The Rotten Thing About Real Estate

Once in a while I come across an article that hits a major problem head on. More often than not those articles are written by Martin Wolf of the Financial Times. Today he does it again with an analysis of housing. I would give you the link, but the article seems to have slipped from the FT website. Go find it if you can.

For those of you who are content with my summary, here goes:

Real estate is a scam. It is a pernicious scam to boot. It distorts economic policy, and it causes otherwise sensible people to make idiots of themselves by speculating on property values. Moreover it represents a massive attack on future generations.

There.

The argument goes like this:

Anyone who buys a home is a socialist. They are speculating in an asset whose value only accretes if the community acts together to rig the market and otherwise extract wealth from future generations. They do this by enforcing planning codes and other attacks on the free market for land. They subsidize the cost of ownership through huge tax abatements: both at the national level – as in mortgage interest rate relief – and at the local level – as in the tax credit for property taxes. So the rise in value of a property hinges mainly on the efforts of society. Yes, an individual who keeps her home in good order will extract more wealth than a messy neighbor, but the majority of the gain in house prices is directly a result of the community at large acting to ensure land ownership is a privileged activity.

Wolf sensibly asks the question: with the value coming from socialized activity do we then socialize the profits?

We all know the answer. No. We privatize the profits.

In fact we gloat over how clever we were to ‘invest’ in this particular home.

The distortions that this land speculation heap on the economy are manifest and manifold.

It twists the banking system into contortions. Mortgage lending is a long term activity. Bank deposits are short term in nature. This means that banks have to lend long and borrow short, which leads, inevitably, to periodic credit crises. About every eighteen years to be precise. During those crises home owners bewail their ‘loss of value’ and force governments to act to ensure a return to inflation. They also force the bail out of the failed banks. Meanwhile the media announces breathlessly, as a sign of strength in the economy, that home prices have returned to their inflationary path.

Imagine the agony of the press were that inflation to be in food costs. Or energy prices. A mere dollar or two in the price of a gallon of fuel and the country goes bananas. A surge in home prices and the nation gets a smug warm feeling that it has done well.

Folks: inflation is inflation is inflation.

I remember, well, sitting in a limo with Alan Greenspan and arguing that the CPI was an incorrect measure of inflation precisely because it failed to account for asset price increases. I have tried to hammer that point for as long as I have written about economics. Real estate should never be an ‘investment’. It is a rent substitute. Owning a home should not become an inflation hedge, nor should it become a source of inflation. Had home price inflation been properly accounted for in our measures of inflation, the recent bubble would have been nipped in the bud. Greenspan would have had to raise interest rates in the early 2000’s. The bank crisis would not have erupted. We would not now be facing ten years or so of miserable economic activity. And eight or nine million more people would have jobs.

That’s how pernicious real estate can be.

Only bad things befall societies obsessed with privatizing social gains on the scale that US seeks to do with housing.

Kudos to Wolf for spitting into the wind on this issue. I doubt he will make headway. The average home owner doesn’t want to face their secret socialist inner self. Instead they want to rob their children of the inflationary gains that they think they have ‘earned’.

One last thing: all those amongst us who gnash their teeth at the erosion of American competitiveness should sell their homes immediately and invest in the stock market instead. Every penny syphoned off from investment in industry because it is ‘invested’ in a home, is one less penny that we can deploy into making our businesses more competitive. Real estate is a useless place to put your money. It produces no productivity gains for the future. It is sterile. Only speculation in manufacturing and other businesses can build our store of future wealth. By being so self-regarding and privatizing the social gains of land ownership we have hobbled future generations of Americans.

That’s the rotten thing about real estate.