Working With Us | Products | Case Studies | FAQ | About Online Media

Fool Me Once…Not Twice

Oct
3
2007

As the housing boom expanded into a bubble, I sat on the sidelines here in my rent-controlled West Hollywood apartment. My brother and his family were chased by rising housing prices from Los Angeles to Portland to San Antonio. Now, if proposals to bail out bubbled borrowers are approved, we may be forced – because of our rational decision-making – to subsidize everyone who made bad choices and bought a home before the bubble burst.

The National Association of Realtors went to President Bush and urged him to propose a mortgage bailout. So, naturally, Democratic presidential candidates must be even more generous in their proposed handouts. Heck, even local officials in Los Angeles have talked about using money from the Affordable Housing Trust Fund to assist homeowners facing foreclosures. This is bad policy and even worse economics. As long as such bailouts are considered possible, they will only create market conditions that bend reality and artificially prop up housing prices, keeping market forces from returning home purchase prices to more rational levels.

In seven semesters of economics at Georgetown and the University of Southern California, I learned one basic truth: markets seek the equilibrium value. Want to know what that is? Well, draw a supply line and a demand line. Where they cross is the equilibrium value whether we’re talking about housing markets or widgets. Where buyers find sellers and exchange money, that’s the equilibrium value.

In a rational housing market, the median home will be affordable to the median homebuyer. That is to say, if you remove the people who are living in apartments and those who already own their homes, then the average home should be affordable to the average person. But that’s not what’s happened. In California, the housing affordability index has fallen from 24% in 2004 to 11% in 2007. In Los Angeles County, it is even lower. Only 3% of homes sold in early 2007 were affordable to the median household!

The economics of a market where only 3% of the people can buy in become unsustainable – as we are now finding out. The market has been inflated by buyers who couldn’t afford their purchased – helped along by loose credit and well, some unsavory mortgage-lending practices. During the irrational exuberance of the housing market, buyers were told that prices were only going up because everyone needs a place to live and the population is only growing! But that’s exactly why housing is a bad investment. You cannot profit from your gains unless you substitute the product you’re selling for something less than what you had before. And if housing prices are only going up, you’ll sell and buy something much less expensive. Unless, of course, you’re willing to play Bubble Roulette.

Say you paid $250,000 for a charming West Hollywood bungalow in 1996 and you sell it today for over a million. Sounds great. But you aren’t going to be able to afford another West Hollywood bungalow with your $1 million. You might be able to take some profits and get into a $900,000 condo or worse yet, move to Texas and pocket the difference but in the end, you are ending up with something less in part because you’ll have a bigger loan to pay off the house that’s replaced the bungalow. And everyone needs housing, so pocketing everything really isn’t an option – unless you’re willing to rent until the market returns to its equilibrium value.

Not everyone had the pleasure of taking seven semesters of economics, of course. But sometimes common sense can substitute. If a bank is going to lend you six figures you should be able to figure out this basic equation: How much money am I making and how much can I afford to spend? It seems many people didn’t even do this math. Now they and the lenders who sought to profit off of their ignorance – some of whom suggested to their clients that the rules of mathematics didn’t apply to home loans – are now paying the piper.

Now, I have a great deal of sympathy for anyone who is losing their house. Not all of those being put out on the street or who are working through the frustration of having to deal with far-away banks and unscrupulous lenders were buying and selling million-dollar property. But I have no sympathy for the lenders and real estate agents who profited from putting them in such a predicament.

The real estate agents have already made their profits when they pocketed their 6 percent commission. But lenders need the borrowers to be solvent in order to cover their bottom line – to keep money flowing through the system. Bailing out the borrower, therefore, will only help the lender while it hurts the rest of us who are stuck to foot the bill–in the form of tighter credit, stock market volatility, a falling dollar and higher taxes to pay for a government bailout. And that’s not fair to anyone.

Share  Posted by Scott Olin Schmidt at 6:08 AM | Permalink

<< Back to the Spotlight blog

Scott Olin Schmidt's bio
Email Scott Olin Schmidt




Get Our Weekly Email Newsletter




What We're Reading - Spot-On Books

Hot Spots - What's Hot Around the Web



Spot-on.com | Promote Your Page Too

Spot-on Main | Pinpoint Persuasion | Spotlight Blog | RSS Subscription | Spot-on Writers | Privacy Policy | Contact Us