April 27, 2006

What if House Prices Don't Go Down?

Marc Faber, author of the excellent book Tomorrow's Gold and the Gloom, Boom, and Doom newsletter prompts an interesting question or two after an interview this week in which he postulated that if the Dow Jones Industrial Average went up by three times in the next ten years, then gold would go up by a minimum of ten times.

What questions were prompted?

If the Dow can rise significantly in the next ten years, why not housing too?

And, if housing continues to rise, what would be the fate of those who have eagerly cashed in their real estate gains with the expectation that prices will fall and they will be able to buy back in at lower levels?

What if house prices don't go down?

These are not the sort of questions that you normally read in this space, as for some time now, expectations have been quite high for a healthy correction, where normalcy is returned to a housing market that has acted eerily like internet stocks a few years back.

But, the highly anticipated correction has been slow in coming - agonizingly slow.

The whole idea is worthy of consideration as many sit and wait for what appeared so obvious, so many months ago, and which is now unfolding at a pace that can only be described as glacial. And, with an outcome that is still uncertain.

Dr. Faber offers his thoughts on gold and the dollar:

The outlook for the precious metal depends on how much money Federal Reserve Chairman Ben Bernanke "will print,'' Faber said in an interview yesterday in Tokyo.

"As you know he has pronounced speeches about asset deflation,'' said Faber, referring to Bernanke. "He's concerned about real estate and stocks going down, so in the long run for sure he'll print money.''

So, printing more money, according to Dr. Faber will be the cure-all. Stocks, housing, you name it - one simple solution for all that ails the post-Greenspan economy.

That's not to say that Mr. Bernanke will have much control over where all that money goes, but some of it surely will find its way into stocks and housing. With a little help from government and big banks, perhaps these favored asset classes will be kept aloft for longer than most could imagine.

But, what about the money that doesn't go into these favored assets?

Pension and mutual funds are pumping record amounts of cash into commodities as China's booming economy stokes demand for oil and other raw materials, leading to a three-year boom in prices. The amount of money invested in index-linked commodity funds rose last year by as much as $30 billion to $80 billion, according to Barclays Capital. The amount may rise by 38 percent this year to $110 billion, the bank said.

Gold for immediate delivery reached a record $850 in 1980. The metal rose 0.4 percent today to $623.09 an ounce at 11:45 a.m. Tokyo time.

Energy and uranium prices will continue to rise on growing Asian demand, said Faber.

"Asian oil demand will double,'' he said. "We don't know whether that will be in eight or 15 years but for sure it will double and I don't think supplies will be able to match that.''

So, with the electronic printing press ready and willing, and with a still irrationally exuberant populace that doesn't seem to tire of working their way from one bubble to the next, why not just keep printing money as a cure for every economic malady that arises.

Can't afford to fill up your tank? Enter the 2007 Working Family Gasoline Subsidy Bill.

Can't make your mortgage payment due to your ARM resetting? How about the 2008 Mortgage Payment Relief Act.

Stock market faltering? The Federal Reserve Bank of New York will be there to prop it up.

The Federal Reserve and the Treasury Department, along with some creative legislation, will have the cure.

Falling Home Prices

House prices are already beginning to fall - yesterday's new home sales report (PDF) from the Census Bureau showed a two percent drop in median price year-over-year and whopping eight percent decline from the peak last summer.

So, as far as the homebuilders go, real estate is now past its peak.

This chart from the very data-friendly Lyons Real Estate in the Sacramento area shows about a five percent decline in average price per square foot since last summer and there are many anecdotal accounts nationwide about faltering housing markets where sellers are faced with the harsh choice of downward price adjustments or letting their property sit on the market where inventory is rising rapidly.

So, it seems that in many areas, the corner has already turned and now it's just a question of where prices head, how fast, and what the response is from the powers that be.

If, as Dr. Faber suggests, Ben Bernanke and crew are ready and willing to do whatever it takes to keep the most recent asset bubble inflated by printing money at virtually no cost, then what?

If in five years, a very ordinary California home still costs a rather extraordinary half million dollars or so, where will that leave the shrewd observers of economic trends who cashed in their real estate gains and parked their bounty in Treasury bills yielding five percent while waiting for a better buying opportunity?

They'll be left disappointed - that's where they'll be.

But, in the event that this scenario does unfold, time may still be on the side of those who exited the real estate market with huge gains in recent years. Extrapolating from Dr. Faber's example above where the Dow goes to 36,000 in ten years and gold goes to $6000, let's figure what that might translate to for housing in five years, assuming an ultra-aggressive monetary policy response in the wake of a declining housing market.

For example, if that $700,000 home today defies all logic and proceeds toward $1 million in the early part of the next decade, how would that stack up against, say, $350,000 in gains from the sale of property in 2005 for someone who is now renting?

It all depends.

If the $350,000 were returning five percent a year, then in five years, the earnings would be roughly $100,000 before taxes, leaving the renter more than $200,000 behind where they would have otherwise been.

Not very good.

If the $350,000 were invested in the Dow, which proceeded to double in five years, the earnings would be roughly $350,000 before taxes, leaving the renter about where they would have been had they just stayed put last year.

Better, but still not worth the trouble.

If the $350,000 were invested in gold, which, over the next five years moved to $3,000 an ounce, then the million dollar home in 2011 could be purchased outright, leaving a cool three-quarters of a million dollars left over to have some fun with.

Hmmm...