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Milton J. Madison - An American Refugee Now Living in China, Where Liberty is Ascending

Federalism, Free Markets and the Liberty To Let One's Mind Wander. I Am Very Worried About the Fate of Liberty in the USA, Where Government is Taking people's Lives ____________________________________________________________________________________________ "Extremism in defense of liberty is no vice. Tolerance in the face of tyranny is no virtue." -Barry Goldwater-

Friday, November 28, 2008

House Prices Globally, Still Have a Long Way To Fall....

House prices are enormously overvalued almost everywhere. As a store of wealth, homes have been a decent place to put your money historically. However, as an investment, they should never be considered as such. Housing here in Hong Kong has been silly for decades. However, prices here have fallen around 30% in some cases, particularly in the very high end. Prices will fall much much more here and probably stay down for a long time.

Looking at the above chart, we can see that in the past 10 years in the US, the price of housing has been in bubble territory. This will definitely return to normal and prices will fall. The big question is what is going to happen to inflation. It seems as if there is very very little risk over the short term that inflation is a problem and there is an actual risk of deflation. Deflation will mean that house prices will fall even more on a nominal basis.

This is why there is a global banking crisis. Banks have lent on the asset values associated with real estate and not on the ability of people to earn money to pay those loans.

Additionally, government policy has been phenomenally poor and has been a primary driver of encouraging excessive speculation in housing in the US. First, by subsidizing mortgages through interest deductibility, housing prices rise since it is the after-tax cost that people look at an consider when one looks at affordability. If there was no tax benefit, then prices would not be able to rise as much a they did since people could not afford to buy houses at these higher prices. Prices would then only rise to levels where transaction can actually take place since houses are not transportable and fungible. So poorly considered tax policy encourages higher prices and more debt on household balance sheets. Just plain stupid. Banks will now adjust their models and less debt will be available to borrowers for housing for the short or intermediate term.

Second, and more importantly to creating a speculative housing bubble was the US Government's involvement in encouraging home ownership among poorer American people. From the phony accusations of 'red-lining' of neighborhoods inhabited by black people back in the 1970's to the Community Reinvestment Act of the Clinton administration, poor lending practices in housing was not only encouraged but forced upon the nations' banks. Additionally, Clinton legislation also forced Freddie Mac and Fannie Mae to hold these securities in order to support lending to sub-prime borrowers. During the 1990's, when banks were consolidating, these institutions were forced to hold a certain amount of sub-prime loans in order to get Justice Department approval for the mergers. Of course, there was never enough of these sub-prime loans in the system since banks had to hold more capital against these loans. So, Wall Street stepped in to fill the need. As housing prices rose, other people used sub-prime loans to speculate on real estate. Since by definition sub-prime is color-blind, I suspect that a lot of non-minorities used these loans to take risks investing in real estate.

And to be very clear, this whole sub-prime mess was an initiative from Democrats and now I understand why there were so many Democrats and former party officials working in senior positions at major Wall Street firms. I used to see Chuck Schumer hanging around the trading floor at Bear Stearns, that was one of the largest dealers in mortgage related securities.

As long as we have government directing economic activity, in this case housing, we will end up with crises such as this.


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