WEBVTT NOTE The Continuing Housing Bust 1 00:00:00.000 --> 00:00:10.000 Music 2 00:00:10.000 --> 00:00:17.000 I'm sitting here with Ed French, the president of the Mises Institute, who's been writing about housing and banking for many years. 3 00:00:17.000 --> 00:00:26.000 The latest news, Doug, is that housing starts have slid. You're not surprised by this? 4 00:00:26.000 --> 00:00:36.000 No, I think that's good news that housing starts have slid and builders probably should stop building for a number of years 5 00:00:36.000 --> 00:00:52.000 while the current housing stock is filled up by demand that is very soft at the moment and probably will continue to be soft for a number of years. 6 00:00:52.000 --> 00:00:54.000 So that's actually good news. 7 00:00:54.000 --> 00:00:59.000 That opinion doesn't seem to be shared by most editorial writers. 8 00:00:59.000 --> 00:01:14.000 Right, there's something about houses and cars that Washington D.C. would like us all to be buying a new house or a different house and buying a new car to stimulate the economy. 9 00:01:14.000 --> 00:01:20.640 But the economy should be, you know, people are doing the smart thing and it's best for 10 00:01:20.640 --> 00:01:26.240 the economy if people continue to save money, continue to pay down their debt, continue 11 00:01:26.240 --> 00:01:37.280 to delay consumption of homes and houses and this is all good news but certainly in Washington 12 00:01:37.280 --> 00:01:39.280 they view it differently. 13 00:01:39.280 --> 00:01:50.280 That's good. It may be wise for the individual household, but the conventional wisdom says that maybe what's good for the individual household is not necessarily good for the economy at large. 14 00:01:50.280 --> 00:02:01.280 I mean, can we experience recovery so long as housing continues to fall? The conventional view now, as it was in the New Deal, is that we can't. 15 00:02:01.280 --> 00:02:10.760 Right, but this is just what the Austrians would say is a kind of a cleansing of the 16 00:02:10.760 --> 00:02:17.320 malinvestments of the last decade or two decades in the United States, and so all the people 17 00:02:17.320 --> 00:02:21.080 that have been involved in housing, whether they be construction workers or whether they 18 00:02:21.080 --> 00:02:31.080 be real estate agents or work for title companies or work for banks, those people need to be 19 00:02:31.080 --> 00:02:39.720 They were in boom time industries and their skills are needed in other parts of the economy. 20 00:02:39.720 --> 00:02:50.840 So propping up old industry, propping up what were boom time phenomena is not going to make 21 00:02:50.840 --> 00:02:51.840 the economy any better. 22 00:02:51.840 --> 00:02:55.240 He's going to continue this for years and years and years. 23 00:02:55.240 --> 00:03:00.800 Do you see this as the beginning of a continuing downtrend or is this the tail end of a fall 24 00:03:00.800 --> 00:03:05.240 That was only interrupted by the stimulus package and the low interest rates and all the rest of this. 25 00:03:05.240 --> 00:03:10.140 Yeah, I think it's probably more of the latter. 26 00:03:10.140 --> 00:03:12.640 I think we'll continue to fall. 27 00:03:12.640 --> 00:03:19.760 And with the occasional Washington paddles being applied to the dead patient, 28 00:03:19.760 --> 00:03:26.080 which lifts the shock, lifts the dead patient off the table briefly, 29 00:03:26.080 --> 00:03:29.560 a few more cars are sold or a few more houses are sold. 30 00:03:29.560 --> 00:03:36.600 But prices need to adjust, the price of cars, the price of houses, so that people can afford them. 31 00:03:36.600 --> 00:03:42.280 And this is a process that's being delayed by Washington. 32 00:03:42.280 --> 00:03:48.840 And instead of re-inflating the bubble, they're just going to pump a little bit of air into it. 33 00:03:48.840 --> 00:03:56.920 But those bubbles and those type of assets needs to deflate further. 34 00:03:56.920 --> 00:04:10.760 and the commercial real estate unwinding has just begun and that will just add to this. 35 00:04:10.760 --> 00:04:15.640 Okay, it raises a number of things. I'm trying to sort through what's the best question to ask. 36 00:04:17.880 --> 00:04:22.360 Let me just draw attention to this new phenomenon that you've been talking about recently where 37 00:04:22.360 --> 00:04:31.360 The number of people just walking away from their homes seems to be rising. 38 00:04:31.360 --> 00:04:35.040 There seems to be a debate even about the ethics of this after all in the contract that 39 00:04:35.040 --> 00:04:38.720 says look if I don't pay my mortgage you can take my home so the people are walking away 40 00:04:38.720 --> 00:04:47.800 from it so maybe it's not such a terrible thing except from the point of view of bankers. 41 00:04:47.800 --> 00:04:51.880 Could you explain a little bit about the economic decision to walk away from your home? 42 00:04:51.880 --> 00:04:53.880 seems in a way perverse. 43 00:05:21.880 --> 00:05:51.880 is higher and the interest rate may or may not be higher but you're now amortizing more debt than you originally had so your payment is significantly larger, maybe your income is the same but you still have a job and you can't make that payment, that's one phenomenon, but the other one that we're really talking about here are people who still have a job and can make the payment 44 00:05:51.880 --> 00:06:02.540 But the asset that is securing that loan has fallen tremendously to the point where they 45 00:06:02.540 --> 00:06:06.140 have no equity in the asset. 46 00:06:06.140 --> 00:06:15.780 They may own 300,000 and the asset's worth, the house in this case, 150,000 or 200,000. 47 00:06:15.780 --> 00:06:21.140 So what's the sense in continuing to make this payment when they have the opportunity 48 00:06:51.140 --> 00:06:58.180 making various cases here that gee you know the mortgage lender knew going in 49 00:06:58.180 --> 00:07:04.100 that they were making a loan you were making a payment based on economic 50 00:07:04.100 --> 00:07:08.820 conditions and if it wasn't going to work out you were going to walk away I'm 51 00:07:08.820 --> 00:07:13.760 not sure that's I'm not sure that was the understanding going in I think laws are 52 00:07:13.760 --> 00:07:17.900 different in various states I think loans are going to be different some are 53 00:07:17.900 --> 00:07:26.540 or non-recourse where, okay, if you walk away, then you hand over the keys and you're done. 54 00:07:26.540 --> 00:07:35.820 But in a number of instances, then lenders are going to go after borrowers for the deficiency. 55 00:07:35.820 --> 00:07:37.580 And so it's going to vary. 56 00:07:37.580 --> 00:07:44.340 I wouldn't even pretend to give anybody any advice because, you know, it's going to vary 57 00:07:44.340 --> 00:08:04.340 I think it's going to vary what your situation is and what the laws are in your state, and it's going to vary depending on the language of your mortgage or the note secured by a trustee, depending on what kind of state you're in, but a number of people are doing this, and I think it just puts further pressure downward on housing prices. 58 00:08:04.340 --> 00:08:11.340 It's a little bit of a mystery from an economic standpoint, because you say a house that's $300,000 is now worth $150,000 or whatever. 59 00:08:11.340 --> 00:08:17.340 How can we really say it's worth anything until it's on the market? It's just an impression that person has, right? 60 00:08:17.340 --> 00:08:25.340 That, gee, you know, they're looking around, noticing that there's better deals out there, even though they're getting exactly what they're paying for. 61 00:08:25.340 --> 00:08:31.340 Namely, they're living in a house and making the same payment they did before, but then suddenly they feel sort of ripped off in some way, 62 00:08:31.340 --> 00:08:37.340 And dumping more money into this house is not a good way to save money, it's not a good investment. 63 00:08:37.340 --> 00:08:48.340 Right, it doesn't make any economic sense, it doesn't make any rational sense to them to make a payment towards something that they're never really going to own. 64 00:08:48.340 --> 00:08:57.780 Yeah. They're just dumping money into a black hole that they're making interest payments 65 00:08:57.780 --> 00:09:04.100 towards something that they're never going to realize the value from. So people are walking 66 00:09:04.100 --> 00:09:09.780 away and interestingly people are keeping credit cards current and keeping them paid 67 00:09:09.780 --> 00:09:13.460 down and possibly paying down on their credit cards so that they have the availability of 68 00:09:13.460 --> 00:09:20.380 Future Credit, rather than pay toward their mortgage. It used to be exactly the opposite. 69 00:09:20.380 --> 00:09:27.660 People would walk away from high interest and high credit card balances and make sure 70 00:09:27.660 --> 00:09:33.380 that their mortgage payment was made because that was the biggest part of your credit report 71 00:09:33.380 --> 00:09:39.860 and that has completely been turned on its head and it's very interesting. Over time, 72 00:09:39.860 --> 00:09:48.280 Scores, trying to find the right word, but say a 700 beacon score a few years ago is 73 00:09:48.280 --> 00:09:50.380 not what a 700 beacon score is now. 74 00:09:50.380 --> 00:09:58.540 In other words, you've heard of grade inflation, well we've had credit score inflation. 75 00:09:58.540 --> 00:10:07.040 The 700 borrower now is not as good as the 700 borrower was a few years ago and the 700 76 00:10:07.040 --> 00:10:12.280 Score Borrower a few years ago wasn't as good as the 700 credit score borrower a few years 77 00:10:12.280 --> 00:10:13.280 before that. 78 00:10:13.280 --> 00:10:19.720 At one point, I had heard a short sale would take 100 points off of your credit score and 79 00:10:19.720 --> 00:10:23.440 now I hear that's down to maybe 60 or 80. 80 00:10:23.440 --> 00:10:33.920 So I think the scoring services are starting to see more and more of people negotiating 81 00:10:33.920 --> 00:10:42.440 Short Sales with their lenders, and I think over time doing a strategic default, if you 82 00:10:42.440 --> 00:10:48.200 will, will probably not cost you as much on your credit score going forward as maybe it 83 00:10:48.200 --> 00:10:50.040 would have in the past. 84 00:10:50.040 --> 00:10:58.120 So people will, even if they're going to weigh that in terms of, gee, if I can save 500 a 85 00:10:58.120 --> 00:11:19.120 How much bad debt is being hidden in the banks? 86 00:11:19.120 --> 00:11:22.720 You know, I don't know for sure, certainly in any individual case. 87 00:11:22.720 --> 00:11:34.720 My guess is that I think that assets have fallen in value on bank balance sheets in 88 00:11:34.720 --> 00:11:41.400 terms of collateral for loans much more than maybe the banks are recognizing. 89 00:11:41.400 --> 00:11:52.280 and you know there's a lag time in the appraisal process anyway and as especially these commercial 90 00:11:52.280 --> 00:12:02.040 loans secured by commercial real estate have not they don't truly reflect what those assets 91 00:12:02.040 --> 00:12:11.880 are valued, vacancy rates are way up, rents are down, and capitalization rates are much 92 00:12:11.880 --> 00:12:20.440 higher than they were a few years ago when many of these loans were underwritten. 93 00:12:20.440 --> 00:12:25.040 Capitalization rate, by the way, is essentially the inverse of a price-earnings ratio. 94 00:12:25.040 --> 00:12:34.040 If you had a 5% capitalization rate, that would equal essentially 20% P-E ratio in stock terms. 95 00:12:34.040 --> 00:12:39.040 And so the lower a cap rate is, the higher the value is. 96 00:12:39.040 --> 00:12:43.040 And as cap rates go up, then values come down. 97 00:12:43.040 --> 00:12:51.040 So there are plenty of commercial real estate loans underwritten at 6%, 7%, 8% cap rates. 98 00:12:51.040 --> 00:13:21.040 Well, those cap rates today are 9, 10, 11 percent and so that means that commercial values, values on commercial real estate have fallen 25, 30, 40 percent and if those loans were written at 70 percent, 75 percent loan to value, they are now under water and I think a lot of banks have that kind of collateral securing their loans 99 00:13:21.040 --> 00:13:27.000 and they are agitating with regulators that if the payments are current you 100 00:13:27.000 --> 00:13:32.880 know please let us keep them on their books at the full loan value I think in 101 00:13:32.880 --> 00:13:38.680 some cases regulators are allowing that but over time as commercial borrowers 102 00:13:38.680 --> 00:13:48.280 throw in the towel you know those values will will eventually creep creep into 103 00:13:48.280 --> 00:13:55.160 Charge-offs, write-offs and that'll affect bank capital and as that capital 104 00:13:55.160 --> 00:14:00.160 erodes and then banks go out of business so and we're just going to see more and 105 00:14:00.160 --> 00:14:05.280 more of that as the years go or as the year goes on and as the years go on 106 00:14:05.280 --> 00:14:12.120 commercial real estate is heavily dependent on unemployment rates being 107 00:14:12.120 --> 00:14:21.520 being low, future development happening, the housing, a robust housing market drove commercial 108 00:14:21.520 --> 00:14:29.920 real estate in that, houses would lead to commercial projects being built, so if you 109 00:14:29.920 --> 00:14:34.800 had a subdivision of houses, then the commercial developer would say, gee, look at all those 110 00:14:34.800 --> 00:14:42.080 houses being built, we need to build commercial property to support that, office projects 111 00:14:42.080 --> 00:14:49.240 Architects are heavily dependent on real estate types of tenants in some markets, whether 112 00:14:49.240 --> 00:14:54.860 they be architects, appraisers, title companies, whatever they may be. 113 00:14:54.860 --> 00:15:01.000 Many office users are dependent on what was essentially a malinvestment during the boom. 114 00:15:01.000 --> 00:15:05.880 It's an interesting point to draw your attention to the integration between these two sectors. 115 00:15:05.880 --> 00:15:16.280 Some critics have argued against the claim that this is essentially a housing bubble blown 116 00:15:16.280 --> 00:15:26.160 up by these government-backed mortgage companies plus the regulatory interventions like Community 117 00:15:26.160 --> 00:15:30.280 Green Investment Act and all the rest of it by pointing to the existence of the commercial 118 00:15:30.280 --> 00:15:34.840 real estate bubble too and saying, like Paul Krugman said this, he said, look, the conservatives 119 00:15:34.840 --> 00:15:47.840 The Austrian position agrees that it was a generalized bubble, but for different reasons than maybe Krugman would say. 120 00:15:47.840 --> 00:15:53.840 Right. They are integrated, as you say. 121 00:15:53.840 --> 00:16:23.840 and so you didn't have a housing bubble in off all by itself without the commercial development following that and I would even say that people being able to borrow against inflated home values not only created a larger money supply growth through commercial banking being able to lend people 122 00:16:23.840 --> 00:16:31.420 of Second Trust Deeds on their homes, and thus we had huge money supply growth during 123 00:16:31.420 --> 00:16:32.420 this period. 124 00:16:32.420 --> 00:16:40.800 But it also spawned tremendous consumer businesses, whether it be casinos in Las Vegas or vacation 125 00:16:40.800 --> 00:16:48.800 properties in Florida or whatever it may be, people had this false sense of being rich 126 00:16:48.800 --> 00:16:55.720 because their homes had this value that they thought they could borrow against forever. 127 00:16:55.720 --> 00:17:02.820 So we've had a number of businesses develop that is wholly dependent on that and those 128 00:17:02.820 --> 00:17:04.880 businesses are beginning to unwind. 129 00:17:04.880 --> 00:17:11.520 It must at some level really shock the American psyche because the conventional wisdom for 130 00:17:11.520 --> 00:17:15.440 a half a century or more has been that the best way to save money is to dump it into 131 00:17:15.440 --> 00:17:16.440 your home. 132 00:17:16.440 --> 00:17:24.360 Well that's exactly right. The, you know, homes would do nothing but go up in value. 133 00:17:25.160 --> 00:17:32.920 The conventional wisdom was to buy the most house that you could possibly afford because it would 134 00:17:32.920 --> 00:17:42.840 go, you would essentially be leveraging the upside of housing to greater wealth. Most people make the 135 00:17:42.840 --> 00:17:49.600 The assumption that the largest asset that any one person has is their home. 136 00:17:49.600 --> 00:17:55.560 And that is right and the way it should be. 137 00:17:55.560 --> 00:18:00.920 There were plenty of schemes going around and plenty of money advisors telling people 138 00:18:00.920 --> 00:18:06.700 not to pay down their mortgage, that they should make the minimum mortgage payment and 139 00:18:06.700 --> 00:18:11.400 put the rest into the stock market. 140 00:18:11.400 --> 00:18:19.720 That was advice that was very prominent and people took that to heart and of course now 141 00:18:19.720 --> 00:18:22.240 the value of their home has gone down. 142 00:18:22.240 --> 00:18:29.120 They haven't paid it down much and so now they're underwater and more than likely they 143 00:18:29.120 --> 00:18:37.640 invested in a bunch of stocks that were cut in half during the 08 financial meltdown, 08-09 144 00:18:37.640 --> 00:18:38.640 financial meltdown. 145 00:18:38.640 --> 00:18:54.640 You know, all of these things, this whole bubble economy is not just houses, not just commercial real estate, but it's stocks and even lifestyle in general is thrown into this. 146 00:18:54.640 --> 00:19:01.640 We've been hearing about the recovery now for a very long time, really probably two years, right? 147 00:19:01.640 --> 00:19:10.640 about how the economy is recovering, but there are very few indicators out there that you can point to that show any good trends. 148 00:19:10.640 --> 00:19:24.640 Right, I haven't seen any, and of course the government's numbers are suspect anyway, but you know, unemployment is still very high, 149 00:19:24.640 --> 00:19:33.920 and if you look at the the broadest measures of it say the u6 that takes 150 00:19:33.920 --> 00:19:38.640 into some discouraged workers not all the scourge workers but at least some of 151 00:19:38.640 --> 00:19:46.520 them were you know 16 70 17 percent unemployed and so we're approaching a 152 00:19:46.520 --> 00:19:51.880 point where one in you know one in every five people is unemployed and and if you 153 00:19:51.880 --> 00:19:58.960 We throw long-term discouraged workers in there. It's even higher than that in the cities. 154 00:19:58.960 --> 00:20:09.320 If you just count cities, urban areas, it's even higher. Not to mention young people typically 155 00:20:09.320 --> 00:20:18.440 are unemployed and minorities. In some sectors, the economy is very bad and we continue to 156 00:20:18.440 --> 00:20:28.960 to see more and more filing of bankruptcy, more and more defaults being filed, both on 157 00:20:28.960 --> 00:20:36.960 the commercial side and on residential, so I don't see any evidence as much as some commentators 158 00:20:36.960 --> 00:20:42.920 would like to point to. Green shoots, if you will, I just don't think they're out there. 159 00:20:42.920 --> 00:20:48.000 What about the magic bullet of low interest rates? You know, people hear bad news and 160 00:20:48.000 --> 00:20:57.500 The very first response from the planning elite is, well, there you go, we've got to push interest rates, so we've got to hold them down to zero for a longer period of time. 161 00:20:57.500 --> 00:21:14.500 Well, Japan's essentially had their interest rates at zero for 17 years now, and it's done nothing for that economy, in fact, their GDP, even at very low levels, has fallen off a cliff in the last two years. 162 00:21:14.500 --> 00:21:22.300 and I fear the same thing is happening here, that we're going to keep rates at zero, but 163 00:21:22.300 --> 00:21:29.540 we have a banking system that is still trying to heal itself. 164 00:21:29.540 --> 00:21:37.580 And what's the incentive for bankers to go out and make loans at 3 or 4% when they know 165 00:21:37.580 --> 00:21:44.260 that higher rates are possibly coming or that the economy is bad and the potential for charge 166 00:21:44.260 --> 00:22:00.260 and a large officer high. So, you know, we should have higher interest rates to entice lenders into making loans, not force interest rates down, that takes away that incentive. 167 00:22:00.260 --> 00:22:06.260 So it works exactly the opposite of what policy thinkers think it might. 168 00:22:06.260 --> 00:22:16.180 This is, to me, a brilliant insight and one that I reflect on all the time and as much 169 00:22:16.180 --> 00:22:22.620 as I'm willing to believe that government bureaucrats and central bankers are stupid, 170 00:22:22.620 --> 00:22:32.740 it still strikes me as really an incredible thing that people miss this obvious point 171 00:22:32.740 --> 00:22:36.900 that the lower the interest rates, the less incentive there is for lending. 172 00:22:36.900 --> 00:22:44.420 Well, they get trapped in this Keynesian point of view that they get caught in their own 173 00:22:44.420 --> 00:22:54.640 liquidity traps, so to speak, and essentially the government and Keynesian policy cannot 174 00:22:54.640 --> 00:22:59.940 pull an economy out of something like this. 175 00:22:59.940 --> 00:23:04.740 As Murray Rothbard pointed out in America's Great Depression is that the government needs 176 00:23:04.740 --> 00:23:13.340 to lessen its impact on an economy and that will lead to the pay down of debt and capital 177 00:23:13.340 --> 00:23:19.700 accumulation and as long as the government stays involved that will do just the opposite 178 00:23:19.700 --> 00:23:21.420 and just prolong the agony. 179 00:23:21.420 --> 00:23:28.260 So the French plan is massive cuts in government spending, higher interest rates, any other 180 00:23:28.260 --> 00:23:39.340 I don't anticipate this being enacted overnight, but you've got state and local governments 181 00:23:39.340 --> 00:23:51.680 that are extremely bloated, and you've got retired workers that are earning every bit 182 00:23:51.680 --> 00:23:54.480 as much as they made when they were on the job. 183 00:23:54.480 --> 00:24:02.040 So instead of local municipalities paying for one fireman on the job to put out a fire 184 00:24:02.040 --> 00:24:08.080 or tape up the kid's ankle that he sprains at a baseball game, you actually have to pay 185 00:24:08.080 --> 00:24:14.460 for him and the retiree or maybe two retirees that are in the system. 186 00:24:14.460 --> 00:24:20.280 And eventually this math won't work either and that's what local governments are struggling 187 00:24:20.280 --> 00:24:29.200 with these kinds of obligations that essentially put Detroit under and so you've got this 188 00:24:29.200 --> 00:24:37.820 massive battle going on with these legal obligations that politicians have made for the taxpayer 189 00:24:37.820 --> 00:24:43.600 and eventually it's all going to fall apart but these things would take time but it would 190 00:24:43.600 --> 00:25:04.600 It would certainly help that if government would back its way out of at least trying to stimulate real estate and stimulate big purchases like cars and let those markets correct themselves, that would certainly be good for the economy. 191 00:25:04.600 --> 00:25:17.600 Well the PPI figures just came out and there's other factors related to inflation that we should talk about some other time but I know I interrupted you today right in the middle of very busy work running the Mises Institute so I'll let you go and thank you very much. 192 00:25:17.600 --> 00:25:18.600 Well thank you.