Home Ownership and Markets

PART THREE

Edward J. Dodson

Faced with the above problems and anticipating serious shocks to the U.S. economy after the October 1987 fall in stock values, the Board of Governors of the Federal Reserve System moved in August of 1988 to calm what Chairman Alan Greenspan saw as escalating inflationary pressures. Relying on traditional recession-causing powers, the Fed raised its discount rate on funds loaned to the nation's banks to 6.5 percent. Anticipating the increased costs of doing business that were to be passed on throughout the economy, mortgage lenders responded by increasing long-term interest rates. At the higher rates, already troubled housing markets were hit by elimination of the marginally qualified home buyer. As recently as May of 1988 (when rates were still below 10.5 percent), prices for homes in the nation's hottest markets were being driven up by buyers bidding against one another in a feeding frenzy of speculation. Then came a warning from housing analysts, one of whom was Ashby Bladen of Forbes magazine:

Now the boom in house prices is fading because interest rates are rising again as inflation worsens. And our prosperity now depends on continuing to borrow from the German and Japanese central banks, which have lost a lot of their taxpayers' money supporting the dollar over the last four years. Our international creditworthiness is wearing thin, and we need to reassure our creditors with high interest rates and a convincing anti-inflation policy. Otherwise, they, not the Fed, will impose the next credit crunch.[17]

In September of 1988 the New York-based investment firm Comstock Partners threw an added chill into market watchers by predicting that housing prices in some regional markets could fall 50 percent over the next ten years.[18] Their forecast proved all too accurate in the overheated markets of New England. Taking very much the opposite view, the chief economist of the National Association of Realtors, John Tuccillo (quoted in the same article), indicated that despite higher interest rates and threats of inflation, house prices should increase slowly but steadily. Tuccillo based his assessment on the fact that residential prices ha[d] shown themselves to be remarkably resilient to to inflation for a very long time, meaning that housing prices had moved upward considerably ahead of any measurement of general price rises (i.e., housing prices were more inflated than that for other goods).

Interpreting the same set of circumstances from a different standpoint, history confirms that the price of housing is sticky downward; that is, once at a certain level a major economic downturn is required to bring about a general decline in housing prices. The reason for this is not that complex to understand. Unlike inventories of goods that, on the shelf, are a cost to an entrepreneur, a region's housing stock (with the exception of speculatively-constructed builder inventory) is primarily shelter and only secondarily an investment for home owners. Other than those who must sell because of a forced relocation or loss of income, most home owners sell in order to move up in the type of housing owned and are willing and able to absorb very long marketing periods in order to obtain their desired price. In this way, the method of pricing housing based on sales data of comparable units is reinforced and the price of housing made less elastic in response to reductions in demand than to increases.

Statistics produced by the Federal Home Loan Bank Board indicated the average price paid for single-family housing (both new and existing) at the beginning of 1988 was $120,300.[19] The annual figure for 1987 was $106,300, based on 3.5 million units sold. The median price paid -- arguably more meaningful than the average price -- during 1987 was $85,600. A rough idea of the affordability crisis in the U.S. at that time can be seen in the following schedule which, based on a buyer's ability to meet a 10 percent down payment against the above median housing price, indicates that only 35 percent of all U.S. families had sufficient income needed to qualify for a mortgage loan of $76,500 when the rate of interest was 9 percent. As rates move upward (as they did during 1994-95) only a fall in housing prices or an increase in family income can moderate the problem of diminished affordability. The depth of this problem is reflected in the following chart:

Interest Rate	9%	11%	13%	15%	17%
Total Monthly Expenses	741	854	974	1097	1219
Annual Income Needed to Afford	31,744	36,586	41,726	46,995	52,222
No. Families With Income Needed	21,833,000	16,806,000	12,718,000	9,354,000	7,074,000
Percent	35.2%	27.1%	20.5%	15.1%	11.4%

Source: NAHB's Economics, Mortgage Finance and Housing Policy Division

Affordability Is Primarily A Land Market Anomaly

What is clear in every regional or local market across the U.S. is that the cost of land makes up an increasingly larger share of the price paid for Housing. The jump began slowly, from 10-15 percent of total housing cost in the late 1940s, to 15-20 percent in the late 1960s and to between 30-35 percent today on average. In many metropolitan markets, areas reflecting land values of 50 percent and higher have also become commonplace. As Michael Sumichrast, senior economic advisor to the National Association of Home Builders, concluded in early 1987:

The effect on affordability is obvious and disastrous. If the price of a finished lot reaches $40,000, that almost forces a builder to abandon the $100,000 to $120,000 market and to begin building $160,000 to $180,000 houses.[20]

The underlying societal problems created by runaway land prices also threaten more than a cyclical recession. In order to acquire housing, many households headed by young adults must rely heavily on parental gifts to meet down payment requirements. The source of these funds is often a loan obtained through refinancing of an existing mortgage loan, thereby reducing the parents' equity position in their own home. In the process, a major source of potential retirement income (and purchasing power) is essentially transferred to the nation's land owners (who may be individual home owners themselves or developers seeking to recoup the cost of land paid to a farmer or land speculator). Borrowings against home equity for educational loans and medical expenses are also adding to the erosion in personal wealth stored in the land value held by individual home owners. This fund of land value has comprised a significant portion of personal wealth with which the overwhelming majority of retirees have retained the ability to enjoy their last years in relative financial security. Though beneficiaries of a system that penalizes the newly born and the newly arrived, the distribution of this unearned wealth was at least widespread and could be handed down to offspring. The speed with which housing costs have out paced income growth has seriously eroded this ameliorating effect.

An absence of savings has already created a new financing mechanism -- the reverse mortgage -- under which home owners relinquish their housing and land equity in exchange for added income in the present. In doing so, the passing of housing equity as a main component of tens of millions of individual estates is threatened. However, this is certainly a rational response to a serious societal problem; namely, that many people are outliving their savings for retirement and whatever pension monies they were entitled to receive.

Conclusion

As this paper has endeavored to explain, the fundamental cause of these complex problems is to be found in the land market anomalies created by socio-political arrangements that discourage operation of a win-win market in land. Title holders to land (whether private individuals, business entities or governments) add nothing to our inventory of produced wealth by their purchases and sales of land, they merely exercise a claim on that wealth which already exists. Looking at the global picture, one cannot help but to notice how the few benefit and the many are impoverished by this circumstance. The majority of citizens in the LDCs and other debtor nations have thus far been made to absorb the loss in purchasing power caused by rising land prices and the fiscal irresponsibility of governments. More and more, however, political instability in these countries threatens repudiation of outstanding debt and potential collapse of the international monetary structure. Unless our governments move quickly to adopt policies that encourage production of wealth through capital goods formation, while simultaneously discouraging land hoarding, the kind of precipitous fall in land prices that hit the Japanese economy a few years ago can be expected to spread quickly through the global economy. Any widespread collapse of land prices in the U.S. or Europe would surely bring on a global recession in the same way the upward spiral fueled speculation and drove prices higher and higher.

At issue is not whether this will occur, but how soon. For millions of people throughout the developing world, the answer to the question, How soon? is, Now.