A spotlight on some tough truths

I have long subscribed to Baseline Scenario and the latest article from James Kwak is a great example of why.

On August 23rd James published a Post with the compelling title of, “Housing in Ten Words”.  Here’s a flavour:

By James Kwak

“Housing Fades as a Means to Build Wealth, Analysts Say.” That’s the title of a New York Times article by David Streitfeld. Here’s most of the lead:

“Many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century, when houses not only provided shelter but also a plump nest egg.

“The wealth generated by housing in those decades, particularly on the coasts, did more than assure the owners a comfortable retirement. It powered the economy, paying for the education of children and grandchildren, keeping the cruise ships and golf courses full and the restaurants humming.

“More than likely, that era is gone for good.”

I’ve been telling my friends for a decade that housing is a bad investment. These are real housing prices over the past century, based on data collected by Robert Shiller:

Robert Schiller is, of course, the well-known Yale University professor who wrote the book, Irrational Exuberance.   From Wikipedia:

Irrational Exuberance is a March 2000 book written by Yale University professor Robert Shiller, named after Alan Greenspan‘s “irrational exuberance” quote. Published at the height of the dot-com boom, it put forth several arguments demonstrating how the stock markets were overvalued at the time. Shiller was soon proven right when the Nasdaq peaked on the very month of the book’s publication, and the stock markets collapsed right after.

The second edition of Irrational Exuberance published in 2005 is updated to cover the housing bubble, especially in the United States. Shiller writes that the real estate bubble may soon burst, and he supports his claim by showing that median home prices are now six to nine times greater than median income in some areas of the country. He also shows that home prices, when adjusted for inflation, have produced very modest returns of less than 1%/year.

Shiller proved right again as witnessed by the fall of the housing bubble which was in part responsible for the Worldwide recession of 2008-2009.

Anyway, do read the full article from James on Baseline Scenario as it has plenty of messages that are still critically important for those trying to work out where it’s all still heading, economically.

For my money, I still think that slowly but steadily we are reverting to the old mean of home prices being about 2 to 2.5 times average annual salaries. With the added proviso that I think that it is more than likely that average salaries will slowly decline on both sides of the Atlantic over the next few years.  Tough times indeed!

By Paul Handover