Bogus Status and Real Estate
Gary North’s REALITY CHECK
June 17, 2005
America is in the midst of a residential real estate mania. It is a rolling mania: from region to region. Florida has been hit in the last three years. Boston and California have been mania locations for a decade — really, two decades.
Here is the rule: “Buy where the mania has not yet hit.” This may not be where you live. If you’re not willing to move away to do this, then you are not a serious real estate investor.
If you are getting ready to buy a spec house in your present location because it’s a boom area, you are a candidate for joining the American Association of Lemmings.
There are marks of the mania mentality in any market. Here are the basics:
1. This time, it’s different.
2. Making big money is easy for the average guy.
3. Buyers really have to own this item.
4. This is the wave of the future.
5. Money is cheap.
6. Money will stay cheap.
7. Even when it isn’t cheap, this market is secure.
8. I can get out at any time.
9. This market is liquid.
These are excuses: rationalizations for highly emotional motivations. Here are the emotional reasons for buying in a mania. The emotional reasons are the real reasons for the mania, coupled with easy money.
1. I didn’t get in at the bottom.
2. I know a few people who did.
3. It really galls me that they did and I didn’t.
4. I’m as smart as they are.
5. I want to prove this to my wife.
6. I deserve to be richer.
7. I’m getting on board the last train out.
To this basic list of all manias are these, which are unique to residential real estate.
1. Homes visibly reflect status.
2. Status motivates wives more than men.
3. Price tags reflect status.
4. As prices rise, status is redistributed.
5. There is a race for status, not shelter.
6. Being left behind in status seems permanent.
The fact that her home is the primary visible source of a woman’s sense of status adds fuel to the fire. A wife who pays no attention to her husband’s portfolio of stocks, or who cannot explain the inverse relationship between interest rates and bond prices, perceives that she is being left behind when she is not a co-owner with her husband of a nice home in a newly red-hot neighborhood. Because she feels as though she is being left behind, possibly forever, her husband will be made to feel it. “When momma’s not happy, ain’t nobody happy.”
What makes housing different from most other common investments is this status element. Owning a particular share of stock conveys no status. Owning a valuable portfolio does, but no one knows about this portfolio unless you are Warren Buffett, who lives in a small home in Omaha — as devoid of status as any city I can think of.
Buffett is not buying status with his home. Bill Gates and the pre-2000 dot-com entrepreneurs did.
In the United States, it is not considered good form to inquire about another person’s net worth. One does not ask his neighbor, “How much are you really worth, after you subtract your debt?” It never has been acceptable.
Yet men want to find socially acceptable ways to express their status. So do their wives. In every Western society, where you live conveys this information. Your neighborhood, the size of your home, and the magnificence (or age) of your furniture all convey this information. The exception: a neighborhood occupied by a specific immigrant group, whose members rarely move out. These are voluntary ghettos. They are rare.
Americans have always been willing to exchange comfort for status. Back in 1870, rural people who lived in “soddies” — dirt homes — in the Great Plains moved into conventional wood homes whenever they earned extra money. These wood homes were poorly insulated. Residents sweltered in summer and froze in winter. This was not true of a soddy, where thick earthen walls kept out the heat in summer and kept out the cold in winter. But a man who made money and who remained in a soddy would never hear the end of it, short of the ultimate soddy: his grave. His wife wanted out of the hole in the ground.
Anyone could live in a hole in the ground. Poor people had to live there. So, up the status hierarchy they climbed. They paid to have wood hauled in for hundreds of miles to build a stick home. Then they had to find a way to heat it in winter. They could not cool it in summer. They had to paint it every few years. It got blown away in tornadoes. There was always the threat of fire. None of this affected low-status soddies.
I have no doubt that they justified the move by saying, “This is a long-term investment.”
They could have compromised. They could have built brick homes. They could have built two-layer brick homes with walls insulated by straw. They didn’t. Why not? Status. Anyone could live in a straw-insulated brick home: less status. They bought status with misery.
In those days, misery bought status. In our day, we have added debt: even more misery.
STATUS PLUS DEBT
The problem today with using a home as a measure of status is mortgage debt. Back when people paid cash for their homes, or close to it, their home reflected their wealth, which in the United States in new areas was a substitute for status. This was less true in the “old” regions: New England, the Tidewater area of the South, and the older cities like New York and Philadelphia. There, family name conveyed status: old money, even if your branch of the family had lost money. But in the great trek west, there was only new money. So, money conveyed status. A home reflected status because it reflected money.
With the spread of residential mortgages in the 1920s, this began to change. Homes and neighborhoods still reflected money, but this was not money already made but rather money assumed to be made. A family received a mortgage based on the lender’s perception of the future earning ability of the husband. The house served as collateral. The lender was protected. He could evict owners who did not make their payments.
There was a problem, however: the value of money. The lender had to compensate himself for the risk of depreciating money. Under the international gold standard, this was a reduced risk. But when Europe in World War I abandoned the full gold coin standard and substituted the gold exchange standard — holding American T-bills and British debt instead of gold — the risk of inflation increased. England went off the gold standard in 1931. Then, in 1933, Roosevelt took the United States off the gold standard by making it illegal for Americans to own gold bullion. Simultaneously, he got the Federal Reserve to inflate the money supply. These two policies were linked.
Then, to make sure everyone got the message, the New Deal expanded the use of government guarantees for bank accounts. This included savings & loan accounts. In 1933, people greatly feared bank failures, for good reason: over 6,000 banks had gone bankrupt under Hoover. But, by insuring deposits in mortgage-generating savings & loan companies, the government created a new opportunity for lending institutions: borrow short (deposits) and lend long (mortgages). This moved more money into mortgages than would otherwise have been the case.
When the boys came home from the war in 1945, this new system of government-guaranteed mortgage lending launched the housing mania that we are still seeing on the front pages. Two movies in 1946 showed this: “The Best Years of Our Lives,” which won the Academy Award in 1947, and “It’s a Wonderful Life,” which didn’t.
Bedford Falls was transformed by the building and loan company. That’s because it let poor people capitalize their future earnings. It let an Italian family move into suburbia. As for “Best Years,” Fredric March’s character, a returning vet who gets a promotion at the local bank, is called on the carpet by the bank’s president for having loaned money to a returning vet who wanted to buy a small farm: his dream. This later becomes an opportunity for the liberal screen writer to have March give a speech about lending money to America’s best young men — a popular theme with America’s movie-attending young men in 1946. March is inebriated in this scene. This speech is the defining scene in the movie for March’s character. The fact that he had made a dumb loan to a young man with no experience in farming, who obviously could not compete with modern agribusiness, was lost on the script writer.
The mortgage market has made America a nation of debtors. Debt has let the average guy buy the primary mark of status. The problem is, this mark of status became a mark of status centuries before the advent of modern mortgage debt. He gets another load of misery to deal with. He has called this an investment.
Then his wife started buying furniture to fill it. Credit was easy. She could buy status symbols with no money down.
What is rarely said is this: real status is always owned debt-free. It honors Max Blumert’s three laws: “Buy the best. Pay cash. Take delivery.”
Real status begins with ethics. Ethics carries a price, but poor people can afford to pay it. When you think “status,” think “Mother Teresa.” She bought status, debt-free. She didn’t pay money for it. And, if we are to believe her, she did not pay in misery, either.
THE ADDICTION OF CONSUMER DEBT
Debtors favor price inflation. There is a little larceny in most men’s hearts, and sticking it to the “rapacious, cold-hearted lenders” gives them a sense of satisfaction. The most convenient means of sticking it to a lender is by depreciating the currency unit. If I were to write a book on the Federal Reserve System, I might choose a variation on Hillary Clinton’s title: “It Takes a Pillage.”
It was the 30-year mortgage, subsidized by the U.S. government’s deposit guarantee, that made lifetime debt a way of life in the United States. The 30-year mortgage, which did not exist prior to Roosevelt’s Presidency, is a product of this guarantee. Top-rated businesses had long sold 30-year bonds, but only after careful screening by major banks and commercial credit ratings agencies. But with a government-guaranteed savings & loan industry, a person with a steady job could now become the equivalent of General Motors. He could sign a promissory note for 30 years, based on his expected earning power and his home’s collateral value.
Then, beginning in the 1960s, he and his wife co- signed, based on their joint earning power. The debt ratchet went up a notch. So did home prices.
The long-term capital markets moved from subsidizing capital goods through corporate bonds to subsidizing consumer goods through mortgages.
It was collateralization that made this a good bet. The loss of status for being evicted from a person’s home placed the noses of the home’s occupiers firmly to the grindstone. The debtors would stay in a capital-absorbing money pit for the sake of status. To buy more status with more debt, they would sell and move up. The tax code subsidized this: deferred capital gains taxes if you bought a more expensive home.
The lenders figured out how to compensate for the economic risk of open default by borrowers. They harnessed the drive for social status to reduce the risk of default. The lust for family status substituted for a close investigation of the borrower’s future prospects. In effect, lenders relied the pressure of wives’ nagging and recriminations. They skipped the corporate balance sheet. This has been a good bet so far, except for one thing: the steady depreciation of the dollar.
The mortgage market has converted Americans from people who demanded sound money into borrowers who demand price inflation. They want to pay off their biggest debt with depreciating money. They see that monthly mortgage payment, and they are ready to accept a weaker dollar. They worry about next month’s bill, not their pensions’ purchasing power 30 years from now. They rejoice in the nominal appreciation of their homes, and they demand that the Federal government Do Something when housing prices fall.
Meanwhile, the local government hikes property taxes. After all, housing prices are up. The owner keeps an ever- declining share of his income. He has to buy new furniture, pay more taxes, and (if he bought with an ARM), pay more on his mortgage if long-term rates go up.
Remember this rule: misery buys bogus status. To load up on bogus status, Americans load up on misery by way of debt.
When investors put their money into Fannie Mae and Freddy Mac rather than in bonds, they are subsidizing consumer debt. They are subsidizing the lust for bogus status. They are like drug dealers and casino operators who have spotted a weakness in their marks, and who have made ways for the victims to indulge their lust.
Today, lenders are subsidizing the get-rich-quick mentality that afflicts middle-class people who are not skilled investors. This is the basis of the housing mania today.
But lenders forget this crucial fact: there are more voters who pay mortgages than there are lenders who collect the money. Congress will accommodate these voters. The Federal Reserve System will ultimately accommodate Congress.
BUY A SHATTERED DREAM
I bought a house in February. It had been on the market 150 days. It was underpriced. It had been occupied by a family that could not afford it. In the terrible storm of 2003 in the Memphis area, this house had been damaged. Part of its roof blew off. The occupant had no money to repair the roof, or chose not to. Rain continued to get into the house. Finally, the family walked away from it. A lending agency repossessed it. It took 150 days for the bank to sell it to me. The bank had to put on a new roof, repaint the interior walls, put in a new carpet, and install a new dishwasher. I bought it for just under $90,000: a 4-bedroom home, 9 years old, in a middle- class neighborhood in a booming area just south of the Memphis city line. There is flight out of Memphis, and people are coming here.
I bought a family’s nightmare, which had handed its nightmare over to a bank. The bank then had to put money into converting its nightmare into a saleable property.
This house is not my wife’s dream home. She and I see it as an investment. We got a 5.34% 30-year loan because we occupy it. In other words, the lenders invested in my supposed lust for status. But I don’t have a well- developed lust for status, except insofar as footnotes convey status.
The moment that a wife looks at a house and thinks “status,” the house has moved from a capital asset to a money pit. The moment she buys status, the family is hooked into consumer debt.
John Schaub, who owns a whole lot of homes debt-free in just about the hottest market in the country, did not buy his first home until he and his wife owned something like half a dozen investment houses. He bought his home, as I recall, for $135,000 — a beachfront property in Sarasota. Who knows what it’s worth today? Lots more than $125,000. He bought it at a substantial discount; it had been abandoned.
Here is the rule: The moment a house is your wife’s dream home, you are no longer an investor. You are an investor when you buy a seller’s nightmare because you know how to fix it cheap. Then you rent it to a family that cannot afford to buy its dream home, but can afford to rent a substitute for a few years until they can find the dream home . . . if the husband does not buy that dream pickup truck or dream fishing boat first.
THE INVESTOR’S MENTALITY
Over 15 years ago, I heard either Schaub or his then- associate Jack Miller tell this story. I think it was Miller. He had just bought a house on a golf course that had lost its roof in a storm. The seller sold it way below market. Miller decided to solve his problem his way: without spending a dime. He drove through the city, looking at apartments. When he saw one that had a pickup truck with a “repairs” sign on it, he stopped. He knocked at the door. He told the man who answered that he wanted to get a roof repaired.
The guy said he could do it. Miller then made him an offer: if he would move into the house, he could rent it reasonably. But he would have to fix the roof first. Here was a guy with three kids, living in an apartment. Did he want to get into a home on a golf course? Did his wife want to live in that home? Of course. Could he? Now he could: just fix the roof. Miller was not concerned about where the guy would get the roofing material and at what price. That was his new renter’s problem. Both parties solved their problem. Miller got the roof fixed for free and immediate occupancy of the abandoned house. The family got a mark of status at a price it could afford.
This is how a wise real estate investor thinks about investing. It is not how newcomers who have just gotten into real estate think. They think it’s easy to make money. Schaub says, “You make your profit when you buy the house.” That is, you buy the other person’s problem, which he does not know how to solve, because you know how to solve it . . . cheap.
Schaub says you must view 100 homes in your area, minimum, to get a sense of the market. You must look at special categories of homes in search of specific categories of sellers. You are buying the property based on a seller’s extreme need to sell. You are not buying a residence for yourself.
If it is a seller’s market, wait. You are looking for highly motivated sellers, not properties in booming areas. You want a seller who needs to get out, not a buyer who wants to get in.
Have you got this formula down pat? I hope so.
I would like to be able to get this formula across to newly motivated real estate investors. I can’t. But maybe I can at least scare some of you from doing something really risky.
If your wife would like to buy a prospective house because she thinks it’s neat, don’t buy it. If she wants to buy it because it’s a sow’s ear that she thinks she can turn into a silk purse with a little TLC, buy it . . . if it’s house number 101 or more that you both have looked at.
I bought my first home after seeing only six houses. This was not normal. The sellers had experienced a tragedy. Their son had committed suicide upstairs. They wanted out. I bought a 3,400 square foot brick home in an upper-middle-class neighborhood in what I knew would soon be a boom city — Durham, North Carolina — for $59,000. That was in 1977. The house had been on the market for three hours when I made the offer, which was accepted two hours later. Normal back then was six months. The sellers got another offer the next day.
I never got any deal like this again.
If everyone is buying, don’t buy. Sell. Move to a place where a few people are buying, but not too many.
If you’re not willing to move to a different region, and everyone is buying in your home town, then you are wise to stay on the sidelines. That’s because you’re not wise to buy in anticipation of another buyer’s dream. You are buying because of an existing owner’s nightmare in order to rent the house to a woman whose husband cannot afford to buy her dream for her, but who can afford to rent her dream for a few years until they can qualify for a mortgage.
The nation is up to its eyeballs in mortgage debt. Political conclusion: the dollar will die. There are too many home owners who want to stick it to lenders. But in between now and then will come a series of recessions, when over-extended home buyers are forced to swallow their pride and move out. The market for status will suffer some setbacks. Misery buys bogus status, and bogus status sometimes responds by providing even more misery: loss of visible status and loss of credit worthiness.
Buy from a lending institution that is sitting on a repossessed dream, a status mania that has turned sour. Buy in a buyer’s market. Sell in a seller’s market. This is obvious, but the lemmings do not understand. “This time, it’s different.” No, it isn’t.
There is nothing like buying residential real estate after the lemmings have rushed into the ocean of easy money to be carried away by the tide.
There are millions of debt-encumbered, status-driven home buyers out there. Their day of reckoning will come. So will your day of opportunity.
Park your status at the money tree.