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Real Estate To 2016 and Beyond

by Alan Noblitt on November 4, 2011 · 7 comments

  
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A bit of good news this week:
* The Wall St. Journal (11/3/2011) reported that “the nation’s seasonally adjusted home-ownership rate stood at 66.1% in the third quarter, up slightly from 66% in the prior quarter” and “suggesting a three-year decline in home ownership may be starting to bottom out.”

* Consumer bankruptcy filings fell in October for the fourth straight month (WSJ, 11/3/2011)

Awww, but what’s this:
* October home prices were down 3%, which means 13 straight months of year-over-year declines, as the flow of distressed properties continues
* The average student loan balance for 2010 college graduates was just over $25K (WSJ, 11/3/2011).  They won’t be buying a house anytime soon … or even renting one unless they can find good jobs
* Freddie Mac lost $4.4 billion in Q3, drawing another $6 billion from Treasury funds

Oh yeah, Ben Bernanke and his pals at the Fed discovered what everyone else already knew, namely that unemployment will remain high and economic growth low for several more years regardless of what fiscal knobs and switches that the Fed fiddles with.  Someone there apparently feels that the $1.25 trillion in purchases of mortgage backed securities was money well spent, so they are considering buying more.

Economic events and government shenanigans that I read about each week only reinforce the predictions that I made last week.  However, I did enjoy reading the responses to that article.  Some savvy investors are clearly able to take advantage of hidden opportunities to increase their wealth.  Others expect a quicker economic recovery.  Let’s drill down on two major issues affecting the real estate market – jobs and the U.S. debt.

Jobs Anyone?

Obviously, people without jobs or those making just enough to get by clearly cannot buy houses.  Even people who want to move up to larger houses because of expanding families or for other reasons often are unable to do so, either because they cannot afford it or because they can’t sell their old house.

The U.S. job market seems to be going through a milestone transition.   Over the past century, America went from having over 1/3 of its jobs in farming to just 2% today.  Most of the difference went to manufacturing.  More recently, as technology allowed for fewer employees to do the same amount of work and as lower-cost countries took over much of the remaining work, manufacturing has become a smaller part of U.S. GDP.  The U.S. successfully transitioned from being primarily agricultural to primarily manufacturing-based, but it is not clear what the next phase will be.  So called “green jobs” don’t seem to be the answer, so the middle-class and below will continue to struggle to raise their average wages.

On the debt side, U.S. spending is out of control.  In the early years of our nation, the U.S. ran surpluses almost every year.  There were sharp increases in debt during times of war (from the War of 1812 through WW II), but generally the country paid back these debts and was fiscally prudent.  Then, from 1965 on, U.S. aggregate debt grew faster than GDP.  When President Nixon took us off of the gold standard, it completely loosened the ties between the U.S. dollar and anything of value.  Since 2003, the debt has increased by at least $500 billion every year, with deficits of over $1 trillion during the past three years.  U.S. debt is now approximately equal to annual GDP at $15 trillion, the largest in the world.

Interest payments on the debt totaled $414 billion in fiscal 2010, and would have been higher if not for low interest rates.  Imagine how many ways that money could have been spent on a better social safety net or to improve our infrastructure!  About half of that $414 billion goes to foreign countries like China and Japan, so it is gone forever. 

This affects real estate in many ways.  Interest rates will go up and inflation will kick in within the next 3-4 years (in my opinion), which will further reduce the pool of potential buyers.  The number of buyers will shrink further if the government does away with the mortgage interest deduction either fully or in part, as has been recommended by several deficit commissions.  Generally confidence will wither away for many otherwise strong buyers.  One analogy I like is that having the large debt is like driving the economy with the emergency brake on.  Real estate and the general economy are least temporarily joined at the hip, and the road ahead looks bumpy.

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{ 7 comments… read them below or add one }

phil gainey November 4, 2011 at 4:57 pm

Alan,

Good article.
The same points you made were put forth on a BP forum many months ago. Namely, how the fed has enabled budget deficits pretty much every year since 1965. Prior to that, we only deficit spent in times of emergency (wars…etc.). Also, how this could only have been done by getting off the gold standard. Of course, the poster got a bunch of knee-jerk pseudo intellectual reactions by some people who think the current system works.

PG

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Alan Noblitt November 6, 2011 at 11:15 am

Phil,
I have received a mixture of feedback from my posts last week and this week. Good to know that another person voiced the same opinions on the forum, though I am not aware of that posting.

Thank you for your good feedback.

Alan

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Kyle Hipp November 5, 2011 at 11:44 am

The US has had about 7 times in its history were the government ran a surplus for some time. Each followed by a depression and now our current ressession following the 90′s surplus. When Nixon took us off the gold standard completely our form of currency changed from a convertable currency with constraints of precious metal value to now a free floating fiat currency. The neo-classical economics that are taught and widely believed are unquestionably inapplicable in today’s economic world.

Alan, I believe your metaphor was backwards. When the federal government “deficit spends” they are actually gassing the car of the economy the break is actually cutting spending wether that be spent on programs, wars, or tax increases. Taxes actually destroy money and money’s value is derived from its relation to inflation and standard of living. People through out that since 1913 the dollar has decreased 95% but this is only a part of the story. Does anyone believe for a second that our standard of living has decreased, I believe it has increased many many times.

Lastly as for your comment on interest on treasuries going to China and Japan. I ask what can China and Japan with US dollars? They must spend it in something sold in US dollars, yes there is leakage in oil and gold but primarily they have to purchase Treasuries. The US recieves real good and services from China and they get paper money with limited use essentially forcing them to purchase Treasuries. What would China do if the US refused to sell treasuries to China. That money would be largely worthless to them. The US could take monetary actions to satisfy the current law on its “financing” and China’s currency would appreciate because their would be no other choice.

Until our leaders understand our monetary system and its operations our economy will continue to stagnate, at the global level as well. As we hit the 7 billion level for population, look at that and how it compares in growth rates through the years to the level of currency in the world. We are not out of control just hugely ignorant of the possibilities in the world around us.

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Alan Noblitt November 6, 2011 at 11:19 am

Kyle,
You’re technically correct that the U.S. has run a surplus about seven times, though those were fairly long stretches of time. Those surpluses usually ended in times of war.

I would respectfully disagree that deficit spending gases the economy. Yes, it provide short term benefits but at a longer term higher cost. The interest on that debt is starting to affect how we can spend on other priorities.

Always good to hear your comments, so thank you.

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Kyle Hipp November 6, 2011 at 1:52 pm

For the last 60-70 years their have been nearly all deficits outside the late 90′s, which didn’t do much good.

I believe firmly that the biggest problem to our solving the problem is we are framing the problem wrong. Its like saying the hood of my car gets really hot if I have the car on for more than a half hour. So we get to work painting the hood a reflective color because it will not absorb the heat from the sun as easily. That doesn’t work so they add another line from the windshield wiper tank to spray on the hood every 5 minutes to cool it down. The thing is that they never realized that 1. The heat is not a problem to begin with and 2. The heat is actually coming from the engine below thw hood.

We all think that the government must run like a household or a business but the federal government which is the sole creator of the US Dollar their role is completely different than a business or household.

It is all about sectoral balances. If the public sector profits, it takes assets out of the private sector. So if the federal government were to run a balance budget right now the minimum that would happen is that the private sector would lose the cumulative of the trade deficit that we have with other nations. Mathmatically the only way to have a growing economy with a trade deficit is to also have a federal deficit. This really takes a long time to get it because it doesn’t make sense based on what we have always thought was correct but once I got it I understood all those things I took for granted but couldn’t explain before. For example, the crowding out theory that the government selling treasuries blocks private investment. Treasury bonds are private sector savings. Have you ever heard someone say, ” man, I really wish I didn’t have these treasury bonds so that I could invest in “X” business or idea.” I never have because treasury bonds are extremely liquid. Also when you look at the federal “debt” a large portion is intergovernmental debt.

Here is an article by stephany kelton. She explains the sectoral balance basics very simplistically, even leaving out the trade balance portion for the time being.

http://pragcap.com/what-happens-when-the-government-tightens-its-belt

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Alan Noblitt November 6, 2011 at 6:35 pm

Kyle,
Thanks for recommending the article. I found her article to be an interesting academic article but nothing more. When she posts part 2, it may make more sense, but part 1 was just theory about a closed system without other moving parts.

What happens when the gov’t has so much debt that it can never pay it off without dramatically raising inflation (like today, for instance)? What about when the financial system is corrupted and has liabilities that it cannot manage? The politicians have poured trillions of dollars into the system over the last few years with very little impact. Because of this overhang of debt, this recession will be more severe and longer lasting than most, as the government will progressively have less money to spend on the economy to cure it.

I don’t think that you and I will resolve our differences in this blog, so may have to agree to disagree. That said, I do appreciate your insights.

Kyle Hipp November 7, 2011 at 8:18 am

Alan, thank you for your consideration. I will leave it be after this on this post. The one thing I would like you to think about is why would the US government have to pay off its national debt and even further what kinds of ramifications would that truely have if they in fact attempted it. I will tell you that it would be impossible for the US to pay off its national debt but increasing revenue and cutting spending. This is because just like the late 90′s, when the public sector has a surplus, the spveriegn country has a trade deficit, this means that the private sector is in deficit thus in order to keep up they must take on debt which isn’t sustainable for the private sector as we have clearly seen being our prolonged balance sheet ressession.

Secondly how could we do anything if we paid off the national debt, even if it were possible. We could not control interest rates and liquidity in treasuries form would vanish. With surpluses, the federal government would have to consider investing in private assets, drawing more out of the private economy. Alan greenspan touched on this in his book “age of turbulance”. This article explains more on this as well.

http://pragcap.com/bill-clinton-was-afraid-to-pay-off-the-national-debt

thanks again for your reading. I apologize for my persistence but feel it is so important to share this with fellow real eatate investors. Once I understood the framework and actual operations, so many things clicked and everything makes so much more sence. I can invest much better and not only explain accurately what is happening in the economic world but also have a better idea of where things are headed. Thanks again Alan. I wish you well.

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