How Much Is Your House Really Worth?

It seems like such an easy question: how much is my house worth? The problem is that this is not an easy question – and that fact that that is a problem is the real problem.  Let me explain…

A long time ago, when Tricky Dick Nixon was President of the United States, our country was running up a huge bill trying to pay for the Vietnam war.  There was only so much money coming in from taxes so we had to borrow money by selling treasury securities to other countries and Americans too.  Treasuries were a pretty safe bet – as good as the dollar, which in those days had its value fixed in relationship to gold.  At one time you could redeem your paper dollar for its equivalent in gold. Later, the paper dollar could be redeemed in silver, if you felt like carrying around bags of silver with you. The point was that a dollar was nothing more than a proxy for your ownership of some precious metals that were stored at Fort Knox or somewhere else.  Nixon’s problem was that there was only so much gold and silver in our vaults – so we could only print so much money.

At some point Nixon or his advisers came up with the perfect solution, disconnect the dollar from any relationship at all to any precious metal – in fact detach it from anything physical. The dollar became a Federal Reserve Note, not redeemable for anything.  This allowed Dick Nixon to print as many dollars as he liked so when it came time for people to cash in their Treasury securities they would be paid back in dollars that were worth much less than if they had been backed by a certain amount of gold. The value of the dollar had dropped – or, another way of looking at it is that the value of gold went up a whole lot.

Which brings us to houses – almost anyway.  There is little doubt that the increase in house prices and lots of other stuff since Dick Nixon inflated his way out of Vietnam War debts was not the same thing as an increase in value. The value of things didn’t change much, just the price because the dollar was losing its purchasing power. OK. So that’s it? No. Not exactly.

If we are talking about the value of a house, and not the price – which we can now see is not the same thing – how do we actually determine its value?  Well, the common sense way of determining the value of something ought to take into account the value of the things that went into it, like wood, stone, paint, drywall, and so forth.  Then there is the cost of labor – a bunch of carpenters, electricians, plumbers and so forth had to be paid for the value of their labor. So we have to figure in that value too. Then there is the value of the land.  How large is the lot? Is it swampland? Is it next to a superhighway? Is it level? Is it cleared?  Some of these items are easy to value, for example, if the lot isn’t level we need to pay for a bulldozer to level it.  And so forth. On the other hand, there are some items that are sort of intangibles, like the proximity to a superhighway.  How do you value that?  This is where things get a little difficult.

The issue we are faced with is trying to place a value on something that has no intrinsic value. It doesn’t cost anything more to build a house next to a superhighway than it does to build it far away.  However, it does make it less desirable.  So, we enter the world of supply and demand, where the value of things is not related to tangible things but to emotional things like desire.  This is where the trouble begins too.

Several years ago we entered a fantasy world of house prices.  The price of houses was going up because…because…well, because the price of houses was going up.  It was a fabulous game anyone could play.  Buy a house, flip it, and make a lot of money.  Except there was nothing tangible supporting the price of houses.  Sort of like the Emperor’s New Clothes, only with houses.  For the past couple of years house prices have been in a near free fall in some parts of the country and they are expected to continue falling. So how far will they go?

Now that the balloon has popped it seems that house prices will have to fall until the “irrational exuberance” of home buyers and the equally exuberant lending banks is completely dead. House prices have to fall to the point where they reflect the actual construction costs of the house, i.e. materials, labor, and land, plus some sort of adjustment for the desirability of its location as determined by the local market.  But all the price inflation due to the irrational exuberance of flipping houses has to go.

Oh. There is one other thing. The dollar isn’t what it used to be either. You need to account for the inflation of the dollar since you bought your house. Figure somewhere between 5% and 10% per year – roughly. It’s a cumulative effect so you need to calculate each year of ownership separately – a computer program might help a lot.  Then there is depreciation. Things wear out. Houses get old and start to fall apart, so unless everything is fixed up like new you need to deduct the loss in value from normal wear and tear, plus the natural aging and decay of things.

All things considered, your house is probably worth a lot less than you think it is – unless you happen to live in one of those parts of the country that, for some reason or other, never got caught up in all the irrational exuberance. For those areas out west like California and Arizona and in the east like Florida, homeowners face more pain to come in the great housing value reality check.

House values are a bit difficult to figure at anytime because of all the ingredients that go into their value like materials, labor, loss of value of the dollar, and so forth.  Irrational exuberance is not part of this equation. It doesn’t add value; it only increases the price.  The problem is that as the irrational exuberance of home buyers fades, so does the price.  Eventually, houses will return to their real value, but it looks like a lot of formerly exuberant, but many ordinary American citizens will continue to have an extremely painful reintroduction to reality.

Thank God the banks are OK.

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Underwater Mortgages – The Thing Is This: You Have To Pay

So I’m having my cup of Joe this morning while I’m watching Morning Eeejit on TV, hoping to get at least a little real news, but finding only not-even-half-baked opinions about how Obama has ruined the economy and such.  So I decide to see if there is any real news being reported on the Vapid News Network (VNN) but the ladies are just chit chatting about this and that when one of the other ladies comes on to talk about the economy.  I’m thinking, “Oh boy, here we go again with some more absolutely mindless advice about investing in stocks or bonds that no self-respecting Wall Street shark would even consider for a heartbeat.”

Suddenly a piece of real economic news (sort of anyway) accidentally slips into the morning news discussion. It seems that Deutsche Bank has made a projection that nearly half (actually 48%) of U.S. home mortgages will be underwater by the time the current recession ends. That’s a lot- as the VNN announcer hastened to add.  However, that wasn’t enough.  The VNN person then felt compelled to opine on the prediction and then predict the dire results of the prediction – sort of predicting the prediction’s possible extrapolated ancillary effects in the years to come.  This is what passes for news in the United States of America these days.

Our Lady of the News went on to inform me that having half of the mortgages underwater would mean that half the people with mortgages would probably not have the ability to get a home equity loan and therefore they wouldn’t be able to send their children to college and besides that certain other very bad things will happen because housing prices have collapsed in the Great Recession.  She neglected to note that it was the ballooning of housing prices in the Great Bubble that was the proximate cause of the Great Recession and that the underwateriness of today’s mortgages is nothing more than an overdue correction that was the result of our collective irrational exuberance.   It seems that she has forgotten that only yesterday (it seems) our economy was in a screaming nosedive because of liar loans and lying bankers and lying insurance companies and lying rating agencies and lying government regulators.  And now it sounds like she is wishing for the good old days of artificially inflated housing prices so we can all borrow money and live the good life.  And VNN calls this news.

The simple fact is that underwater mortgages are a necessary and painful part of the correction process.  After all somebody has to pay the bill and it might as well be you.  What?  You didn’t really expect the banks to pay, did you?  No, you have to pay. Either through your mortgage or your taxes or pay cuts or layoffs or higher bus fares or something.  The point is: you have to pay.  I hope that’s not news.

Here’s another thing that’s not news: television news. At least the non-stop, daily sort of stuff that used to be news.  The half hour deals on the major networks are still pretty good.  So is the BBC – if you can get it.  So is PBS – if you watch it.  But, if you want up to the minute, late-breaking headlines, it seems to me that the best place to find that these days is the internet.  All the news services and newspapers race to get their headlines on the net first, while the talking heads on television pseudo-news opine and chit chat their way through the day spreading drivel at best and deliberate propaganda at the worst.

As for the half of us who will have underwater mortgages by the time the recession is over – look on the bright side.  First, be happy you even have a mortgage or a house.

Second, remember that inflation is always with us – it’s a necessary component of a growing capitalist economy – so you’ll soon be paying your mortgage with dollars that are continually decreasing in value. So you actually beat the banks! You’ll be paying with worthless money!  (Actually, not really – but it won’t be as bad as it looks right now).

Third, you’ll have a real house to live in and not a bubble.

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What Is a Barrel of Oil Really Worth?

Five months ago, the price of oil was over $147 a barrel. Today it is about $47 a barrel. How can that be? Did the intrinsic value of oil just evaporate?  Is oil just not as useful as it used to be? Or is it that the U.S. dollar is now worth a lot more than it used to be? How could that happen?  Did we just strike oil or something? No, we didn’t, and yes, oil is just as useful as it used to be. So what is going on here?

How about Las Vegas. In June of 2007 the median price of a home in Las Vegas was $305,000; in June of 2008 the median price of a Las Vegas home was $225, 000 – a loss of 26% of its value. So, what happened to its value? How can the intrinsic value of a house just disappear? Or did the U.S. dollar suddenly increase in value so you don’t need so many of them to buy a house? The problem we are facing today when we try to establish the value of commodities, whether they are barrels of oil, ounces of gold, or three bedroom homes is that not only does the value of each commodity change over time, but so does the value of the U.S. dollar.  It’s like trying to drive a car at a constant 50mph while you have to keep adjusting your pressure on the gas pedal because your fuel flow keeps changing while at the same time your speedometer is fluctuating randomly.  Sooner or later you are going to get a speeding ticket.

The value of commodities is more or less based upon the work needed to create them and the amount of demand for them. Sometimes, breakthroughs are made in production methods and prices can fall drastically; sometimes the price can skyrocket because all of a sudden everyone decides they need a particular thing – like maybe a hula hoop.  This is understandable and it is something that most of us can learn to live with, but the problem becomes much more difficult when our currency is also wildly fluctuating.  The time has come for us to reassess how our currency obtains is value.

For thousands of years, money in many civilizations consisted of gold or something related to gold. Even the U.S. valued it currency in relation to gold, until 1971 when President Nixon decided to decouple the dollar entirely from gold. Its value is now somewhat arbitrary and it is traded on the world markets by speculators.  Gold, although long used as a monetary standard, is not necessarily the best way to determine the value of a dollar. In fact, because there is a limited supply of gold in the world, having a gold standard places a limit on how much money can be created and therefore a limit on how much wealth can exist.

It appears that Nixon’s decision to eliminate the gold standard for the U.S. dollar worked for a while, but now we are beginning to see an unintended effect: the rapid and enhanced fluctuation in prices of “commodities” because the value of the dollar and the value of commodities priced in dollars are changing independently and simultaneously.

A partial solution to this problem can be borrowed from the way science defines the meter. The meter, which really could be any arbitrary length, is defined as “the length of the path traveled by light in vacuum during a time interval of 1/299792458 of a second”. Pretty exact, isn’t it?  With this agreed upon definition of the meter, scientists and engineers all over the world can design products and devices, knowing that they will fit perfectly together with each other today, tomorrow, and ten years from now.  Even though the value of your house may increase or decrease by 50% or more next year, you can be sure than the boundary markers of your house lot, that was surveyed by people using laser devices, won’t change by a millionth of an inch in a hundred years.

So why can’t we also come up with a solid definition of the dollar? We can, the problem is that our government likes having an arbitrary value for the dollar. That way our government has the ability to print its way out of debt.  That Dick Nixon was a genius, wasn’t he? Wouldn’t it be great if we could all do that?

Perhaps it is time to create a new currency – a world dollar – that does derive a fixed value from something that can be easily defined, but not limited in extent, like gold. Then all world currencies would be valued against this, and, I suppose, eventually the entire world would use this single, solid, unchanging currency.

Maybe then we would even be able to say what a barrel of oil is really worth.

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The End of a Bubble Based Economy

We can learn a lot from history, but, too often, we don’t pay attention to the lessons of the past. We are now in an economic position that parallels one of the most devastating economic events in the history of the U.S., the stock market crash of 1929 and the Great Depression that followed. Consider the 1920s. It was a time of rapid economic growth and the stock market was showing exceptional performance. It was becoming common knowledge that the way to get rich was to buy and sell stocks because they were only going to go up. It was such a sure bet that a man could get a loan to buy stocks even though he didn’t own enough resources to pay back the loan. Even the banks knew that the stock market was a sure thing. Lending rules were discarded. It was economic euphoria. In the space of five years the value of the stock market had seen a five-fold increase.

On September 3, 1929, the DOW reached a record peak value at 381.17. About three weeks later, on September 23, 1929, people began to sell, reaping great profits, then the market went up again a week later and then it turned downward. A month later, on October 24, 1929 (Black Thursday) 12.9 million shares were traded, a new volume record. On October 28, a Monday, the DOW lost 13% of its value. The next day, (Black Tuesday) 16.4 million shares were traded, another new record, and the DOW lost another 12% of its value. Wild fluctuations in the stock market continued for about three more years. About six months after the market had crashed, the DOW had even recovered to a value of 294, but the fluctuations continued, and the DOW inexorably lost value until it finally hit bottom on July 8, 1932. It had fallen to an unbelievable value of only 41.22. It would not go above its record high of 381.17 until 1954, twenty-five years after the crash.

The principle lesson to learn from this is that the economic disaster was caused by an irrational euphoria, to borrow a phrase from Alan Greenspan. People thought that the stock market was a surefire way to get rich quick. This was a self-fulfilling prophecy, for a while anyway, because as more people bought stock the market went up. Everyone could see that, even the ordinary workingman. So they borrowed money to invest in the market. The geniuses of finance at the banks were happy to lend money to completely unqualified borrowers because they also knew that you couldn’t lose by investing in stocks. It was a Ponzi scheme, a pyramid scheme, a bubble, call it what you will. The bankers should have known. The government should have known. It was an economy out of control running on false hopes.

After watching the rise of the new tech-based economy in the late 1990s, Alan Greenspan declared that this rapid rise of these upstart industries was due to irrational exuberance. He decided to nip it in the bud, so to speak. (I’ll write more about all that another time). So, he started a relentless process of increasing interest rates. The plan was to make the cost of credit too great for the fledgling tech startups and they would have to stop expanding. He was right, sort of. On March 10, 2000 the dot com bubble came to an end as the Nasdaq, that newcomer, tech-based, stock exchange, hit a high value of 5,048.62. About two years later on October 9, 2002, the Nasdaq hit bottom at 1114.11. Investors had lost about $5 trillion in the slide that occurred after Greenspan saved us from our irrational exuberance.

With the new, tech-based economy a smoking ruin, and the old economy of manufacturing big stuff like bricks and locomotives going nowhere, Alan Greenspan decided to decrease interest rates to stimulate the economy. The thing is that everyone had learned their lesson about tech, so they weren’t going back there. And, everyone still knew that the old economy was moribund, so they weren’t going to put their money there either. Greenspan kept dropping interest rates and then, before you knew it you could borrow money really cheaply, but what was there worth investing in? Then the sages in Washington stepped in and quietly made a change in the tax laws, just to help out us homeowners. The old tax law had a provision created for people who were about to retire and downsize their big old family house. They could take a once in a lifetime tax exemption on the profit on the sale of the family residence up to a value of $200,000. (I think that’s the number – it was quite a while ago). Well, the financial geniuses in DC changed the law. The tax laws now said you could get a $500,000 tax exemption on the profits from the sale of your house every two years, as long as you lived in it for a little while. That, my friends, is a sure moneymaker. Why, all you have to do is buy a fixer upper, fix it up, and live in it a few months, and then flip it! You will make a nice profit every time and it’s tax free!

Before you could say “Alan Greenspan” we had morphed into a housing bubble economy. Our highly educated bankers and financial managers, having learned absolutely nothing from history, gleefully handed out loans to anyone who could still draw a breath, no questions asked, as long as the loan was for buying a house. That’s because everyone knew you could make a fortune buying and selling houses. So everyone started buying and selling houses and the economy took off again. The problem, of course, is that it was another one of those Ponzi, pyramid, sort of deals and eventually there were too many houses and nobody to buy them and no one could actually pay the mortgage payments are live in the houses and POP! There went the economy again, sort of a financial blowout on the one and only wheel of the financial vehicle we are riding in.

So here we are, drifting along. We’ve already spent George Bush’s $600 stimulus checks, and we’re still drifting. The DOW is wildly fluctuating. The government has lowered interest rates as low as they can go. So what now? Shall we turn to the financial geniuses of Wall Street, the marvelous bankers with their keen knowledge of the workings of our economy for guidance? Maybe we should bring Alan Greenspan back with his oh-so-delicate touch on the interest rate controls. Maybe George-in-the-White House will have another inspiration and give us all another 600 bucks.

Here’s the thing that our Republican government and our big businesses don’t want you to know: it’s not about you. It’s about the world economy, not yours. You see, our major businesses, all of them, are multi-national now and we import and export lots of stuff, although some of our imports and exports don’t literally go through the U.S. (I’ll leave that for another time.) One of the things we’ve exported is our economic engine. Yes! We are driving an economic vehicle with its only tire blown out, and now we find out the engine is missing too! See, we don’t make anything anymore. And that, my friends, is our problem. We have become an economy that only functions on bubbles instead of steady growth based upon honest trade. Here’s the scary part for our bubble-based economy: I don’t see any more bubbles in sight, do you?

We’ve had our housing bubble market crash, but we probably haven’t reached a sort of “1932 bottom” yet. But we will, and what will we do when we get there with our one flat tire and no engine? Will we bump along into our own 21^st century version of the Great Depression or will another magic bubble come along to save us? Time will tell.

However, there is another way out you know, a way that actually makes sense – but I’ll tell you about that another time. Meanwhile, here’s 600 bucks, have a ball.

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