January 02, 2011

The Historical Arc of American Real Estate Fantasies

One curious feature from the late 1970's, as I recall among the hominid subgroup technically known as Yuppus Californicus (the thirty something, sub/urban professional milieu in which, always somewhat uncomfortably, I found myself immersed), was the real estate conversation. These discussions followed a predictable course. Someone mentioned they had bought their house for $140,000; however, they believed they could now sell it for $180,000. After only 3 years! Well, that was nothing, someone else would say; a friend bought their house in Mill Valley for $160,000, and now it was worth well over $200,000, and that was after one year!

And so these dreary, boring, vaguely sickening conversations went, all the time, everywhere. Californians of that period were absolutely obsessed with real estate, home ownership, and the rapid, accelerating appreciation thereof. It's what life was about. You might be thinking of the fugue movement from Bach's Lute Suite in E Minor you were learning on classical guitar. Didn't matter, that's nothing to talk about; shut up and listen to how much cash I just pulled out of this killer re-fi I'm about to close!

Yet another curious feature of the same historical epoch was this: it was generally conceded that the actual income of most people was insufficient to explain this meteoric rise in real estate prices. Which is another way of saying that the general economy did not seem to have anything to do with what was going on with property values. Meanwhile, one could see the deleterious effects of this phantasmal wealth. Well-to-do enclaves (the East Bay hills, the west side of the Peninsula, southern Marin County) were becoming ghettos infested by only two types of (white) people: "legacy" owners, ordinary people who had been in their houses a long time and were aging along with the house; and the YUPs who were invading these enclaves with their high salaries (doctors, lawyers, investment bankers). The ad valorem basis of real property taxes in these pre-Prop 13 days meant that the escalating prices were hammering the older, fixed-income people, which led to the "1% rule" of Prop 13, which led to the death of California's once-proud public education system. To a large extent, "ordinary life" disappeared from the Bay Area's upscale suburban areas in favor of real estate speculation and the devotion of ever-increasing amounts of one's income to keeping a roof over your head. The artists, the Bohemian or "genteel" poor, the people who just didn't want to focus their lives on working for a huge mortgage payment, were first marginalized and then driven from the scene altogether, along with all the mom-'n-pop stores and the other charming features of what we used to think of as real life.

The past is prologue. It was interesting to me to read a recent analysis by the brilliant, always useful Robert Shiller of Yale University (an economist who can see, unlike the confused and erratic Paul Krugman, the big picture and see it whole) about the actual historical trends in American real estate prices, from 1900 to the present. What he found was that real estate, except in aberrational periods, has tended to appreciate about 3.5% per year, year in and year out. It obviously declined heavily during the (first) Depression, and grew at ridiculous rates (about 19% per year) during the period 1998 to 2007 (although, as I said, the absurd was happening much sooner in California, as is often the case - The Golden Canary in the Coal Mine of American Life). 3.5% is essentially savings passbook return, or used to be, before we became so wealthy our banks could no longer afford to pay us interest. That's normal life. A house is actually a shelter from the elements, when you get right down to it. It's Vital Heat Maintenance Factor #1, in Thoreauvian terms, food being #2. Houses should appreciate along with general rates of low inflation, not substitute for a hot stock tip or a Ponzi scheme you've dreamed up.

So what is really going on in the "real estate crash?" A reversion to the trend line, as the water in housing prices is inexorably squeezed and wrung out. Peter Schiff, another brilliant Cal man (I don't mean me, I was thinking of Michael Milken), who never met a dismal economic fact he didn't like, has taken Shiller's analysis and run with it (into the ground). If housing prices have lost about 30% so far (and this is already a Depression-level number), they need to drop another 23% from present levels in order to fall back in line with the gently sloping upward line of Shiller's graph. In so doing, the slope would rejoin the essentially flat trend line of American earnings among the hoi polloi, that is to say, everyone outside about a ten square block area in Lower Manhattan. Americans have gotten essentially nowhere in their earning capacity since about 1973, which is why we substituted house appreciation for saved earnings as a way of building wealth.

So how far back will this regression need to go in order to regain congruence with Reality? You might think of prices in the late 1980's, early 1990's as your guide. Schiff, who has a kind of genius for making the blood redder in the water, predicts that the move downward will "overshoot" the trend line because of the general dislocation caused by Americans realizing they're dirt poor instead of real estate magnates. Thus, the move away from discretionary spending will be given another impetus once this reality sets in. The more general category of U.S.A. hominid, Americanus Consumerus, will pull in their horns.

I find this all intensely interesting, reflecting as it does the economic reality of my time on Earth, as an American. I think I'll write some more about it, especially the futile, insane attempts of Washington, D.C. and The Ben Bernank to fight these essential Laws of Economic Gravity by madly injecting trillions of dollars of notional "money" into the system in an effort to re-levitate the housing market. All because it has become a form of political suicide ever to admit that the last forty years of American economic history have, in essence, been a complete hoax.

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