Housing 'wealth' and illusion

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Article Highlights

  • Asset bubbles make a great many people very happy while they last, because they think they are becoming wealthier.

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  • Inevitably following each bubble is a price shrivel, as of course happened with U.S. house prices.

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  • Increasing real aggregate wealth can only result from increasing production.

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Modern fiat-currency central banks are in the money illusion business, which turns into the wealth illusion business, notably when it comes to housing and the “wealth” represented by houses.

Before 2007, central bankers in the U.S. and Europe managed to convince themselves they had created a new era, “The Great Moderation” — but what they actually presided over was the Era of Great Bubbles.

In the U.S. we had first the Great Overpaying for Tech Stocks in the 1990s, then the Great Leveraging of Real Estate in the 2000s. (Of course, the Great Leveraging of Real Estate also occurred in other countries at about the same time, and Europe in addition managed to create the Great Sovereign Debt Mistake.)

Bubbles make a great many people very happy while they last, because they think they are becoming wealthier. But this so-called “wealth” is an illusion, as they discover afterwards. Inevitably following each bubble is a price shrivel, as of course happened with U.S. house prices, which fell on average over 30%. Then many American commentators talked about how people “lost their wealth,” with statements like “in the housing crisis households lost $7 trillion in wealth.” But since the $7 trillion is based on the house prices of the bubble, it was never really there in the first place, so it wasn’t really lost.

Common calculations of aggregate “wealth” take the entire stock of an asset class and multiply it by the bubble prices, on the theory that financial value is what you can sell something for. Of course, some clever or lucky individuals do succeed in selling at the bubble highs, but the aggregate bubble prices can never be realized by sale. As soon as large numbers of the owners of a bubble asset try to sell their stake in it, the bubble collapses, the evanescent “wealth” disappears, and the longterm trend reasserts itself, as Figure 1 shows.

Consider the longterm path of U.S. house prices relative to inflation. Figure 1 displays a 60-year history, 1953-2013, setting the U.S. Consumer Price Index and average American house prices both equal to 1953=100. The high correlation of general inflation and house prices over time is obvious. Equally obvious is the huge deviation from the trend relationship created by the housing bubble. Note especially how the shrivel took house prices all the way back to the longterm inflation line.

Now, however, the Federal Reserve has on its own balance sheet about $1.5 trillion of mortgage securities, making it the biggest savings and loan in the world. Under the prompting of the Fed’s bond market manipulation, U.S. house prices again are moving above the inflation line. In my opinion, this is a central bank-induced asset price distortion. When the Fed ultimately stops buying bonds, and longterm interest rates rise to normal, significantly higher, levels, it willput downward pressure on these artificially boosted house prices.

In any case, the longterm trends suggest that there is little, if any, increase in U.S. house prices on an inflation-adjusted, or real, basis which is sustained over time. The trends do suggest that houses are, on average, a good hedge against the inflation that fiat-currency central banks intend to and do create.

Let us turn to another trend–that of wealth owned by U.S. households per capita, both houses and all financial assets, including pension funds. As shown in Figure 2, the tech stockand housing bubbles created big, non-sustainable departures from the longterm trend, which then disappeared.

Considered over the long term, however, netting out the bubbles, Americans have still achieved impressive increases in their ongoing wealth.The trend is for inflation-adjusted, per capita wealth in the U.S. to increase by about 2% per year. The rate of increase may seem modest, but in fact represents a miracle of the market economy. Figure 2 is the 60-year record, 1953-2013.

The Era of Great Bubbles is readily apparent, as is the subsequent regression right back to the trend. Equally apparent is the longterm trend itself, rising at 2% per year compounded on average.

Why should it be 2%? Increasing real aggregate wealth can only result from increasing production. From 1953-2013, U.S. real GDP grew by approximately 3% a year; the U.S. population by about 1%. Thus it makes sense that on the trend, per capita wealth of the sustainable kind grows at about 3% minus 1%, or 2%, once the up and down excesses of bubbles have netted themselves out. With a 2% trend increase, in a lifetime of 83 years, Americans will on average grow five times as wealthy.

But along the way, they should avoid confusing the “wealth” of bubbles with actual wealth. They should most especially avoid incurring a lot of debt, which will prove to be quite real, against bubble asset prices, which will prove to be illusions.

Moving to a North American context, it does appear that Canada is experiencing a build-up of illusory housing wealth. Figure 3 shows the remarkable contrast between Canadian and U.S. house prices, indexed to the year 2000=100.

Where and how this Canadian house price runup will end is continues to be debated. The peak of the U.S. housing price bubble was in the second quarter of 2006, more than seven years ago. With an interim correction in 2008, Canada has since then gone to levels far above the U.S. peak. Will the Canadian housing finance structures handle a shrivel, if it comes, better than the U.S. and other countries have, or not? Here is a North American study in contrast, so far, and a housing finance drama to watch.

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About the Author


Alex J.
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.

    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.

    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.

    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.

  • Phone: 202.862.7190
    Email: apollock@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

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