Poor House, Part I
Your very own home, on trial…
We begin today’s reflection with a shocking illumination:
It is a mean, mean world we live in.
Americans believe their favorite and most reliable assets, their homes, are making them rich. But could the contrary be true? Will they be trading down soon…from their split foyers, neo-colonials and desert contemporaries directly to the poorhouse?
Could it be that the same roof and four walls that seem to give shelter actually expose their denizens to a world of cruel and unforgiving elements? In an effort to improve their financial health, Americans have slathered on mortgages, lines of credit and home equity loans as if they were sunblock. What a disappointment it would be to discover that they didn’t really stop the harmful rays, after all!
Many are the reasons given why real estate prices must continue to rise. On the other hand, we immediately see one reason why they might all be wrong: everyone believes them. As they say on Wall Street, when everyone thinks the same thing, no one is thinking.
And so we began to think…and came to a disturbing conclusion. The average house, we believe, is a dangerous place for your money. But since this little aperçu is completely at odds with the entire corpus of modern household economics, clearly the burden of proof is on us. Fair enough.
We begin our case with an examination not of the house itself, but its contents – what are known in the modern lingo as its ‘peripherals.’ To be precise, we ask the refrigerator and washing machine to come to the witness stand.
We invite you, dear reader, to examine these appliances closely. You will notice that neither is the simple device it appears to be. Merely turning a dial or pushing a button produces a complex variety of reactions involving centuries of accumulated knowledge of metallurgy, at least 200 years’ worth of progress in mechanical engineering, about 100 years’ worth of trial and error in making household appliances and electrical engineering, and half a century of electronics.
These machines might rightfully feel proud, mightn’t they? Do they not represent the accumulated wisdom and technical knowledge of generations? For the purpose of keeping food cool or getting the dirt out of clothes, are they not the best machines that mankind has ever built? Couldn’t it be said that they – at least in speaking of household appliances – are the crown of modern creation?
We thought you would agree with us there, dear reader, so let us move on.
But suppose you buy one of these marvels. Suppose you pay $1,000. And suppose, a year later, you decide to leave the country and need to sell it. How much do you think you could get for it?
Five hundred dollars? Seven hundred? We don’t know, but it would be unlikely that you would get as much as you paid. Instead, you would rightly expect to lose money on your appliance asset. And, setting aside art, antiques, collectibles, and the gold coins you have hidden, isn’t that true of the entire contents of the house? Does a one- year-old couch have the same value as a new one? How about a one-year-old trash compactor…or a one-year-old baby stroller? We could go on, but you take our point.
And so we take it one step further. What about household furnishings as opposed to furniture? Do you expect your carpets to rise in value after you have spilled a few bottles of beer on them? Do your drapes go up in price after they fade?
Here we invite readers to inspect the house itself. Take a look at the lighting fixtures. How much have they gone up in value in the last 10 years? And now let your eye wander. What about the light switches? And the paint on the walls, surely that must go down in resale value rapidly, once it is applied to the walls. And the wallboards? The 2 x 4s behind them? The wires and pipes and cinder blocks…if you called in a crew and had the house deconstructed…what would you get for it? Wouldn’t you see that every single element had deflated dramatically….that, reduced to its component parts, the entire house had a ‘break-up value’ of less than, say, 10 cents on the dollar?
But suppose you did not break it up or knock it down. Suppose you merely picked it up, put it on a flat-bed truck and sold the whole thing to a friend in a nearby state. Would you make a killing? Or suppose, you notice that the averagish house in Southern California sells for $350,000 and the averagish house in southern Arkansas goes for less than half that much. Could you make money by buying in Arkansas and shipping it to the coast? Have you ever heard of such a thing, dear reader?
"Well, actually, it’s a good business down here," said our friend at dinner. "People buy a lot with a house on it. They want to build a new house. So they give away the house to anyone who will take it away. A friend of ours got one, loaded it on a barge and floated it up the intra-coastal waterway and put it down on another lot. It was beautiful. And she saved a lot of money."
"But she got the house for nothing, right?"
Isn’t it true, then, that it is not just the appliances, the furniture, the furnishings, and the building materials that lose value over time….but the entire house itself? And isn’t that what you would expect? Over time, all physical things wear out. Metal corrodes, plastics warp and fade, fabrics weaken. Even granite turns to sand and dust….worn by wind, rain, sun, and cold…eventually.
And we, dear reader. We are no exceptions. We turn to dust too, don’t we? And wouldn’t it be an affront to all the world if we didn’t?
But before we move on to our next point, we would like to call our first surprise witness: the célèbre architect Le Corbusier.
It will be a surprise to us if the man actually comes to the witness stand, for he has been dead for over half a century. But we would like ask him some questions anyway.
"Please just answer yes or no," we begin. "Isn’t it true that you are…or were…one of the world’s most famous architects?"
"Yes," answers Le Corbusier’s ghost.
"And isn’t it also true that you designed many houses during your career."
"And so it might be said that you were an expert on domestic architecture.
"Yes, that is right."
"And in your expert opinion, which you expressed whenever you had the chance, a house really was nothing more…and here we quote your exact words…than ‘a machine for living?’"
"In other words, in your opinion, a house is just like a dishwasher, or a refrigerator…or an automobile…isn’t that right…?"
"And since a house is no different from any other machine…isn’t it logical and correct to think that it will wear out…"
"And since it will wear out like any other machine…isn’t it logical and correct to think that its price will fall….JUST LIKE ANY OTHER HOUSEHOLD APPLIANCE OR MACHINE….?!"
At this point in the proceeding, the opposing attorney rises from his chair…
"Counsel is asking the witness to speculate about things he knows nothing about…"
We take the point. Neither the world’s most famous architect, nor even we, can say what will happen. So, we content ourselves to direct your attention, dear reader, to what has always happened: Over time, almost all things man creates depreciates. Even the tax code recognizes it…allowing a taxpayer to write off the value of a new building, even a house, over a few decades. At the end of the period, the building is presumed to be worthless.
But let us move along. Next witness! We call Mr. Hubert Homeowner.
"Mr. Homeowner," we commence, "you are the owner of an averagish house, wouldn’t you say? Well, just stop us if we’re wrong…we’re just reading from the dossier…
"Your house has risen at nearly double-digit rates for about the last 8 years, isn’t that right? And you have cleverly taken advantage of that, isn’t that right? Isn’t it true that you’ve refinanced your house 3 times in the last 5 years, partly to get a lower interest rate and partly to get some extra cash? And isn’t it true that you used some of that cash to build a new sunroom on the house and upgrade the kitchen?
"Now, you consider yourself a smart man. Those improvements to the house certainly improved your enjoyment of the property. But would you describe them as good investments?
"You would. Because the house itself has been a very good investment for you, hasn’t it? You only put down $15,000 when you bought it 8 years ago. The return on that investment has been spectacular. And so, you feel that improving the quality of the asset is a good investment too, right?
"But you’ve listened to the testimony so far. In light of what has been said about the normal depreciation of a house and its contents, how do you reconcile the two points of view? Isn’t it perhaps more true to say that the new kitchen was a lifestyle improvement…which you could afford because the house itself has gained value?
"Okay…yes…maybe that is a better way to put it. And, yes…of course, these things make the house easier to sell. But then, isn’t it also true that if you don’t make these sorts of upgrades, your house will be harder to sell? So, in fact, you really have to make them, don’t you…if you want to maintain the house’s value?
"Wait, I can see you’re struggling with that idea…because all houses have gone up in price, haven’t they? Even some of your neighbors who didn’t make these improvements have been able to sell at higher prices, isn’t that correct? So, at least in this market, the improvement may not be necessary. If property prices were stable, on the other hand, do you think you could get away without making improvements? Hard to say, isn’t it? But certainly you’d have to replace the roof from time to time. And paint. And put in new carpets. And, yes, probably upgrade the kitchen and so forth.
"So, isn’t it safe to say that owning a home actually imposes some costs on its proprietor? Even if the house is not going up in value?
"Still, you consider your house your major asset, are we right about that?
"But it is a funny asset, isn’t it? You get to live in it, which is a bit like a dividend or interest coupon. But you also have to take care of it…and spend money on it…if you want it to hold its value. And, all things considered, the physical thing – the house itself…if you could separate it from the ground that it is on….would naturally lose value over time, right?
"Strange asset, isn’t it.
"And yet, you say that your house has gone up in value – dramatically – over the past 8 years. Not only that, but almost every house you know about has done the same. That is real money, isn’t it? We mean, you can take the equity out if you want. You refinance your house to get it. And then you can take it and spend it just like any other dollars you get. We see here in your dossier that you bought all kinds of things, including a new bicycle for your boy, Huey.
"Can you tell us where that bicycle was made?
"How about that. You were able to take out this ‘equity’ from your house and trade it for a bicycle that came all the way from China. It’s a remarkable world, isn’t it? We mean, you didn’t have to work an extra minute for that bike, did you? You didn’t win it…no one gave it to you…you didn’t have to save for it or start a business or make a profit. It came almost like magic from the ‘equity’ buildup in your house.
"Well, what do you think about this stuff called ‘equity?’ What do you think it really is? Where does it come from? How come the Chinese guy didn’t take the equity out of his house and buy the bike himself?
"Your house is worth about $200,000 if we have our information correct. Let’s see, if prices in your area were rising at about 10% per year, that would be an increase in your wealth – tax free, we might add – of about $20,000 per year. Not bad. That’s about 10 times the average income in China. And you get it without lifting a finger.
"And…let’s see…your household income is about $80,000 per year. Or, about $60,000 after you’ve paid taxes. And, well…don’t you think it is remarkable that you get another $20,000 to spend…equal to a third of your disposable income…without doing anything for it? How is that possible? Where does the money come from?
"Yes, it comes from an increase in the value of your house…but how? How is it possible, that after all we’ve heard about the depreciating value of your house and all its contents…that YOUR house seems to go in the opposite direction? Everything else – even natural stone – deteriorates, degrades, deflates, depreciates…but your house! Your house gets better…more valuable…more desirable…more fetching and more appealing every blooming day. Your wife doesn’t get better looking every day, does she? We mean…looking at the matter objectively, of course. But, somehow, your house does. How is that possible? It seems almost to violate a law of nature…it almost seems an affront to God himself, doesn’t it? He made the world and everything in it to decline with time…and your house stands like a beacon out of time and space…out of this world, almost…somehow resisting all His efforts to take it down…to reduce it…to make it bend to His laws. HOW IS IT POSSIBLE?"
"Objection, counsel is badgering the witness."
"May I be excused?" asks the homeowner.
Yes. And so may you, dear reader. At least for now. Tune in next week, when we call our star witness: you.
October 03, 2003 — DelRay Beach, Florida
"It’s not that simple," explained our friend. "Houses go up in price because the lots become scarcer and the houses themselves become more and more expensive to replace. Building codes, zoning restrictions, environmental rules…delays…paperwork…they all increase the value of a house, even if the house itself, physically, is depreciating. Here in Florida, for example, you can’t just replace a window in your house. You have to buy an very expensive window that has been approved for hurricanes. So, in effect, all the existing windows in your houses get marked up to the value of the replacement."
More to come….
Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).
Robert ‘Go out and buy an SUV’ McTeer sounded as though he had been out in the sun too long yesterday. Ten-year Treasury notes dropped sharply after the Fed governor told the world he expected the economy to grow faster – at a 4% rate – for the rest of the year.
But you, dear reader, know something McTeer may not. You know that most of the growth reported in the economy is a shimmering, statistical mirage. (In fact, we give you more evidence below…)
Despite the grandest reflation and reliquification effort of all time…with 13 rate cuts and the biggest Federal budget flip-flop, from surplus to deficit, in history…plus trillions of new money and credit flooding throughout the world economy…there has been little or no real growth in the American economy.
On Wall Street, this heroic reflation effort has produced a rally. But it is only a rally that might be considered standard for a bear market – the Dow has recovered just half its losses. And at this halfway point, the tide of cash seems to be drying up before it can do stocks any more good.
What’s wrong? Economists are stumped. According to their models, lower rates and more government spending should produce a boom. So sure are they that this must happen that they think they see one…like the illusion of an oasis in the desert. It is always just ahead. Just over the hill. Just a little further.
Rather than stop to check their bearings, they trudge along, reassuring each other that their theories are correct. "There it is, just ahead…" they say. "Oh, yes, I can see it…yes, right next to the productivity miracle…"
If the economy real were really recovering, it would be producing more jobs. But where are they? Perhaps they are in China?
Still, housing prices are still rising. And consumers are still spending, borrowing, and mortgaging. Corporations, too, are taking advantage of this Fed-induced once-in-a- lifetime opportunity to separate lenders from their money at absurdly low interest rates. "Corporate America on Borrowing Binge," says a CFO.com headline.
On a hot, sunny day, if you take your hat off and squint…it almost looks like a recovery ahead, if that is what you are looking for. But like an oasis in the desert, you might have to walk a long time before you reach it.
Eric Fry on the Street of Dreams…(By the way, you can catch Eric on CNNfn’s morning show, "Market Call," from 9 to 11 A.M. Eastern Time on October 8, 9, and 10. We’ll keep you posted…!)
– We New Yorkers enjoyed a beautiful autumn day Thursday. In the early morning, your Manhattan correspondent picked up his habitual triple cappuccino at Starbucks, then strolled across the street to Union Square park. He found an empty park bench and sipped his morning coffee in the crisp sunshine. A gentle breeze escorted countless red and gold leaves to the ground, like so many unwanted dollar bills. Slowly, the leaves piled up on the ground like greenbacks at the Bank of Japan. (They have to pile up somewhere, we suppose. They can’t just disappear.)
– But what happens next? If the autumn of dollar hegemony has arrived, winter must be fast approaching. And what sort of monetary blossoms should we expect next spring? Golden blossoms, perhaps?
– Most stock market investors don’t trouble themselves worrying about the dollar…and that’s lucky for them. Worrying about risk when stocks are going up every day is a very expensive attitude. Footloose and fancy-free is far more profitable. Yesterday, the footloose bulls made another devalued dollar or two as the Dow gained 18 points to 9,488 and the Nasdaq added 4 points to 1,836. But government bonds tumbled for the second straight day as the yield on the 10-year Treasury jumped back above 4%.
– The dollar, which had tumbled to nearly $1.18 per euro in Asian trading, managed to recover a bit during the New York session to finish at $1.17 per euro. December gold slipped another $1.30 to $383.70 an ounce. But surprisingly, most gold stocks edged higher yesterday. The XAU Index of gold stocks bounced 1.4%…Maybe the gold stocks are starting to ‘smell’ another gold rally in the making.
– Meanwhile, out on Main Street, the ‘muddle-through’ economy continues to muddle through. Another 399,000 ex- workers filed a claim for unemployment insurance last week – maintaining the stubbornly high rate of about 400,000 new claims per week. Also, orders for durable goods dropped 1.1% in August, despite hefty demand from the Defense Department. Excluding the 37% increase in orders for defense capital goods, total orders fell a whopping 1.7% – which is one more indication that the manufacturing sector will be slow to revive.
– Hmmm…seems like we may need to clip another 20% to 30% off of the coin of the realm. The lower the dollar falls, the more competitive our manufacturing industries become…or so the gang on Capitol Hill believes. We needn’t make the dollar bills physically smaller, of course, just functionally smaller. For example, a couple of years ago, 265 dollar bills purchased one ounce of gold. Today, an ounce of gold costs 383 dollar bills. And on the day that an ounce of gold costs 1,000 dollar bills, our manufacturers will have become so competitive that they will be exporting firecrackers to the Chinese…or so the gang on Capitol Hill believes.
– We don’t believe it. We believe we will all be poorer for embracing the idiocy of ‘competitive devaluations.’ How can we be so sure that devaluing the dollar is idiotic? Well, truth be told, we cannot be absolutely sure. But let’s consider the evidence: Alan Greenspan, most of the FOMC governors, Treasury Secretary Snow and President Bush all favor boosting economic growth by devaluing the dollar…We rest our case.
– Lately, Strategic Investment editor Dan Denning has been spilling a lot of ink over the sorry state of the U.S. dollar – even going the extra mile for his subscribers by instructing them on how to profit from a dollar decline. "What is the easiest, least expensive way for you to profit?" Dan asks rhetorically. "First, there is obviously gold, both gold stocks and physical gold, coins, or bullion-based trusts like the one in Australia, in which shares are redeemable for actual gold."
– A more direct – albeit short-term – approach would be to buy put options on dollar index futures. "The U.S. Dollar Index," Dan explains, "trades on the New York Board of Trade under the symbol DX. The index measures the market value of the dollar versus the trade-weighted geo-metric average of six currencies (although 17 countries are represented in the index because there are 12 counties which use the euro).
– "Here are the six currencies and their most recent weightings: Euro 57.6%, Japanese yen 13.6%, UK pound 11.9%, Canadian dollar 9.1%, Swedish krona 4.2% and Swiss franc 3.6%. – "Why these countries and these currencies? These countries constitute most of America’s international trade (excepting Mexico and China), and have relatively well- developed foreign exchange markets. Most importantly, the value of these currencies are, with the exception of central bank intervention, freely determined by market forces and market participants (central banks are market participants, too.)
– "Because the exchange rate of each of the currencies that the dollar is measured against is determined by the market, the index should, at least in theory, tell you what the market thinks of the strength of America’s economy as represented by the dollar. Strong economy, strong dollar. Weak economy with chronic debt, structural employment problems, and a pathological consumption addiction…weaker dollar."
Back in Delray Beach…
*** Down here, the conversation often turns to real estate. Florida is one of the best real estate markets in America. Delray Beach is one of the hottest areas in the state.
"You can’t really talk about a real estate market," said a canny friend over dinner last night. "There are hundreds of different real estate markets. You have to look at each one separately. But if you look hard enough you can make some money. Because it’s not like buying a share in Microsoft, where you don’t really know what is going on and…in any case…you can’t possibly know as much as the insiders…so you can never really have an advantage. But down here, I know who is building…who is buying and selling…what areas are hot…Down here, I’m an insider. And I can do deals with such a wide margin of safety that I will be the last person to get hurt.
"Frankly, I’m convinced that real estate is in a bubble, generally speaking. I think a lot of these properties are going to fall in price. And if there is a serious economic decline, a lot of people are going to have to downsize. They’ve over-reached and they’re not going to be able to keep up with their payments. So, I’m buying the apartments that they are going to downsize towards. I get a good return on my money now…and when the collapse comes, I’ll still have demand for my units at a reasonable rent."
*** Ah ha! We’ve said the recovery was a fraud. So is Alan Greenspan’s ‘productivity miracle.’ They are ‘statistical artifacts’ – the results of crunching numbers into such grotesque shapes that even their own mothers wouldn’t recognize them. The following note was sent by our friend Martin Spring:
"My thanks to Sjoerd Schalekamp who forwarded the link to this highly informative article by V. Anantha Nageswaran for The Business Times (Singapore). For those interested, this is too important to miss, so I have reproduced it in full.
"My view – I’m not in a position to either confirm or refute all the statistics quoted by V. Anantha Nageswaran. However, the overall theme – that the U.S.’s method of economic reporting overstates GDP data, is certainly familiar to me…There seems little doubt that a more conservative method of reporting, not least regarding the nominal value of IT spending rather than the quality- adjusted hedonic reporting described above, would show a much weaker economic performance by the U.S..
"So why the hedonic spin? I suspect because it makes the government look better, which hopes that its innovative data will boost confidence, leading to more real GDP growth. The growth story spin also helps to attract foreign investment in the U.S., necessary to fund the current account deficit.
"How will it all end? With disappointment. Being somewhat more optimistic than V. Anantha Nageswaran, I maintain that the U.S. economy will grow faster than Europe over the next 9 months, due to its additional boost from record monetary expansion, record fiscal spending, exceptionally low interest rates and a soft dollar. I also maintain that this growth is unsustainable. A denouement is likely to occur following the U.S. presidential election in November 2004, when both the Federal Reserve and White House will attempt to rein in the deficits."
*** We don’t know anything about Paul Bremer. But the U.S. Viceroy in Iraq, currently engaged in an historic effort to ‘transform’ the nation with 100,000 troops and a budget vastly greater than anything the Iraqis ever spent themselves, must either have a sense of humor or a loose connection. He complained recently that Iran was "meddling in the country’s internal affairs."