Wednesday, August 29, 2007

Home prices, stocks: What goes up, must come down, then up again? A sine wave?

“Real Estate” is supposed to increase in value forever because, in theory, the amount of available land is finite. Now, that isn’t exactly true as high rise buildings sell condos (Donald Trump loves to talk about “air rights”) and as Dubai builds artificial islands that could get wiped out by a rise in sea level.

Despite all the pundits who claim that you must own a home to become financially respectable, real estate has been subject to ups and downs like everything else. In Texas, in the late 1980s, it plunged as oil prices dropped after the Saudis were jawboned by the Reagan administration into increasing production. Various land scandals were exposed, leading to a savings and loan crisis than are now part of long memory. A nice townhouse that I bought in 1984 in Pleasant Grove in Dallas, VA, for $39990, plunged in value into the teens and didn’t climb out of it until sometime in the 1990s. Earlier in the 1980s, conversions had been popular in North Dallas; some of them made a profit for their sellers in the early 80s, but then would plunge and even be back-converted into garden apartment complexes.

There is a lot of technical discussion of jumbo loans (the threshold magic number of $417000), subprime loans, combinations of those. But there has always been a structural problem when a market encourages consumers to get something for nothing, particularly in the context of reinforcing societal roles of family providers. I can remember that up through the 70s, saving for a down payment (which could wipe out a cushion of net worth) was considered a financial virtue for a young family. We had a period of low interest rates, no down payments, sometimes no credit or job check – so what can one expect? Eventually, as Isaac Bentov wrote in a 70s modern physics book, the wild pendulum must be stalked. Is that cube of space that is somone’s one bedroom condo really “worth” $500000 as a consumer item. Get real.

Les Christie has a Chicken Little “Sky is falling” story “Home prices: No relief on horizon: The S&P Case-Shiller Home Price Index says price declines are worsening, with no sign of slowing down. Link here. This is now supposed to be the biggest drop in home prices since the Great Depression.

The talk is that it is all about investor behavior. You know the adage. If interest rates rise, yields rise, but the value of bond funds falls (and I have some of them). I don’t know if the two countering forces balance out.

But the biggest worry is the underlying financial unsoundness. Consumers suddenly have much less net worth (sometimes negative), and as in the late 80s, some could face deficiency lawsuits after foreclosures (maybe even for those who sold properties under unqualified assumptions, which are not supposed to be allowed any more), and be forced into bankruptcy, and even that has been made tougher. This does sound dangerous. The IRS will tax forgiven foreclosure deficiencies as ordinary income.

You pre-calculus students, school is starting. (Yup, I've taught math before. Maybe again.) Go to the trigonometry textbooks and study periodic functions. Stocks and real estate prices seem to make good examples.

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