Monday, April 14, 2008

Think how low land had to get...

To induce some of us to buy in 1987 or so. That's the problem facing the housing market, and a big headache for economists and policy-makers.
A FEW weeks ago I argued, to the consternation of many commenters, that government intervention in mortgage markets might be warranted. My view was that home prices were likely to overshoot on the way down, with potentially catastrophic effects. Falling prices destabilise borrowers leading to default, defaults roil credit markets, and tight credit sucks any willing buyers out the market, perpetuating the downward spiral.

This diagnosis is gaining ground in the economic community, but proposed solutions continue to differ. In the New York Times today, Edward Leamer agrees that the market is in desperate need of buyers, and that lower prices and cuts in the federal funds rate are insufficient to deliver them. Mr Leamer goes on to suggest that a massive tax credit to first-time homebuyers--of something like $25,000--is needed. Colour me sceptical. While a tax credit of that magnitude would create a powerful incentive to buy, it would have little effect on markets if desiring buyers are unable to secure a mortgage loan. The credit would essentially lower home prices to new buyers by $25,000, but if low prices aren't able to solve the problem, as Mr Leamer says, then the subsidy is useless. [More]
Looking back, I think it is fair to say land prices overshot on the way down. My brother casually bought some ground for about $1250 on a whim with profits from his medical group. That land is now worth north of $7000, I would guess. Pretty good gains. In fact, the land doubled in the first about 5 years back up to ~$2500 or so, hence my call that prices overshot.

For home buyers, it may be different. This is not a productive (income-generating) investment that can reach an income capitalization figure that makes buying a good idea. Which to me indicates it will be harder to prevent a gross devaluation before recovery. In fact, we seem to be gathering momentum downward.

As my son tries to sell a house in Will County - just a few months ago the hottest area in the country, our family is parsing real-time data. (OK - an anecdote.) But I'm having trouble imagining the motivation for a home buyer right now.

And I'm also glad I'm not a residential real estate appraiser.
The lender now faced a dilemma: whether to pay maintenance costs on the vacant house or dump the property at a fire sale price. Both of these options can reduce real estate values. Homes that sit vacant can become neighborhood eyesores, while rock-bottom sales prices drag down the values of similar properties.
I spoke with Rodney Ready, who owns Aegis Appraisals in Napa. He said that when the lenders dump the properties on the market at ridiculously low prices, he must take those sales into consideration when he completes an appraisal. The reduced price artificially lowers the prices of other homes in the neighborhood, and dramatically affects those who are not being foreclosed upon. He said, “It is criminal the way the lenders’ decisions are driving down the equity of every homeowner. They just want to get the property off their books at almost any price with no concern of the impact.”

Back to the Jones example: After the foreclosure, the lender decided it didn’t want to carry the house and sold it for $345,000. The lender simply ate the $140,000 loss and wrote it off as a bad loan. [More]
Whaddaya think? Will a 30% drop be enough to restart house buyers? Is there any other way to make it happen?


Anonymous said...

I am a little disappointed in my favorite "borderline liberterian" (thats you John). Let the market find its own level as we do in grain, stocks etc. Why penalize the people who are saving money and help out those whose motto is borrow, borrow, borrow?
p.s. Just finished reading "The Day The Bubble Burst". Very good.
Mn Dave

John Phipps said...


I concede my drifting from the path. One of my life heroes is Herbert Hoover, for many reasons. But he followed strict libertarian instincts such as you suggest and in letting the chips fall where they may, let far too many chips fall.

I temper my belief in justice with the knowledge that increasingly we are so interconnected it would be hard for even the virtuous to avoid being drawn into the whirlpool if we simply let consequences fall as hard as they should.

Secondly, I have noticed the rigor of my philosophy melts away in the face of personal suffering deserved or not. The people who have made bad choices could be my friends, and on that basis the moral and intellectual high ground is cold and lonely.

The middle path is hard to find and follow, but the dangers of an "overshoot" are so large, I think undeserved charity is warranted in some form.

Economies are really, really hard to restart.

Thanks for the book rec.

Anonymous said...

Your brother is a very savvy investor! Ask him for advice!
Good IN land was 3000 going into the 80's, then fell to about 1500 in a short time. There were some real good buys from the lenders in the late 80,s, anxious to get real estate off their books.