Saturday, June 5, 2010

Will Home Prices Go Up Cause They Always Have

I hear the argument real estate will now rise because in the long term it has always risen. Now I know prices just don’t rise, just because, there are fundamental reason why that is the case.

During the US bubble it is easy to see one of the largest contributors to home price appreciation was loose lending standards. The loose lending standards meant more money chased a scarce good pushing up prices.

There were also additional fundamental reasons why home prices rose. The economic foundation of the country must be set up to support higher home prices. I think it is best to look at two time periods in the post war. The 1945 to 1981 and 1982 to 2006.

During the first time period the US was a net exporter of goods and services gaining wealth from the rest of the world. The population was young and received few government services. While there was a high marginal federal tax rate there were many deductions leaving the US with a fairly low tax burden. State tax rates were much lower and states like NJ and CT did not even have income taxes.

During the 1982 to 2006 the US became a net importer of goods. Factories across the Midwest closed down as the nation chose to import the goods. Where did the income come from to push up home prices? This is an easy question to answer: the US borrowed the money. Prior to 1982 most people in the country did not have credit card, car loans were not 72 months, and 20% down payments were needed to purchase a home. This all changed during this time period. In the finals stages as the country and individuals ran out of money the government guaranteed the loans as long as there was a home attached to it.

The states that benefitted the most from the change in the US economy were Cal, FL AZ, NV, NY, and NJ. In the NJ and NY region the financial services industry grew in order to help foreign creditors invest in the US. Paul Volker noted financial services contribution to GDP increased from 2% to 6%. The Sand States benefitted as former factory workers flooded to warm weather states and much of the borrowing from the rest of the world was transferred through NY and NJ then invested in homes and hotels in the Sand States.

How does the current state of the economy compare to the previous two periods that allowed for home price appreciation. It appears quite different:

· Consumer credit is declining

· Tax rates are rising

· The population is aging and the young are being asked to support their seniors

· Foreign creditors appear unwilling to lend unless there is a government guarantee

· Regulations being placed on the financial services industry may reduce employment opportunities in the NY and NJ region

The current foundation seems quite different than the economy of the previous 60 years. Prices could rise but it seems unlikely unless there are larger government subsidies or a hyperinflation. Sadly the hyperinflation does not seem out of the realm of possibilities when the policies of Obama, Geithner, and Bernanke are considered.