June 23, 2018

The Flawed Nature Of Economic Theory

A weekend topic on housing bubble awareness starting with the Bellingham Herald in Washington. “The steady drumbeat in local real estate recently is that inventory is tight and home prices keep rising. It appears some buyers have had enough. While inventory remains tight, sales are solid and home prices continue to rise, price reductions are also increasing along with homes being pulled off the market. Between June 13-20, 52 price reductions were made on homes for sale across Whatcom County, including 23 price reductions in Bellingham, said Darin Stenvers, branch manager at John L. Scott’s Bellingham office, adding that this is up from earlier this year.”

“Another telling statistic: Of the homes that have come on the market within the last 30 days, 46 Whatcom County homes have been pulled off the market, including 10 in Bellingham. Newly listed homes get taken off the market for a variety of reasons, including being priced too high and not getting offers. Troy Muljat of Muljat Group Realtors agreed there is a split happening in the market, and not just because some sellers are asking too much for a house. The rise in interest rates earlier this year has reduced the purchasing power of buyers who are taking out mortgages. ‘What prices are and what people can afford — that gap is widening,’ Muljat said.”

The Naples Daily News in Florida. “May also saw inventory levels continue to stabilize, according to the Naples Area Board of REALTORS®. There was very good news for buyers in the report as May’s overall median closed price dropped 5 percent to $337,000 from $355,000 in May 2017. Moreover, the overall median closed price for homes priced above $500,000 decreased 14 percent to $507,000 from $590,000 in May 2017. ‘We haven’t seen inventory levels in May this high since 2013,’ said Mike Hughes, general manager for Downing-Frye Realty, Inc. ‘I was concerned that the low end of the market would start shrinking after season, but the May report showed inventory increased 6 percent for homes under $300,000.’”

From Bloomberg on Canada. “The chill that has crept over some segments of the Toronto housing market may soon extend to one of its persistent hot spots: condominiums. Evidence of a slowdown is emerging as new rules make it tougher to get a mortgage and borrowing costs rise for the first time in almost a decade. Projects are taking longer to sell and, in some areas, developers are using incentives to move units. Unlike prices for detached homes, which are down almost 10 per cent from the peak last year, condo prices have continued to climb, reaching a record in May. But the pace of appreciation has slowed. At the same time, supply is rising.”

“Negative monthly cash flow reached $424 on average for resale condos in the first quarter of 2017, according to an April report. Many investors will accept negative cash flow as long as they see price gains on the underlying asset. However sustaining the recent pace of price gains over the longer term may be difficult, the Bank of Canada said in a report this month. ‘If expectations reverse and prices recede, speculators may quickly sell their assets, which could lead to large, rapid price declines.’”

From North Shore News in Canada. “Dear Editor: Allan Angell’s comments that the ‘NDP should be shot’ and the resulting ‘hear, hear’ from the crowd is a tragic reminder that, as the famous economist Thomas Picketty wrote, ‘No hypocrisy is too large when elites are forced to justify their positions.’ As an owner of a real estate brokerage, Mr. Angell has been one of the biggest beneficiaries from this phenomenal rising real estate market, and it shameful that he is the most vocal against a relatively small increase in education levy.”

From Nine News in Australia. “Painful though it may be for existing property owners who are selling, we are witnessing what a bubble slowly deflating back to reality looks like. Data showed that across Australia’s eight capital cities prices fell in the first quarter of 2017. Sydney was hardest hit. This downward price pressure is consistent with a reduction in auction clearance rates documented by CoreLogic. A big correction to property prices would require a major trigger. The most likely candidate for that trigger is interest-only loans. More and more attention is finally being paid to dangers caused by Australia’s profligate use of such loans. As written last year, at the peak a staggering 40 percent of residential mortgages in Australia were interest only.”

“The Australian Prudential Regulation Authority (APRA) stepped in last year, capping new interest-only loans at 30 percent of new loans. That, along with a tightening of underwriting standards by banks, has led to a sharp drop in such loans. In a moment of gaping honesty eight weeks ago, the RBA’s Chris Kent highlighted the difference between the average and marginal borrower. ‘About half of owner-occupier loans have prepayment balances of more than six months of scheduled payments. While that leaves half with only modest balances, some of those borrowers have relatively new loans,’ he said.”

“It doesn’t matter than some of them are new borrowers – other than that they bought at the height of the bubble, making them more susceptible to financial stress than other borrowers. The fact is that a whole bunch of folks are on the wire. If their payments go up they are going to struggle to make them. And if a lot need to sell at once then, as they say at NASA, ‘Houston, we have a problem.’”

“We are about to see a three-year wave of shifts to principal-and-interest loans. Worse still, the loans originated in those years were heavily mediated by mortgage brokers whose incentives were all about moving volume, not quality. The air may fizzle out of the Australian balloon, or it may burst violently. Either way Australians should be asking hard questions about why APRA waited so late to act on interest-only loans, liar loans and underwriting standards in general.”

From Domain News in Australia. “A financial crisis may be poised to swallow Australia’s housing-debt-laden economy and usher in the first recession the country has seen in 26 years, a leading Australian economist says. Australian household debt is now hovering at a record high of about 120 per cent of GDP – among the highest in the world and well above Canada, Britain and the United States. And with the bulk of that debt confined to mortgage debt, and house prices now falling in Sydney and Melbourne, economists are sweating.”

“‘Economic history shows that more often than not a rapid build-up of debt usually comes with a consequence,’ Capital Economics’ Paul Dales writes. ‘The only question is how bad will that consequence be?’”

“Banks have tightened their lending practices following intense scrutiny from the financial services royal commission, which held deeper and darker issues than were first thought. And housing finance has slipped, particularly in the investor and interest-only segments of the market, with experts doubting a reversal will occur any time soon. ‘In a financial-crisis scenario, credit conditions tighten significantly, credit falls outright and the resulting bigger fall in house prices and weakening in the economy calls into question the quality of banks’ assets,’ Dales writes. ‘Banks then tighten credit further, triggering further falls in house prices and a deeper recession.’”

From Multibriefs. “Several years ago, a picture was taken at night of the One Hyde Park development in London. The building is home to some of the world’s most expensive real estate, reaping in up to $180 million for a single apartment. In the photo, there was not a single light on in the gleaming tower. Because no one lives there. As real estate prices continue to steadily rise, seemingly endlessly, we have seen the concept of a ‘home’ become divorced from its original purpose as shelter, and becoming instead a financial asset class in built form.”

“The extension of financial thinking into housing has led to our homes being increasingly viewed as commodities. As Manhattan apartments become popular as a ‘pied-a-terre’ for holders of global capital, it has been reported that in some parts, up to 1 in 3 apartments lies empty for at least 10 months a year. Apparently, landlords in the city are sometimes making such a good return on their investment that they simply don’t want the ‘hassle’ of renting the apartments out to tenants — a process known as ‘warehousing.’”

“At the most shifty end of the spectrum, these properties serve as a haven for laundering money stolen from state budgets over the world. By using offshore companies, this means of parking your ill-gotten money can be largely untraceable. Stories abound of prime properties being bought with cash. If the investor needs an injection of cash, the building becomes their ATM. It can also act as collateral to leverage further investment. International property investment can serve another purpose too — sometimes buying their investor the ultimate prize, the so-called ‘golden passport.’ It appears that even citizenship is up for sale, and property can be one way to buy it.”

“Beyond the rarified world of the so-called ‘1 percent,’ however, the rest of the market is no stranger to the financialization of housing. The number of ordinary citizens who are beginning to think more like property developers than residents of a home in on the rise — fueled by TV programs like ‘Property Ladder.’ Home improvements today are often not made based on pragmatic needs, such as an extension to provide a bedroom for a growing family. They are now often made on the basis of the impact on sales value.”

From The Irish Times. “Almost every economic event or phenomenon is considered the product of the interaction of the laws of supply and demand, argues The Concise Encyclopedia of Economics. The ‘law’ is currently being invoked by those who believe the solution to the Irish housing crisis is to simply build more houses. It is an analysis echoed regularly by grateful developers and estate agents. But the ‘law’ of supply and demand is a micro-economic concept and applicable only to the ‘economy’ of individuals, households and firms.”

“The ‘economy’ of a globalised country such as Ireland is, in stark contrast, a macro-economic concept, the result of analysing the aggregate activities of more than four million people operating within global markets for housing and other assets. As evidence of the flawed nature of this fundamental micro-economic theory, we only have to look at Ireland’s housing market in 2006 – the year in which the market boomed before imploding catastrophically.”

“Further evidence can be found in the Irish housing market since 2006. One glance at the CSO’s 2016 census of housing stock makes clear that Ireland’s surplus stock is higher than it was in 1991 – then at 9.1 per cent. In 2016, the overall vacancy rate, including holiday homes, was 12.3 per cent. If holiday homes are excluded from the housing stock, the vacancy rate drops to 9.4 per cent. In 1991, Dublin’s surplus was 5.1 per cent of the total.”

“To understand Ireland’s housing crisis, and to formulate sound policy to deal with it, requires a macro-economic approach. As Josh Ryan-Collins and Laurie McFarlane argue in Rethinking the Economics of Land and Housing, land is inelastic, a gift of nature. It cannot be created and converted into capital. It cannot be produced or reproduced, or ‘used up.’ Above all, land (and property) is confined by boundaries. It cannot be moved out of Ireland.”

“The supply of credit, by contrast, is elastic and with the help of global central banks and financial institutions can be produced almost ad infinitum by both global but also Irish monetary and financial systems. And unlike land, credit and capital are not confined by boundaries. In our globalised world, capital is highly mobile and its unregulated flows unreliable and unstable.”

“To understand Ireland’s housing crisis we need to lift our eyes from the micro- to the global macro-economy. To follow ‘the Great Wall of Money’ – $453 billion (€390 billion) – aimed at global markets in real estate. Ireland is just one country whose finite and fixed stock of land and property is massively inflated by this onslaught of unregulated capital. The global owners of capital are in a frantic search for safe, high-yielding assets in which to park their capital.”

“House prices have been blasted into the stratosphere, not because of a shortage of supply, but by the excess of a potent propellant – finance. House prices will fall when the propellant is withdrawn – and flows of finance decline. Indeed, there are already signs that globally, capital flows are in retreat. Expect Irish house prices to follow suit.”