Best of 2006: My Personal Newsletter Post on Buying a House

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Comment on the Economy

This is a general-purpose commentary on the economy. I have not edited it for precise focus on a single topic. Indeed, my purpose in writing it is to bring this blog more up to date on several themes that seem to be emerging in recent articles on the state of the American and global economies.

That said, it seems to me that those several themes are related, and to some extent I have sketched out what I see as that relationship. My decision, in writing this piece, was to use the available time to present several ideas in imperfect form; it was not to present one idea in highly coherent fashion. It is, in short, consistent with this blog’s effort to offer ideas for further thought and development.

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When times change, assumptions get tested. Sometimes the tested assumptions are small ones – that e.g., tomorrow will be sunny, or that I will not catch cold and spend the day in bed. Sometimes the assumptions are larger – that the President won’t be assassinated, or that electricity will reliably come through my outlet to this computer.

We have been assuming that real estate prices would always go up. They are still going up, in some locations. But they are going down in others, sometimes dramatically so. This seems especially likely to occur, not only in markets that got overheated, but also in places where the people doing most of the buying were able to get mortgages only because mortgages were available to virtually anyone.

The rules are now changing. That sort of mortgage is increasingly a thing of the past. So there will be some units – quite a few, I gather – that were built for people on the economic margin, who now will not be buying them. Those people will instead be renting, and as a result will not be taking out home equity loans (as they may well have done, had housing prices continued to rise) with which to purchase things. So that part of business as usual is changing; and the portion of our economy’s planning and investing that depended on it will be hurt.

Of course, as those people become unable to afford their mortgages, their units – again, quite a few, as I understand, amounting to (if I remember correctly) as many as 20% of all mortgages in the United States – will be foreclosed upon. That will not happen if their lenders or the government or somebody gets on top of the problem and figures out some way to keep them in their houses. Which is what should happen, since foreclosed and vacant units are at serious risk of being looted for their wiring and plumbing, and/or may become refuges for drug dealers.

None of these things is good for a neighborhood’s property values. But at present, it seems that foreclosures and vacancies continue to be the dominant theme, among those who cannot keep up with the terms of their mortgages. Apparently quite a few mortgage terms will be reset within the next three to six months, so this should be a highly informative time period on the question of what will be happening to the financial health of banks, neighborhoods, and homeowners.

The tightening of credit, and the slowing growth in paper wealth of homeowners, will combine to reduce the ability and/or the inclination of other homeowners to take out home equity loans that they can then spend. We can no longer assume that the American consumer will continue to drive the world economy. In practical terms, this means that people may not be willing or able to buy whatever they need, whenever they need it.

Already, of course, we cannot buy whatever we want; that is a privilege for the wealthy. We cannot even buy what we need, if need is defined as including health care or a home. Even before the subprime mortgage crisis, few people could afford to own their homes outright. Invariably, they took out mortgages that gave the bank the final say over whether they could remain there if they suddenly became unable to make their monthly payments. But now, as we see, not even the 30-year mortgage is available to a substantial number of would-be homeowners.

People will continue to be able to buy a great number of things they need, along with some they want, as long as they have jobs that pay a decent wage. As the U.S. dollar declines precipitously (and appears likely to continue to do so), there should be a lot of hiring in export-oriented businesses. American goods will become more affordable for people in the rest of the world, so to some extent we will reduce or hopefully even reverse our present enormous trade deficit. It is not clear how much this will occur, however: as long as China continues to peg its currency to the dollar, its exports will continue to be cheaper than ours, for buyers elsewhere in the world.

Moreover, wages paid to those who have jobs may not be sufficient to let them keep buying what they want and need. The decline of the dollar means that things from elsewhere (other than China, at present) continue to become more expensive. That includes oil, a major component in the things that the world makes and in how the world makes them. There is concern that inflation may begin to rise again. I would say it will rise dramatically, over time, as the world’s cautious financial players gradually steer their ponderous institutions toward a new scheme in which the dollar is not the reigning currency. So you may still be making $1,000 a month, or $10,000; but the rising cost of oil and other inputs may mean that other things in your life will follow health care and housing into the realm of unaffordability.

There is hope, among global-scale financiers, that people in other countries (e.g., China and India) will step up and take the place of the American consumer, to buy all sorts of things and keep the world’s people working and making a living. No doubt that will happen, at least for those who are better-off in those places. Consumers in developing nations face limitations, however, that consumers in America did not face during their own heyday. Our sort of consumption may not be able to occur in those places within the foreseeable future.

There are many such limitations. For one, commodities (e.g., gold, copper, oil, iron) are scarcer and more expensive now. It is not clear that those countries will be able to afford, as we could, to run iron (or even plastic) pipes and copper (or even aluminum) power lines as we have done. They are also nowhere near having enough clean water. The acceleration of global warming makes it unlikely that the average Chinese or Indian town will ever enjoy the green lawns and running water now found in almost every American town. If anything, the pace of dirty industrialization in China makes it more likely that that nation will become known, around the world, as a center for cancers, birth defects, respiratory diseases, and toxic foods -- as China lurches, once again, to a collectivist and self-destructive extreme in pursuit of an ideal. Developing countries generally will also tend to suffer increased rates of infectious disease as global warming facilitates the growth and spread of harmful bacteria.

There are other potential shocks whose impact can barely be guessed at present. Terrorism – especially, but not only, Islamic terrorism – has become international, and as such has found unprecedented access to funding and materiél. Criminal gangs now have sufficient wealth and firepower, not only in Latin America but also in some places within the United States, to stand and fight it out with the police. In these and other ways, people with grievances are better equipped, now, to inflict serious damage upon the smooth machinery of government and finance. Equally important, through the Internet they have acquired means of unification and mutual support. In many regards, their movements are intrinsically (even if not expressly) opposed to much of the foundation upon which business as usual rests.

The hope seems to be, not that developing nations will become knock-offs of the United States, but rather just that a growing middle class within those nations will come to have spending power comparable to that which has been wielded by the middle class in the U.S. – that, collectively, there will continue to be growth in the numbers of millions, around the world, who will have spare money to spend on gizmos and modest luxuries. This could happen. But in China, at least, the prospects for such growth will be hampered if, as seems likely, the overpriced Chinese stock market crashes, wiping out the savings of millions of would-be members of the middle class.

Generally, a middle class does not grow in a vacuum. To the extent permitted by law and culture, or mandated by necessity, the rich will feed off of it, and the needs of the poor – the multitudinous poor, in China and India – will drain it. Of course, China and India are booming. But they are starting from an extremely low level. As they move closer toward developing a genuine middle class, they will also see – they are presently seeing – that the benefits are not equitably distributed among the many. Over the long term, nations of haves and have-nots tend, not toward dynamic long-term growth and increased consumption, but rather toward the relative economic stagnation and political instability for which many Latin America countries have typically been notorious.

What seems to be unfolding is a sort of theater, in which people in other countries succeed in developing their own gated communities for their own nouveaux riches, as if to prove that they, too, can be like America. But a story loses its impact on the second telling. China can recreate American lifestyles for some, but at the risk of enormous damage and upheaval for most. It would be interesting to construct an index linking concrete production (China is now responsible for half of all the world’s concrete) and population density to upheaval (China experiences thousands of protests each year). India can try its hand at the same game, as long as it is willing to endure nightmare gridlocks – of traffic and otherwise – as the masses reconstruct the chaos of ordinary American life within a much more densely populated setting. But this does not seem to be a tenable long-term strategy.

Like most smooth-running machines, the global financial machine is vulnerable to slight upsets. It is resilient, in the sense that there will always be people who conduct trade and facilitate business; but its enjoyment of profit rather than loss frequently depends upon small margins and minuscule adjustments. All the calculations go out the window when serious upheaval unbalances the scales; and at present, upheaval is in the offing. Terrorism, the environment, the subprime crisis, the sudden fall of the dollar – these and other sources of radical change can easily alter the calculation to such an extent that many business people will pull in their horns and wait.

What seems increasingly likely, at present, is that the United States will experience what we will call a recession, but what will actually be part of a global readjustment that brings the circumstances of American consumers more in line with the circumstances of other people around the world. That is, we continue to move toward a situation in which we will have our haves, and we will have our have-nots; and except as alleviated by political intervention (e.g., socialized medicine), the have-nots will increasingly experience the living conditions and opportunities of have-nots elsewhere. Seen in this light, the financiers’ hope could be construed as a sense that, in this country as elsewhere, some will be saved for continued participation in the middle-class lifestyle, even if many must be lost. That is not at all a newly accepted sentiment on the financiers' part, but it may be more obvious in the future.

Global finance has been very good for many people for the short term. Over the longer term, however, more is taken than is given in the bargain. People should have homes, period, without regard to who profits from the arrangement. They should not be held under the 30-year threat of a mortgage, much less of a foreclosure. People should have health care. They should retain unspoiled access to the natural environment that has been with us for all of human existence. They should have clean water, period – even if that means that some businesspeople will not be able to create factories and to give all community residents daily exposure to carcinogens (along with the jobs that may be available, until economic circumstances change, to a fraction of the community’s residents). People should live in communities, period – not in isolated collections of competing residences designed and located so as to facilitate profits for homeowners, realtors, bankers, or employers.

Those, anyway, are the sorts of sentiments that tend to matter to people – especially to the have-nots, who are acutely aware of what they lack, and who do their best to reconstruct it in other terms as circumstances permit. A growing economy can be seen as a movement in its own right, one that succeeds as long as it resonates with enough people to keep it on track, and as long as it does not so seriously offend those whom it excludes as to inspire them to sabotage it. Beyond a certain point, however – as attested by the rise of armed criminal gangs and Iraqi suicide bombers – the human search for hope will drive people to seek out their own routes, authorized or not, toward something that they can consider an achievement.

It seems, in short, that we may be entering a period in which all sorts of financial assumptions – including some that have not been so good for us – are tested by many rapid changes around the world. It is entirely possible that increasing numbers of people will become, and remain, convinced of the superiority of business as usual. In that case, the testing of financial assumptions may yield only a relatively mild continuation of adjustment to new circumstances within the next several years.

It is also possible, however, that we are just at the start of an epochal transition, out of the American century into one that will be almost unrecognizably different, where the assumptions underlying American consumerism become radically rethought and retooled. Of course, business will (and should) seek to keep up with such changes. The point here is just that economic and consumerist forces (as we know them) may not be capable of accepting and adapting to the remarkably different attitudes that people of the future may have toward economic matters. To the extent that occurs, it may well develop that politics, religion, or other sources of power come to eclipse money as the guiding source of ideals by which people live their lives and direct their energies -- in which event "recession" will be an understatement and/or a misstatement of what develops.

Speculation on Home Prices

The real estate news is bad. Some are now saying it will be 2009, at the earliest, before property values recover. Apparently the tax base for cities is eroding because of the decline in home values and the rise in foreclosures. An ordinary house is an expensive thing. Not just in terms of what it costs, but also in terms of what we take for granted about it. In that regard, four basics are lately coming into question: financing, transportation, public services, and water. On the financial front, house prices have risen because we have had money, and have been willing to spend that money on our homes. We have had money, in the earlier years, because America was a rich country and getting richer and, in the later years, because foreign investors could make money by lending their money here. That second tenet is now failing because the value of the dollar has been falling. They say that a foreign investor -- an Asian investor, say -- who invested in the stock market in 2000 has lost money, despite the Dow's rise, because the dollars in which stocks are priced have lost so much value. The dollar fall has not stopped; indeed, it may have a ways to go. Thus, foreigners are increasingly looking to invest elsewhere. Transportation becomes an issue when people cannot afford to get to the place in question. As long as the money is there, the government can keep building highways, people can keep buying cars, and cars can keep burning gas. This piece of the puzzle is still in place. But gas is becoming more expensive as it becomes rarer for us (you don't find much oil in the Quaker State anymore). Hopefully the experts will develop vehicles that run on alternate fuels -- hopefully other than biofuels, which entail the questionable water- and (for some countries) starvation-intensive prospect of, basically, burning food. But it still costs money to build highways, and rising numbers of people still have to jostle for space on increasingly congested roads. In the long term, we would have been further ahead if we invested in mass transit. But the point here is that there are limits to urban sprawl. One, long known, is that people won't drive five hours each way to work. But another, less familiar, is that suburbs may not keep expanding outwards forever. At some point, there may be a frontier where you are essentially gentrifying -- where you are buying a piece of land that, in the past, was not used for purposes of housing your kind of people, and you are betting that it will be continue to be used for that purpose in the future. And some of those people on the fringe, in some places, may have bet wrong. The ability to build highways goes along with the ability to provide public services generally. Again, as long as the money is there, there is no problem. But cities are running into difficulty now. Their tax bases are taking a hit because of the drop in house prices and the rising number of foreclosures. Empty houses don't generate tax revenues, in which case cities can't provide everything we have gotten used to. With fewer people paying property taxes, and those taxes not rising at the expected rates, cities will have to increase fees and taxes if they are to keep providing the services we expect. For each additional $50 per month of property taxes and other service fees, there will be some people who are priced out of the housing market. So the drop in the tax base may have its own self-perpetuating dynamic to some extent: as fewer pay, costs rise, so even fewer can afford to pay. Among those public services, water is particularly worrisome. There is not enough of it, and there will be less. Even if the cities could continue to afford to supply the same levels of services, there have to be the resources for them to supply -- the water, in particular, but to an increasing extent the electricity as well, particularly during peak periods. There is no long-term plan in place, at present, for resolving the nation's (never mind the world's) shortages of water, electricity, or, for that matter, food. We have largely squandered the opportunities we have had to take leadership in such matters during the past two generations. It will be harder for us to do so in the future. China will run into extreme problems along these lines before we do, but we will have those problems too; and to the extent that China owns us, there may be some very interesting deals made in the future. Most likely wars will be fought for such things, and they will not always be wars involving uniformed armies. If you are a homeowner, you are valuable to the wealthy people only as long as you continue to be a vehicle for production of wealth. The system on which you have been that sort of vehicle is now undergoing extensive modification. Your house is becoming a less reliable way of creating transactions in which realtors, lawyers, bankers, et al. become wealthy, and that means that your own value is declining: you are no longer capable of serving as a conduit for the generation of wealth through the automatic operation of a system of rising house prices. If you are to continue to have value in this system, you must achieve it by having stable, good-paying employment and an ongoing ability to make your house payments. Of course, you may still be vulnerable to a decline in your home's value, to the point that some people will be working to make payments on a combination of mortgage and home equity loan that puts them under water. In other words, some will ask themselves why they are struggling to keep a house that's worth less than they owe on it. Regardless of your own stability, your operative assumptions will continue to mutate as your neighbors ask themselves questions of this sort. The time to buy is when nobody wants the thing you are buying -- assuming, of course, that they will want it later. The time to sell is when everyone wants the thing you are selling -- assuming that you won't then have to turn around and buy it back at a higher price later. When *everyone* was buying a house, when it was *obvious* that everyone should buy a house -- that was the time to sell. People will be buying shelter again in the future. It is not yet clear what form of shelter will be most attractive. Resource questions will likely influence this issue.