My friend Tom and I had a bet on the direction of the Cambridge real estate market. In November 2008, with everyone running around panicked, I argued that it was unlikely to get worse. Tom thought Harvard Square condo prices would fall further and bet dinner. A year later we asked an expert real estate agent which way the market had gone. She said “up maybe 2 percent.” So Tom lost his bet and will be buying me dinner tonight.
I would like to take credit for being smarter than Tom, a professional “money guy”, but further reflection makes me realize that I was wrong about the market fundamentals. The economy stagnated and demand for real estate continued to deteriorate during the period of our bet. Tom’s prediction was correct as far as that went. What Tom failed to predict was government action. He did not expect, apparently, the government to hand out $8,000 to every condo buyer (this alone is about 2% of the cost of a condo in Cambridge, where the median price is about $400,000). Nor did he expect the government to buy mortgage-backed securities or prop up Fannie Mae with almost $400 billion in tax money (nytimes).
I wonder if the money-dumb guy winning this bet with the money-smart guy indicates that traditional financial and business acumen are becoming obsolete in the U.S. The most important skill may be an ability to predict what the government is going to do next.
I bought a house two and a half years ago in Northern California. I knew at that point that sanity said that the house was going to lose a lot of value, but I also knew that if it lost too much, the populace would be in open revolt.
So I went with the theory that the way it’ll lose value is inflation, and got a 30 year fixed. Let the bank take that risk.
Law and “level playing fields” and all that are malleable to the whims of the electorate, and even though we’re gonna tie the financial system into further knots to make it happen, I was confident then and I’m pretty confident now that rational thinking about investments will be overruled by the mob.
Your friend’s biggest mistake was agreeing to let a real estate agent be the arbiter of the bet. The optimism necessary for sales can could judgments of this type. As Peter Lynch put it about another type of salesperson in One Up on Wall Street: “The worst you’d ever hear from an apparel person during a retailers’ Black Plague would be that things were ‘basically okay’.”
It seems unlikely that the real estate agent’s judgment “up 2%” was correct. There is a Case-Shiller Index of Boston condo prices, which declined from 161.43 (2008:11) to 158.67 (2009:11). While it is possible that the local market you describe did not follow the trend of the broader area covered by the index, my experience is that the intuitive impressions of real estate professionals are routinely contradicted by the objective evidence of the indexes.
Dikran: Boston is a very local market. Blocks of high-rise condos next to a highway, built optimistically in the mid-2000s, went down way more than the Case-Shiller Index would suggest. The condo we were discussing was one right next to Harvard University. Both Harvard and MIT suffered big endowment losses but they continued to operate more or less as before (and as I’ve previously argued, they could survive the permanent relative decline of the U.S. economy by accepting foreign students paying full tuition in Chinese, Indian, Brazilian currency or whatever (would have said Euros until a few months ago!)).
[Meanwhile, I talked to a real estate in the wealthy western suburbs of Boston and she said that prices had continued to slide since the fall of 2008; she estimated things were down 15 percent since November 2008.]
Marc Faber made the same point recently:
“It is no longer sufficient to analyze macroeconomic and microeconomic trends and individual companies and sectors; we now increasingly need the help of a political analyst who can warn us of what governments’ next regulatory ‘Schnapsideen’ (ideas developed while heavily intoxicated) are likely to be.”
Have you read The Black Swan? In it Taleb shows some interesting research (by others) showing that economists and other social scientists are no better at making predictions in their field of expertise than a random selection of NYT readers. This could also account for your victory.
I think it is not that hard to take one extra variable into the equation. In this case your government acts as a rational investor. Without rapid price declines and with the media promising a rebound in a couple of years, the troubles of defaulting will be just not worth it for most of the owners.
If we take Japan as a guide, by 2021 the buyers of 2006 on average may have a property that is worth half the original price. They also will have paid (voluntarily) twice that in mortgage payments. 8K to facilitate this looks like a good investment.
I would even call this “a perfect tax” if there is such a thing.