Translation/explanation needed

opportunity cost?

My understanding (I should probably just wait for someone who knows this better than I do!) is that the idea is that if you own some house you could do several things with it: 1)Live in it, 2) Sell it, 3) Rent it to someone. Doing 1) is a lot like doing 3) but with yourself as the renter from a neutral perspective. Rents and selling prices are connected but sometimes not perfectly. Supposedly one sign of a bubble is that selling prices are high compared to rents. In such a case you’re getting less value if you hold property and rent it than if you sell it. This applies to a house you own and live in as well- if you hold it and live in it rather than sell it when the price diverges from the rental cost you’re “losing” money. (If you were rational, transaction costs were low, etc. you’d sell your place and rent from someone else to take advantage of the divergence in sale and rental price.) But, if sale prices come down and align more closely with rental prices this “loss” becomes smaller and might even turn into a “gain”. At least that’s how I’ve understood the idea. Since I’d like to be clear on it, too, I’d appreciate it if whatever mistakes I have here would be corrected by people who know better. I’m sure there must be several around!

He is talking about imputed rents

http://en.wikipedia.org/wiki/Imputed_rent

“it doesn’t matter what happens to the market price as long as any moves you make are to another house of the same value.”

But, of course, it does matter, if you refinanced, or borrowed to buy the house in the higher market, because when you sell in the lower market, you might have negative equity, all of which comes due upon selling the house.

Imagine that you own a house, you rent it out to someone, and you yourself rent an identical house and pay rent to someone else.

If we assume that the amounts of rent you collect and the rent pay are identical and proportional to the market price of the house, then price of the house becomes irrelevant. The amount of rent you collect and the amount of rent pay bounce up and down, but the balance is always zero.

“just cock”

Sounds that way to me, too. But don’t ask us Chris, … er, Professor Bertram, … why don’t you e-mail Wolf? Maybe he’d explain.

Why, it’s just another (convoluted) way of saying that as long as you happily live in you own house its price doesn’t matter.

If you speculate in a market, you might win or lose. In general, for every speculator who loses another speculator gets a bargain. It’s a wash on average, although there are losers.

Ignoring his argument that you ought to feel OK when you’re a loser because somebody else is winning….

If the government bases its policy on keeping speculators from losing when they speculate, where does that lead us? Isn’t it better for government policy to encourage creating wealth that benefits many people?

As a homeowner, I’ve lost a fair chunk of paper wealth. But for me, the positive side is that my kids, when they’re out of the house, will have a much better chance of actually buying a house in place they grew up (or another desirable place) without having to kill themselves to make the mortgage (or…hit up Mom & Dad for a big down payment).

Unless of course the bubble re-inflates before they’re in the market.

Just another econoblatherer on the front page

No. Wolf is describing what economists think. He goes on to offer a different view — the credit crunch is causing pain.

As he says in the next paragraph:

Yet things are not so simple. What matters is why house prices are falling. It is no good having cheaper houses if the reason they are cheaper is that fewer people can afford to buy them because credit is so expensive.

Too much of the “endowment effect” is going on in the US market. We have many people who bought their houses before the bubble but who insist on selling it at near peak-bubble prices. They will refuse to accept an offer of that gives them a nominal appreciation of 6.5% a year over a 10 year period without having made any major improvements to the house.

It is no good having cheaper houses if the reason they are cheaper is that fewer people can afford to buy them because credit is so expensive.

Actually the obverse is true: It is no good having more expensive houses if the reason they are more expensive is that more people can afford to buy them because credit is unsustainably cheap. The problem with bubbles is not that they end but that they started in the first place.

The problem with bubbles is that we’re already in the first stages of the next one – alternative energy sources. Every day a new hype; last week it was diesel-excreting algae, today it’s paint-on photocells for your windows…

This makes no sense to me. When you own a house, there are lots of costs beyond the mortgage. Property taxes are the biggest, but there can also be sewer rent, homeowner’s insurance, mortgage insurance (the kind the bank forces you to get, not the kind you want for yourself). In some municipalities there are yearly fees for getting your trash and recyclables hauled away.

There are upkeep costs — not optional maintenance like painting, but crucial things like fixing broken pipes. There are non-optional things like shoveling snow off your sidewalk (which can cost money if you are not physically able to do it or if you live in a place where you can get fined/ticked for not clearing the way).

Many of these costs are completely invisible to renters, or are inelastic over the course of the lease. If I own a $300K house and am paying $1500/month in mortgage and taxes, not counting the other costs listed above, and the housing market dips so my home is now worth $220K but I’m still paying the same $1500 plus now the school district is raising taxes because they aren’t getting as much revenue as they expected, how does that not make me worse off than if I were renting and not having to pay some/all of those other costs?

Also, the original quotation seems to ignore the overwhelming use of home equity as a safety net — to pay for medical bills, education, spells of unemployment, emergency home repairs, loss of car, even bail or court costs. The cost to a family of not having that equity to draw on can be very dear indeed.

Bah. 11 got it right.

He may be saying that to the economy in general, a change in the price of any asset is a wash, winners exactly balance out losers. But this is only true to zeroth order, if the price changes, then investment decisions change. And the losers can be a bigger burden to society than the gain of the winners is a boost. Even if a own the house free and clear, and have no intention to ever sell it, some things such as my perceived net worth, my credit rating, my ability to borrow funds in an emergency, are all affected. The ability of the banking economy to loan money into existence has also changed, and this affects the macroeconomy.

I’d just like to say I’m touched, touched, to find so many esteemed colleagues in agreement with me…

I think the grain of sense in this is that falling house prices are less painful to owner-occupiers than to speculators. As long as there aren’t credit problems that lead to foreclosure, if you bought a house because you wanted a house, you still have it — and even if you need to move, you sell your house for less, but you buy the new one for less.

On the other hand, if you bought a house as an alternative to buying stocks or an oil well, you win some, you lose some, but investors are supposed to understand that.

The aspect of the bubble that is really causing pain — and it is hard to see foreclosures of owner-occupied houses as anything but painful — is that the bubble, and the creative financing it engendered, blurred the line between buying a house for the shelter, and buying one to speculate in housing — the loans were only sustainable if the value of the house was growing, so in order to buy a house for the housing you had to bet on the continued increase in house prices.

Well, I suppose you have to also assume that the owner does not accelerate the payments. A lot of assumptions, I agree, but at least they are not too fancy.

The problem with even if you need to move, you sell your house for less, but you buy the new one for less is that it ignores the effects of leverage on your investment. Take a family that saved for years to accumulate a $50,000 down payment, and bought a $500,000 house with 10% down at the peak of the bubble. Now (ignoring transaction costs) each x% increase in the price of the house gains them 10x% on their investment, but each y% decrease loses them 10y% of their investment. So if housing prices decline only 10% and they have to sell, their investment is completely wiped out. It’s true that they could (in theory) now buy a comparable house for $450,000 instead of $500,000, but they would first need to accumulate a new $45,000 down payment in order to do so. By the time they are able to do so, housing prices may have recovered to the point where they recognize no benefit at all from the temporary decrease.

Taking transaction costs into account makes this effect even stronger: if they have to pay a 6% real estate commission in order to sell, it only takes a 4% decline to wipe out their entire investment.

Leverage is a cute cuddly puppy in a rising market that allows you to realize huge profits from even modest increases in the price of the underlying asset. In a declining market, though, it turns into a ravenous wolf with slathering fangs – that bite.

28’s take makes most sense to me. Wolf’s clearly talking about an alleged detrimental effect on the economy as a whole, not to any particular person and her respective position on the bubble. Bigtom also correctly points out, however, that the potential aggregating effects that a critical mass of losers can have (particularly regionally) may have a magnified macroeconomic effect.

dsquared is, regrettably, on holiday. (I gather!)

Matt at #4 is about right. To tread on the dangerous ground of analogy, higher food prices don’t matter to a subsistence farmer since the increased value of their crop is exactly offset by the increased value of the food they are consuming.

You can think of a house as providing a flow of services (shelter, comfort and so on). A landlord sells these services to a tenant, but a homeowner is like a subsistence farmer, both producing and consuming the same services.

So if the house price is just the capitalized value of rental services, a change in the value of the services and in the price of houses should make no difference to homeowners.

But it’s a confusing way of putting the point made worse by the fact (noted by several commenters already) that the market value of houses has gone up much faster than the rental value of the services they provide.

All in all, not the clearest sentence Wolf has written, but the basic point is right. The gains and losses from changing houses prices pretty much cancel out, so there’s no general reason to applaud rising prices or deplore falling prices.

I’m back! Although rendered otiose by John’s #42. It’s the “Housing Is Not Net Wealth” argument; technically flawless and convincing to roughly nobody.

The reason why housing *feels* like net wealth is that it’s just about the only way that a private individual can get meaningful amounts of leverage on an investment; if you’ve bought a house with a mortgage then you’re in the position of a subsistence farmer who has to pay a tithe in cash and suddenly the nominal value of your house does actually matter quite a lot (to you, that is; these things all even out at the level of the whole economy).

Wolf was making a good point, in that thinking about it helps you understand some of the real sources of the problem here. As several people have said, starting with Brett Bellmore way up in comment 8, the problem is leverage. A house is the major investment asset for most people, and most still owe money on it. Recent purchasers can easily end up with negative equity.

Think of a bailout plan where the banks agreed to reduce mortgage values to the current value of the house and then were fully reimbursed by government. That would have inflationary effects on the overall economy (not to mention a lot of moral hazard for the future), but the homeowners would no longer be worse off. The issue is all the speculative debt that was accumulated during the bubble, even by ordinary homeowners. People were forced to be speculators in this bubble.

44: It’s also popular because it’s the only way you can force your kids to transfer wealth to you while you’re still in a condition to enjoy it.

This is definitely a posh list. The only postcodes south of the river are Lambeth, Battersea and Richmond x2 (for those of you not in London: dodgy-but-extremely-central, posh, posh, posh). Half of London lives south of the river, but you only list 4 postcodes, and 3 are posh?

I think that this isn’t really about the effect of the lower imputed rent on the individual homeowners but is rather an example of the mindless aggregation that a certain class of economists practice whenever there’s some disruptive economic shift. Think of the way that apologists for a certain kind of global trade regime argue that lower prices for imports compensate for the pain inflicted by job losses, even though the losses and benefits largely go to very different people.

If rents had in fact been going up in step with home prices, this argument would at least be internally consistent.