walkitout (walkitout) wrote,

Some Speculation (ahem) About the Housing Bubble

Prior to the really bad inflation of the 1970s and the traumatizing efforts to reduce that inflation of the 1980s, my parents bought a suburban ranch house. My father worked as a union electrician, mostly in new high rise commercial construction in downtown Seattle, so he wasn't a one or two guy shop. He had a nice wage, some benefits, and an organization (to which he paid dues) which did the negotiations for him. Sweet deal, because his real wages stayed level or rose, while his real costs (payments on the house) dropped like a rock as inflation ate away at the debt he owed. My father was smart enough to understand that selling that house to buy a bigger house for his growing family was Stupid; he built on a second floor with two more bedrooms and a bathroom instead, doing a lot of the work himself and hiring people he knew for the parts that required additional hands or skills he was weak in.

The experience of my family was not uncommon. I know dozens of people whose parents "lucked out", buying a house with a 30 year fixed rate mortgage of 6% or lower in the late 1960s, and then refusing to move or refinance thus enjoying fantastically low housing costs (I suspect by the late 1980s they were paying more in property taxes than they were on the note payments). They ultimately paid off the mortgage early, because they were paying so little interest that the tax deduction didn't get them anything.

For most of my life, I thought of this as Awesome, and a reason not to fear inflation.

But for people who had to sell and move, the 1970s were awful and the 1980s worse. House prices did all kinds of bizarre things. People moved from California to Seattle and brought an enormous amount of money from the sale of their house in California thus raising prices in Seattle because what they thought was a screaming deal was in fact a seller taking horrible advantage of them -- but then that became the new normal and everyone was paying higher prices for housing. That didn't happen to my family, but I knew a lot of people who felt the impact, and at least into the early 2000s, California plated cars in Seattle were at a high risk of being keyed because of the long-standing resentment this phenomenon incurred.

Very high interest rates encouraged all kinds of mortgage "innovation". The efforts to bring down inflation in the 1980s resulted in extremely volatile interest rates. ARM mortgages tied to those rates meant people who had one of those mortgages had no idea what their payments were going to be.

One of the reasons entrenched inflation isn't "safe" is because everyone starts to "expect" more of it and then plan accordingly. This tends to lead to an acceleration in inflation, and then fleeing to alternative stores of value/forms of currency. It's not easy to identify at what point inflation becomes a problem, but it's safe to say that if people are really happy to take on debt, because they expect it will be inflated away and their wages will be adjusted to keep up with the general rise in prices, you've got a serious problem.

The long-run manifestation of 1970s inflation, I suggest, is the idea of the family house as something you pay way too much for (expecting it to be reduced by time), because you'll be able to afford the payments better later as your wages rise (expecting your real wages to remain stable), and then retire and live off the results (using the house as an alternative store of value). There was a point in time when this strategy was brilliant, but here's the thing about inflation expectations: they tend to hang on around a little too long. When prices are stable, people don't take seriously the beginning of a rise in prices because they expect them to drop again (and they may ignore a drop because they expect a rise again). When prices are rising, they expect them to keep rising -- you have to make them fall for a while, or do random things for a while, to get their attention. When prices are falling, they expect them to keep falling (that's the worst, because then no one wants to do _anything_, and everything grinds to a halt).

We beat inflation expectations out of grocery stores and car dealers a long while ago. But we didn't beat them out of housing, so people kept buying too much house, thinking it was a safe store of value (prices will ALWAYS rise! and the debt will become more affordable over time).

I think some of the housing bubble was baked in by the inflation expectations of our youth, reified as a "financial management" strategy, and then everyone complained that the "real" problem was stagnant wages. Someone must have noticed this, right?


ETA: http://www.unc.edu/depts/econ/byrns_web/Economicae/typesofinflation.html

"For example, investors who speculated that California real estate prices would continue on an upward trend that had lasted from 1946 into the 1980s were often bankrupted when housing prices plummeted in the early 1990s."

You know, it's one thing if you _realize_ what you are doing is betting on an inflationary rise. It's a whole other thing when you think you are pursuing a conservative financial life plan.

Still reading this one:


But it looks promising. It takes into consideration generational cohorts, which is promising. I left out of the above story all the people from pre-war generations who lost their shirts because inflation wiped out the value of their bonds (something presidents like Truman were terrified of seeing happen, because they'd seen it in _their_ youth).
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