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« previous: Mortgage Crisis Bailout: Relief for Some, Risk for Others   |  next: Podcast: Bear Stearns, Rate Cuts and the Threat of Inflation »

Friday, March 21, 2008

Unconventional wisdom on housing and the credit crisis

The strength of an economy comes, fundamentally, from what it can produce. Can America still produce homes? Yes. Can America still produce desirable urban and suburban areas that people are willing to pay a fortune to live in? Yes.
- ALEX TABARROK, GEORGE MASON UNIVERSITY

economyIt was a stormy week of news that rattled the financial markets, beginning with the collapse and buyout of Bear Sterns for a stunningly low $2 per share by J.P. Morgan-Chase. It sparked a crisis of confidence and some extreme volatility with triple digit swings in the Dow averages. After more rate cuts from the Fed, which also financed the bailout of the Bear, and some moves aimed at adding liquidity to the markets, the week ended with the them looking like they might be finally getting their legs back; with a couple of days of triple digit gains, and commodities like oil and gold dropping.

The confidence level of Wall Street investors may be shored up for the moment, yet it seems fragile too— like the next bit of bad news will once again have the potential to panic the market. The coming week will be telling. The bag of tricks that the Fed may have to quell the economic roller coaster is thinning, and is almost bound to backlash in this election year as the public sees aid for investment bankers as a high priority and ultimately a cost borne by the U.S. Treasury and taxpayers; while help for people who's home investments are underwater, is anemic at best.

Amid all of the dire economic news, there were also a couple of articles which offered some unconventional wisdom abut the credit crisis and housing. They talked common sense rather than fear. One of them was Can’t Grasp Credit Crisis? Join the Club by David Leonhardt in the New York Times who writes: "...the overwhelming majority of homeowners are doing just fine. So how is it that a mess concentrated in one part of the mortgage business — subprime loans — has frozen the credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?...I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis." The theory being that confusion can lead to panic, can lead to an economic meltdown. The Fed did a good job of averting a panic this week, but the lack of transparency in the Bear deal was likely more of a factor in sending the markets sharply down. How was it that their share price went so quickly from $80, to $30, to almost worthless? What else is not being disclosed on the Street? After all the metrics are digested and debated, could it be as simple as that markets are profoundly psychological instruments? According to Mr. Leonhardt, Wall Street has been shell-shocked into an ultra conservative lending mode.

The soundness of any investment firm depends largely on other firms having confidence that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are.
- DAVID LEONHARDT, THE NEW YORK TIMES

Mr. Leonhardt goes on to comment on the beginning of the real estate boom, "It really started in 1998, when large numbers of people decided that real estate, which still hadn’t recovered from the early 1990s slump, had become a bargain." How far away are we right now to that. Judging from the performance and volatility of the capital markets recently, why wouldn't people see real estate today as a good deal in many parts of the country?

I find that comparisons between the way real estate markets operate and the way capital markets miss some fundamental differences. Real estate's illiquid nature means that that as a market, it reacts with less volatility than the capital markets, it is by nature a long-term investment in which hiccups of the economy don't have as much of an effect. Speculators trying to turn real estate into a short term investment strategy have discovered its lack of liquidity the hard way in recently. It is also a fundamentally necessary commodity. In Manhattan we are selling homes where people live, not where one where small investors flip condos for fun and profit like on TV.

I'd suggest that in our market, home pricing is at fair value as it reflects genuine user demand. We have not seen a reversal in prices, and available housing inventory is being absorbed and is actually shrinking. My customers are getting financing on their home purchases at pretty low rates of interest. You do need a good FICO score, and income that's on paper. Manhattan has never been a place where there was much room for speculators to drive up prices, most of our homes are primary residences (co-ops don't permit investors to buy in), and users of property actually are willing to pay more for it than investors. Demand is still very high.

A more rational look at housing was summarized quite well in a recent Op-ed piece titled Home Sweet Investment by economist Alex Tabarrok in the Times. His piece affirms some of my own opinions about the current state of the market. The fear today is of an economic recession which might feed further erosion in housing. It could become a self perpetuating downward spiral. He writes, "But if the financial markets remain uncertain about when the decline in house prices will end, then fear will tighten credit even further, which would strangle the housing market and generate even more fear...The best way to overcome fear is to look at the long run. The typical home buyer keeps a home for 10 years or more, so there is time for those who bought in 2005 and 2006 to weather the current decline in prices. Those who bought at the top are unlikely to see any windfalls from house appreciation, but they will not necessarily suffer from buyers’ remorse."

Most Americans are paying their mortgages, living in their homes, and will hold their properties for a good amount of time. Most are not affected by the sub-prime crisis directly. The credit crisis may have the effect of curtailing new housing development temporarily, causing inventory levels to start dropping and putting upward pressure on prices. If that happens without it putting too much additional drag on the overall economic conditions driven by the housing and construction industries, than we may see a bottom nationally.

I personally see a healthy market in the coming year for Manhattan. In recent weeks I've been involved a bidding war on a west side co-op, which sold above asking. All of my recent deals as a matter of fact have closed at or above asking. I've been working with a new buyer with a healthy budget looking for a pied-a terre in the city, and actually finding not very much that meets his requirements. The buyer is based for business in a nearby city and wants to commute here on weekends to enjoy what we have to offer. There is not a lot out there in any particular neighborhood and price category to be had. Is it a good time to bring your property on the market? Yes. People do buy location, and New York City is still one of the most desirable on the globe.

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