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Homes Are Consumer Items - Not Investments


If the Fed knew how to manage an economy, housing prices would be included in CPI.

In response to my repost of a Wall Street Journal article about an aborted move by the Peacock family to sell a 10,000-square-foot home (complete with an exotic game room that featured a hyena and the heads of an elephant and a wildebeest), along with 6 sports cars and other items, I received this email from Minyan MB.

Dear Professor Shedlock,

I'm a long-time reader and always enjoy your take on things. The article on the failed auction of the mansion in Florida points out a change I think we're facing: Huge, overly ostentatious homes are dinosaurs.

But I was recently tempted by a "bargain" property here in the Portland area. The bargain property is a 10,000-square-foot home on a 1.4-acre lot in the most prestigious gated community around. It's appraised at $3.5 million, has a $2.7 million mortgage, is bank-owned by a mortgage company in bankruptcy, and the price has continued to drop (it's now at $900,000).

On the one hand, I can't see ending up with a 10,000-square-foot home with huge utility bills and a tax bill of $41,000. Who will ever want to live in a home like this again? I considered offering $600,000 for it, but decided to walk away, not wanting to own it at any price.

Minyan MB

Dear Minyan MB,

Those who think we've seen the bottom in housing -- especially luxury housing -- need to think again. Attitudes are changing, and they're not changing back. Peak credit and peak earnings are in. Those expecting otherwise need to consider the effect of household deleveraging on housing, consumption, and the stock market.

Peacock aborted the auction of the cars because he owes more on them than the offers he's getting. He aborted the sale of the mansion, even though he would have walked away with over $2 million. Will the next offer be as good?

Cash-strapped boomers will be traveling less, eating out less, and buying fewer toys in retirement than they expected. How many of them can afford to buy such mansions? Of those who can, who will want to?

Is Housing an Investment or a Consumable?

Note what happens to homes that aren't maintained: Dry rot sets in; in Florida, mold and termites take over. Those who think of housing as an investment are now finding out the reality: Housing is more of a consumption item - companies like Toll Brothers (TOL), or Hovnanian (HOV), or Pulte Homes (PHM) or Beazer (BZH) may wish to take note.

As a consumable, housing prices ought to be reflected in the CPI, but officially they're not. Unofficially, I've included them, as the following chart shows.

Case-Shiller-CPI (CS-CPI) versus CPI-U

Click to enlarge

(See CS-CPI Negative 5.0% Third Straight Month for more details.)

Greenspan ignored the effects of asset bubbles like housing, by failing to take into consideration housing in the CPI. Real interest rates were -5% in mid-2004 and stayed that low for quite some time, spawning the biggest credit boom the world has ever seen. Now, in spite of a Fed Fund's rate of zero, real interest rates are +5%.

Think the Fed knows how to manage an economy? Think again.

Greenspan had the winds of productivity, credit expansion, and consumer attitudes at his back. Bernanke has the winds of credit contraction, consumer attitudes, and demographics blowing stiffly in his face.

Those betting on Bernanke's ability to reflate should take another look at his Deflation Prevention Scorecard: He's failed a perfect 13 out of 13 times. And shifting consumer attitudes toward debt and bank-lending are the reasons why.
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