Connecting the Dots

I love economists. They can accurately predict anything-about 50% of the time. They can break down and provide insightful analysis of any set of meaningful or meaningless data. For example, as a group they predict with a 95% certainty that the sun will rise again tomorrow. And, if they are wrong…

The problem with focusing on certain sets of data is that you can easily miss the whole picture. The whole picture is driven by a common sense that connects one issue with another. For example, let’s take the housing bubble. I think by now everyone can acknowledge there was a housing bubble.

However, as little as 12 months ago there were economists that were adamant in their forecasts that there was no housing bubble, or, at least, that it existed only in isolated pockets. The caveats to this assertion were that no bubble would exist as long as housing demand was sustained and there was a continuing availability of ready financing.

The problem of this assertion, of course, is the connection of the dots between sustainability and affordability. Potential problems begin to exist when the median price of a home is affordable to the average household income of less than 20%. In my opinion, when the median price becomes affordable to less than 15% of the population, unless there is a degree of scarcity, it becomes unsustainable.

In order to get back on the track to sustainability one of two things needs to happen: 1) median household incomes need to rise, or 2) the price of the median home needs to decline. If median household incomes need to rise substantially, it can only come out of profits or rising costs of goods and services, which is inflation. If the market cannot support diminishing profits or rising costs, then the median price of a home must decrease.

The two things that pushed the median price of a home to unsustainable levels were speculation and liquidity (debt) that was too easy to acquire. Successful speculation is simply a matter of market timing and has nothing to do with sustainability. The easy debt situation was the vehicle that primarily created this bubble and what is causing the major correction we are in now. I doubt you will find any reputable economist that will tell you that 1% adjustable financing for someone that does not have income to support their debt and has no money down on a house is sustainable. The unreasonable and unsustainable “sub-prime” and “Alt A” financing has gone away for good and exposed the real problem of affordability.

Unfortunately, it is time to pay the piper as there is no real “new economy.” Whether it is producing housing that is affordable, commercial and industrial space that generates a reasonable rate of return for its risk, or retail space that can be supported at high rates of occupancy by affordable lease rates, the real estate market needs to return to fundamental values in order to be sustainable and not purely speculative. So, when I get asked how long the real estate market will continue its downward trend, my answer is until it returns to sustainability or economists forecast differently and help create another speculative bubble.