What About the Silent Majority in Housing?

Could it be that current housing prices are not real? Are houses undervalued? Are current prices as artificially low as they were artificially high in 2006?

Something to consider for many market watchers and analysts is that the majority of homeowners are current on their mortgages and fifty percent of home owners have title to their house. These individuals are not participating in the current market. These home owners wouldn't even consider selling at 140% of current appraised values. Most crucially these are the true sellers.

Right now housing prices are determined by transactions between willing buyers and unwilling sellers (i.e. banks, unemployed workers, and forced sellers). This is not a traditional market. It is certainly not an efficient equilibrium- it is a slaughter.

Even with the enormous amounts of inventory coming on line from short-sales and foreclosures, this inventory is a mere fraction of the total houses in existence. So there are seven million foreclosures, so what? That is nothing for a growing population of 330 million strong. The United States needs substantial amounts of additional housing year after year and with home builder's sidelined with prices significantly below their costs to construct, the Country is pure and simply running in a supply deficit in the long run.

For buyers the current situation is an absolute blessing. First time home buyers, investors and people with impeccable timing have gotten a windfall. They are buying an asset for less than its input cost (the materials, land cost and permits to build the house are higher than the sale price). This cannot sustain itself in the long run. Even better for the US economy these home purchases are easily fitting into the purchaser's budget. Seriously, we are talking mortgage payments at 10-15% of the buyer's monthly income. What does that equate to? Disposable income.

Take my friend Dr. C for example. Dr C. paid $550,000 for his home and added $250,000 in cash upgrades and modifications. He also 1031 exchanged an investment into another home at $440,000 as an investment property. Both homes are currently appraised at 50% or less than his basis in these homes. However, if a buyer offered to purchase either of these properties, the offer would not be accepted for anything less than his investment. So what is his home worth? Well, we cannot answer the question because their is no willing buyer or seller to fill the transaction.

The point here is that just as buyers were artificially created by creative financing in 2002-2006 to meet seller's demands, now artificial sellers are catering to buyer's demands. I cannot tell you what the "right" price is, but I can assure you this isn't it. In our Country's more intelligent and logical past, housing prices could be derived either by median income of a given area or as a factor of market rents in an area. In an effort to be concise the reader should see Benjamin Graham and David Dodd's Securities Analysis 1934 to learn these principles. Simply stated, stock prices should be reflective of the earnings of that company in a direct analysis or current bond returns in an alternative analysis- so the same is true of housing prices by the above methods.

If all this is too complicated, simply stated this too shall pass.

What is the "Market?"

While I don't want to be purely hypothetical, I believe the use of the term "market" as a synonym for commerce creates great misunderstanding in our society. The market is not simply business or the exchange of goods. The market is society, government, and commerce wound into a single concept.

According to Wikepedia the Market (disambiguation) "is an ARRANGEMENT that allows buyers and sellers to exchange things." That's right, an arrangement! Markets are the function of a human agreement to allow the exchange, not the act of exchanging and certainly not the participants themselves (businesses, consumers, traders, brokers, etc.).

Once a population decides that it wishes to develop a market as an economic model, mind that it is a decision not as some would lead us to believe an act of nature, the choice becomes whether the market should be a market economy, a.k.a. free market economy, a mixed market economy or market socialism (like China). While there exists no true free market economy in practice, it is a useful concept to illustrate the ecomomic spectrum that ranges from free market economy to planned economy. So what are the differences? The choice by a population to allow prices to be set by market participants and the choice on how labor is to be allocated.

In its truest sense a free market would allow market participants to set prices and divide labor according to their transactions. A choice to create this type of economy can expeirence periods that are quite harsh and can result in social unrest and inefficiency in prices for extended periods of time. On the complete other side, a planned economy would set prices and labor by decision. Planned economies tend to be very harsh as output levels rarely meet necessary needs of thepopulation and labor tends to become lethargic and atrophied. As a result, the entire world attempts to address the inefficiencies of the free market model, i.e. long periods of price and societal stagnation, without the stagnation and generations without innovation that result from a planned economy.

That said, there are a number of caveats to the free market model. There is Laissez-Faire where there are no laws including property rights enforced by the government. This is the free market model on steroids as most economists believe even a free market consists of government overview with regard to settling, in whole or in part, property, contracts and general access to the market. This form of free market literally places the onus on the buyer and seller to deal with one another without appeal or recourse. This is a no holds barred, steal it if you can, John Locke State of Nature system.

Also, there is capitalism which takes a twist on the free market model and develops a coordinated system of protections that allows capital to flow to other users. Here, its no longer buyers and sellers alone, but capital investors and leverage as societally enforced instruments.

The point of all this is that before there is a market, there is a choice to have a market. The market cannot decide anything. Contrary to popular belief the market is not a decider of prices, capital flows, efficiencies, good business, stock prices, commodities, or anything else for that matter. The market participants acting within the construct of an agreed upon arrangement can decide all of those things. Markets are societal creations to create increased standards of living for its populations. In the end, the market is greater than the prices set by its participants or the efficiencies reached by its functioning.

The market is a population's arrangement to trade goods and services. As such, once cannot separate government from the market or the market from sociological trends. The market is politics, it is family values, it is government regulation, it is capitalism, it is socialism, it is laissez faire, it is communism, it is business, it is consumers, it is buyers, it is sellers, it is competition, it is oligolpoly, it is monopoly, it is those who participate and those who choose to protest it- it is what we as society decide it to be. Why? The market is a choice of the population. Whether or not it exists and to what form it takes has to be chosen. As I have blogged, the market is not an end, but a means to an end- prosperity.