One of the most vocal proponents of the Chicken Little philosophy of real estate
is John R. Talbott, who in 2003 wrote the best selling book The Coming Crash
in the Housing Market. His new book Sell Now! The End of the Housing
Bubble was published this year and has occasioned a lot of press and a
certain amount of hysteria.
Talbott states in his introduction that, at the time he wrote his first book,
home values nationally, adjusted for inflation had increased almost 61 percent
from 1981 to 2003 and he admits that prices have increased an additional 35
percent since his book went to press.
So those who listened to him last time and followed his advice are probably
not terribly thrilled with his visionary skills. Was he wrong the first time,
or just a little early? Who knows, still he has some interesting approaches
to the issue of the housing bubble
- ideas that fly straight
in the face of the "soft landing" theories being promoted by those with a dog
in the fight like the Federal Reserve, and the National Association of Realtors.
He admits that he has allowed his anger and bitterness to enter his writing
style. "I decided," he says, "that these emotions were a very real part of the
story... By including these emotions in the narrative, I try to bring the reader
closer to the underlying truths in this tale."
And what are the underlying truths? Talbott puts forth a number of candidates,
a few of which we will try to explain here and enough data, graphs, and charts
to fill a full semester of Econ 101 lectures. Some of his ideas, such as the
tax shield he believes is responsible for some of the appreciation starting
in 1980, are best read about in their entirety (which are weasel words for "we
don't really understand it either.")
Some of his thoughts, however, are intriguing. First of all, he maintains that
the bubble is more of an anomaly than has been commonly believed. While the
Conventional Wisdom holds that housing prices always go up, with few historic
downward adjustments, Talbot maintains that house prices remained remarkably
flat for the 100 years preceding, 1996 if those prices are adjusted for inflation.
The only dramatic change was a substantial depression in prices from the end
of WWI to the end of WWII.
Housing prices began to rise in the late 1960's and then took
off around 1980, but Talbot maintains that until recently most of this increase
was inflation driven. During the period 1980-85 house prices did not even keep
up with inflation, rising about 21 percent while the inflation rate was about
30 percent. From 1985-1990 inflation and house price appreciation ran neck-in-neck.
In the next five year period ending in 1995 inflation ran slightly behind house
price increases, about 18 percent against 20 percent. But in the 1995 to 2000
period house prices rose at a rate nearly double that of inflation and between
2000 and 2005, with inflation fairly well dampened down by federal monetary
policy, house prices went nuts, appreciating at around 50 percent
nationally as compared to a modest 12-13 percent in overall price increases.
So, if he is correct, then the tremendous price increases of the last ten years
amount to not only more of a housing bubble than previously thought, but more
of a fragile bubble; one without an awful lot of logic behind it or technicals
to support it.
Talbott offers a number of reasons for the increase in home prices.
- People see great value in their homes or they would not agree to pay
the high prices;
- Prices can only increase in the face of adequate financing;
- Construction of new homes is restrained by strict zoning limits and/or
the availability of land for such construction;
- Real estate fits very nicely into the "traditional Ponzi-like model of pyramiding
profits until the game runs out".
His second point, that prices can only increase in the face of adequate financing,
leads to one of his more interesting theories and one that may exemplify the
anger and bitterness he confesses to early on; that there was a conspiracy
involving the nation's banks to largely shift interest rate risk from lenders,
who traditionally assumed that risk, to homeowners. He states that former Federal
Reserve Chairman Alan Greenspan quite deliberately misled the American public
about the safety and wisdom of adjustable rate mortgages in
pursuit of this goal and that aggressive banks fueled house price increases
by progressively lowering lending standards. Further, he faults Congress and
government regulators for failing to provide oversight of the banking system
and especially of Freddie Mac and Fannie Mae.
His rationale behind this claim will probably strike a chord with many people
in today's political climate. He maintains that, while the Fed chairman is appointed
by the President, his actual allegiance is to the 12 regional Federal Reserve
Banks which are controlled by the nation's large commercial banks, and, with
interest rates at historic lows, banks were taking on risk with each 30-year
fixed rate loan they wrote. By convincing people to take variable rate loans
the risk of rising rates shifted to the homeowner. The FDIC, likewise, primarily
regulates banks not to benefit consumers but to protect the bank insurance fund
into which the banks pay. And Congress, he maintains, is reluctant to insist
on greater oversight of the housing industry, banks, and Freddie
and Fannie because these are the big contributors that fund their election campaigns.
So, if we accept Talbott's theory that the hosuing bubble is much larger than
most "experts" believe and that all good things must eventually come to an end,
what will happen when the situation begins to unravel and where will it all
end. Talbott not only paints a pretty detailed picture of the process but actually
projects where prices will end up in five to seven years in dozens of metropolitan
areas. It is sobering stuff and we will try to briefly summarize his findings
in a second article.