My Housing Prediction from June, 2004

June 21, 2004

There are a lot of thing I don't know, but one thing I do know are houses. My father was a general contractor all his life, his father was a carpenter, all my relatives are contractors, and I built many a house starting when I was 12, and ending in my 20s when I finished college.

I know houses, and because I know them, I know there is a boom right now, one that will be followed by a bust. I wouldn't be surprised if houses in some areas dropped by 90% in value. I just don't know when.

Thirty-five years ago, when I was a kid, a nice middle-class house cost $25,000. Now they can cost up to $250,000, depending, of course, where you live (the three most important things for selling a house are "location, location, and location").

People have tried to tell me this increase in price is due to supply-and- demand. No, it's not. Under the free market, as demand goes up, so does the supply. As supply goes up, the price drops. Under a truly free market, you'd have stable prices that would last a century. If prices did anything, they'd drop slightly over several decades.

Those brand-new $25,000 houses of 35 years ago should still cost $25,000 today, not $250,000. What caused this increase?

Overwhelmingly, it's inflation-the Federal Reserve pumping billions of paper dollars into the economy. That extra money in people's hands has bid up the prices of houses. That causes a bubble. Bubbles, of course, are always followed by busts.

The same thing happened during the dot com boom-bust during the 90's. All that extra money pumped into the economy went into the dot coms. Then, bam, the bust. The same thing is happening right in the housing market in some areas. All the money Greenspan is pumping into the economy is going into those markets. Sooner or later, they will blow.

All the money flowing into the housing market has turned housing into a gamble. People are buying houses and hoping the value continues to go up, so they can sell and make a huge profit. This works just fine except for the last people to buy the house, when the bubble bursts and they're left with a house that is worth $200,000 less than what they paid for it.

Houses are what are called "durable consumer goods." Strictly speaking, they are not investments. You generally aren't supposed to make a profit off of them, no more than you would make a profit of off an old car, unless it became the kind people wanted and bid the price up. The main reason houses become profitable investments is when inflated money pours into the market. And then it's not so much "investing" as it is gambling. And gambling's a heck of a lousy thing to base an economy on. It's certainly never the basis for a solid, long-lasting economy that provides good, high-paying jobs for people.

This gambling is made worse by the Fed's dropping the interest rates to the lowest I've ever seen. People are quite rightly refinancing their houses, but if they're taking the extra money and getting deeper into debt they have no idea what they are doing. When the economy goes bad, it will all backfire on them. Pushing down the interest rates that low is a desperate attempt by the Fed to keep the economy going just a little big longer.

Imagine if many people bought brand-new cars and kept hoping the price went up so they could sell them used and make a huge profit. You'd think they were nuts. The same should apply to houses, except houses last a lot longer than cars (that's why they are durable consumer goods). Whereas cars depreciate rapidly in a few years, houses should depreciate very, very slowly over several decades.

Two of my friends who live in the San Franciso area-where there is a huge bubble-just sold their houses. Each probably made $100,000. I know that sounds great. It is, for them. But if you look at the long-run, it's doesn't look great at all. The housing market will blow, as will the economy in that area.

Some people will lose their jobs, lose their houses, and declare bankruptcy. That is the long-term effect of inflation. My two friends made $100,000 each, but down the line lot more than two people will lose just about everything. And most of them won't have a clue what happened.

What would I do if I owned a home in an area where the prices kept skyrocketing every year? I'll sell and get the heck out. I'd go someplace where prices are a lot more stable.

An inflationary boom-bust cycle is something you can bet on. It's such a sure thing it's not even gambling.