Tuesday, July 12, 2011

Housing's Misplaced Role in Personal Finance

Robert Bridges, described as "professor of clinical finance and business economics at the University of Southern California's Marshall School of Business," wrote a very useful editorial in yesterday's edition of the Wall Street Journal entitled A Home Is a Lousy Investment.

I found, as I read his piece, that much of what he contends meshes well with some of the points I made in this July 4th post.

Bridges begins by providing some factual evidence that homeownership in a state once considered home to many Americans who grew prosperous with the nation's and state's economy has actually been a comparatively bad deal,

"Between 1980 and 2010, the value of a median-price, single-family house in California rose by an average of 3.6% per year—to $296,820 from $99,550, according to data from the California Association of Realtors, Freddie Mac and the U.S. Census. Even if that house was sold at the most recent market peak in 2007, the average annual price growth was just 6.61%.

So a dollar used to purchase a median-price, single-family California home in 1980 would have grown to $5.63 in 2007, and to $2.98 in 2010. The same dollar invested in the Dow Jones Industrial Index would have been worth $14.41 in 2007, and $11.49 in 2010.

Here's another way of looking at the situation. If a disciplined investor who might have considered purchasing that median-price house in 1980 had opted instead to invest the 20% down payment of $19,910 and the normal homeownership expenses (above the cost of renting) over the years in the Dow Jones Industrial Index, the value of his portfolio in 2010 would have been $1,800,016. The stocks would have been worth more than the house by $1,503,196. If the analysis is based on 2007, the stock portfolio would have been worth $2,186,120, exceeding the house value by $1,625,850."

Note that Bridges provides data on end values before the recent financial crisis destroyed so much California residential real estate wealth.

If you argue that California became a less-desirable state in which to own a home over the period, that, too, is evidence. Who, nowadays, can predict a state's spending and taxation climate over 30+ years? Or even 20 years?

My current state of residence, New Jersey, went from a fiscally more responsible neighbor to New York to one of the nation's worst economic disasters from 1970 to today.

Bridges continues, based upon his knocking the supports out from under the 'housing as investment' argument, to ask why we, as a nation, are so preoccupied with housing as an driver of our economy,

"In light of this lackluster investment performance, and in the aftermath of the recent housing-market collapse, why is there such rapt attention to the revival of the homebuilding industry and residential property markets? The answer is that for policy makers whose survival depends on economic recovery, few activities have such direct, intense and immediate positive economic impact as new home construction.

Home values may gain value over time, but home equity is locked-in until the house is sold. The profits may then be reinvested or spent, creating significant stimulative effects, but usually this happens when market conditions are strong, exacerbating unsustainable market booms. When troubled assets are dumped, or when defaults occur during weak market conditions, the trough is deepened.

Housing markets may be forever doomed to cyclicality for many reasons, but public policies that stimulate new construction or home purchases by tax and financing subsidies, reduction of qualifying incomes, buyer credits, mortgage backstopping, and preferential zoning and permitting, only intensify these cycles. Efforts to reduce loan balances and to create special rescue programs have reduced the security of loans, challenged the enforceability of contracts, and driven up real borrowing costs. Nearly a third of our states do not allow lenders the recourse provisions necessary to go after a borrower's personal assets in case of default on a residential mortgage. The sanctity of mortgage obligations has become the rough moral equivalent of the 55-mile-per-hour speed limit."

Next, Bridges debunks the myth of home as emergency piggy bank,

"There is also a misconception that paying off a home mortgage is a path to financial or retirement security. The reality is that tapping the equity is expensive: Home-equity loans or lines of credit made with low qualifying incomes often command high interest rates and costs. If an emergency occurs—the loss of a job, or a business setback—it's likely that the same conditions creating the problem will lower the value and impede the marketability of the home and curtail the availability of financing for a buyer. Funds set aside for emergencies should always be liquid assets."

Having cast serious doubt over the wisdom of homeownership, Bridges then directly asks,

"Is it wise for coming generations to continue to view ownership as the cornerstone of personal finance? Young people planning for retirement increasingly face a choice between house payments and contributions to retirement accounts. They simply can't afford both. With the specter of looming cuts in Social Security and other entitlement programs, or even possible systemic insolvency, the challenge for tomorrow's retirees is income self-sufficiency.

A nation of house buyers becomes captive to the economic cyclicality caused by bursts of construction activity, and it is not lifted or sustained by the limited levels of service employment related to existing housing. By contrast, a nation of business startups and investors supports our capital markets and creates long-term employment, income, exports and the myriad technological advancements desperately needed by an expanding American society.

New home construction and the markets for existing homes should be recognized as activities secondary to, and dependent on, employment. Healthy job markets create healthy property markets, not the reverse. Housing demand driven by job growth creates conditions capable of sustaining a stable level of construction employment, attracting private equity investment, sustaining competitive private debt markets, encouraging capital growth, and ensuring the lowest possible housing prices."

The observation that "healthy job markets create healthy property markets, not the reverse," is, I believe, more important historically than Bridges realizes.

Much as I contended in my recent, linked post, that much bad US social welfare policy was posited on a brief, passing period of economic hegemony from 1945-75, so, too, I realized, after reading Bridges' excellent piece, has been US housing policy and beliefs thereabout.

For, contemporaneous with returning GIs, the rise of suburbs, etc., after WWII, was the new phenomenon of widespread middle-class ownership of non-farm homes.

I read an editorial in the Journal sometime within the past two years which contrasted US cities having advanced technology jobs with those having more blue-collarish, heavy industry employment. This isn't an exact list, but the former included San Francisco, whereas the latter included St. Louis and Cleveland.

What the author found was that homeownership was associated with cities having older, more industrial job bases. In effect, employees of high technology firms expected to be more mobile and, thus, didn't bother to own homes in as high proportions as blue-collar workers.

Could it be that much of our American view of the importance, the near-necessity of homeownership, result from a short period of just 30 years after WWII, when so many middle-class, blue-collar Americans enjoyed the fruits of the nation's unchallenged economic supremacy?

I did a little informal survey of friends last winter. All are college-educated and work in white-collar jobs. I asked what their grandparents did for work, and in what sort of homes they lived?

Without exception, most grandparents were not college-educated and lived in rental housing. One of my friends had a grandmother whose lumberjack husband was crushed to death on the job, requiring her to become a maid and laundress to support her children.

The mythic imagery of poorer, less-educated ancestors sacrificing so that future generations could own homes as a major part of "the American Dream," is, I believe, a curiously materialistic side-effect of a temporary period of American economic power.

It takes little thought to see that education is the most valuable asset a person can ever possess. It's portable, can be applied as creatively as the person to whom it belongs and, once acquired, is never truly lost.

Physical homes are different. They are, in truth, expensive luxuries in an unpredictable world. As investments, they are lumpy, costly to buy and sell, and require constant, expensive maintenance.

How we got to the point of subsidizing those who could barely afford to own homes is less a mystery than the continued misguided conclusions of Americans and their government, from 1945 onward, that the nation had come into some sort of economic and financial Promised Land of eternally rising living standards. In short, the exception became the norm, became the expected birthright of employed, educated Americans.

Bridges ends his piece with this passage,

"Owner-occupied homes will always be the basis for healthy and stable neighborhoods. But coming generations need to realize that while houses are possessions and part of a good life, they are not always good investments on the road to financial independence."

I would go further. Owned homes may be "part of a good life," but, more correctly, they would be part of "a good, predictable, dependable economic life."

Otherwise, they are a cursed millstone. I suspect that while land or judiciously-chosen investments in rental properties would be good investments, homes, generally, across all economic eras, are not. And won't be in the future.

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