One of the frustrating things about personal finance is watching people, smart people, make the same mistakes over and over. Those bad decisions happen at the personal level, then bubble up to the macro statistical level, where they morph together to influence broad economic trends.
That’s why I was shocked, but not surprised, to find that consumers are once again putting real estate at the top of their list of what they think are the best long-term investments. That would be a really good development, if only it were true. The facts are that, when prices are adjusted for inflation, real estate is and has always been a really poor investment. I’m not talking about commercial real estate, where people like Donald Trump made fortunes; I mean buying a home that you occupy through the retail housing market.
After the insane run-up in valuations in 2005/2006, and the economy-crushing recession that followed when the housing bubble burst, I really thought the lessons about debt and real estate would finally sink in. The lesson did sink in, but only for about six years. Once prices started to recover, people once again started seeing a 3 bedroom, 2½ bath pile of bricks and sticks with a tarpaper roof as a source of “equity” in their financial life. The American consumer has happily embarked on the process of “releveraging”, once again running up mortgage, credit card, and auto loan debt.
Outright insanity is once again in full swing, especially in markets like California and Nevada. According to Trulia Trends, real estate prices in Las Vegas are up 60% from their lows, and prices in many markets are now higher than they were in 2006. While there are certainly bubbles forming in many local markets, there are reasons this time around might be different.
Continued Headwinds for Household Formation
Even though the rate of household formation is going to pick up again, it’s coming back from pitch black. Uncertainty in employment, and young people with a crushing burden of student loans, are going to continue to supply a headwind for household formation.
Tighter Lending Standards
Consumer protections, in the form of tighter lending standards, will keep a damper on home prices, at least for a while. Home values in some areas are up 17%, but it already appears as though those gains are slowing down. Tighter lending standards will tend to keep a lid on prices, by limiting the pool of potential home buyers.
All Real Estate Is Local
While prices in very active markets like California, New York, Miami, and other large urban areas are moving into bubble territory, it’s far from universal this time around. In 2005/2006, all 100 of the housing areas Trulia monitors were overvalued; today only 19 are overvalued, and nationally housing prices are still undervalued as viewed through their historical average. If there is another housing market crash, it’s far more likely to be contained within specific geographic areas, and limited in scope. With the new rules in place for big banks, which now have to keep more cash on hand to cover bad loans, it’s less likely that a regional housing crash will turn into massive bank failures and frozen credit markets the way it did in 2008.
While all that sounds like good news, there’s a danger in protecting the economy from the consequences of collective bad decisions. In the late 1920s and early 1930s, when economic morass gripped the nation, people actually starved. That type of hunger, where a true abyss of suffering existed, was a lesson that stuck with us for generations until the early 1980s. Even the lessons of 2008 stuck with us a few years, though it’s wearing off faster this time around.
Today, we have just enough regulation in place to limit the damage if one of our regional housing markets collapses. We’ll be wounded, but not on the verge of a meltdown, like we were in late 2007. Instead of a great crash that we get out of our system, learn from, and move on, we may instead be facing a never ending series of mini-bubbles popping here and there. Each little pop causes pain and weakness, but not enough do the kind of damage that brings about a national awakening.
While it sounds like I’m hoping for another economic collapse, that’s most definitely not the case. All I’m suggesting is that we are stuck in a middle ground of regulation, that will prevent just enough damage to zombify our economy by saddling it with long-term sickness and regional weakness. It’s hard not to wonder if the cure is worse than the disease.