaries liable only for their discharge of their fiduciary duties, and for others to act only as beneficiaries of the residual assets of an entity.

  The other alternative would be to legally accept the idea that individuals can incorporate corporations by constituting and labelling them, without the need for the state to grant such status.

  It is interesting to note that most American jurisdictions have been innovative and generous in granting the idea that all the partners of a partnership (unincorporated company) can have limited liability, without incorporation, whereas elsewhere in the Anglo world, partnerships have been allowed to incorporate to grant limited liability to all shareholders (i.e. become an incorporated company), or to allow limited liability to only some partners through a special or limited partnership, where the general partners retain unlimited liability.

  Published: June 25, 2009 1:51 AM

• gene

  Hi David,

  I think if we truly believe that state intervention is ill advised then granting "limited liability" to anyone is uncalled for. If we take into account the State actually "privileging" some over others, in violation of the constitution, then there is no doubt it is wrong.

  Not making a judgement on bankruptcy in particular [which also applies to corporations], I think the courts have a right to make judgements concerning liability on a case by case basis.

  If we look at the fact that we have "privileged" a class of citizens [the incorporated] and then view the amount of legislation surrounding this privilege [corporate law], we see how far down this road we have gone.

  To have a free market, there needs to be no special classifications applied to the actors, advantaging one or disadvantaging others, before they enter into a transaction. What they agree on is up to them. If one wants to declare limited liability in reference to the transaction, they have to compete and bear the pressures of the market in that regard. They don't have to do that now with state sanctioning of incorporation.

  I don't know why any of your ideas couldn't be agreed on by the parties involved, but what is the point of legislating market activity other than the basics we all agree on, fraud, harm, etc.?

  As far as debts, secured debts are no problem. I don't know the answer on "unsecured" debt. Is it a crime to default on an "unsecured" debt. I don't think a return to debtor's prisons are the answer. Possibly, if the answer was agreed on beforehand, then we all would have a concrete idea which could determine risk and reward and we could call it good. It's a tough question.

  Published: June 26, 2009 10:08 AM