Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
UK House Building and House Prices Trend Forecast - 20th Aug 19
The Next Stock Market Breakdown And The Setup - 20th Aug 19
5 Ways to Save by Using a Mortgage Broker - 20th Aug 19
Is This Time Different? Predictive Power of the Yield Curve and Gold - 19th Aug 19
New Dawn for the iGaming Industry in the United States - 19th Aug 19
Gold Set to Correct but Internals Remain Bullish - 19th Aug 19
Stock Market Correction Continues - 19th Aug 19
The Number One Gold Stock Of 2019 - 19th Aug 19
The State of the Financial Union - 18th Aug 19
The Nuts and Bolts: Yield Inversion Says Recession is Coming But it May take 24 months - 18th Aug 19
Markets August 19 Turn Date is Tomorrow – Are You Ready? - 18th Aug 19
JOHNSON AND JOHNSON - JNJ for Life Extension Pharma Stocks Investing - 17th Aug 19
Negative Bond Market Yields Tell A Story Of Shifting Economic Stock Market Leadership - 17th Aug 19
Is Stock Market About to Crash? Three Charts That Suggest It’s Possible - 17th Aug 19
It’s Time For Colombia To Dump The Peso - 17th Aug 19
Gold & Silver Stand Strong amid Stock Volatility & Falling Rates - 16th Aug 19
Gold Mining Stocks Q2’19 Fundamentals - 16th Aug 19
Silver, Transports, and Dow Jones Index At Targets – What Direct Next? - 16th Aug 19
When the US Bond Market Bubble Blows Up! - 16th Aug 19
Dark days are closing in on Apple - 16th Aug 19
Precious Metals Gone Wild! Reaching Initial Targets – Now What’s Next - 16th Aug 19
US Government Is Beholden To The Fed; And Vice-Versa - 15th Aug 19
GBP vs USD Forex Pair Swings Into Focus Amid Brexit Chaos - 15th Aug 19
US Negative Interest Rates Go Mainstream - With Some Glaring Omissions - 15th Aug 19
GOLD BULL RUN TREND ANALYSIS - 15th Aug 19
US Stock Market Could Fall 12% to 25% - 15th Aug 19
A Level Exam Results School Live Reaction Shock 2019! - 15th Aug 19
It's Time to Get Serious about Silver - 15th Aug 19
The EagleFX Beginners Guide – Financial Markets - 15th Aug 19
Central Banks Move To Keep The Global Markets Party Rolling – Part III - 14th Aug 19
You Have to Buy Bonds Even When Interest Rates Are Low - 14th Aug 19
Gold Near Term Risk is Increasing - 14th Aug 19
Installment Loans vs Personal Bank Loans - 14th Aug 19
ROCHE - RHHBY Life Extension Pharma Stocks Investing - 14th Aug 19
Gold Bulls Must Love the Hong Kong Protests - 14th Aug 19
Gold, Markets and Invasive Species - 14th Aug 19
Cannabis Stocks With Millennial Appeal - 14th Aug 19
August 19 (Crazy Ivan) Stock Market Event Only A Few Days Away - 13th Aug 19
This is the real move in gold and silver… it’s going to be multiyear - 13th Aug 19
Global Central Banks Kick Can Down The Road Again - 13th Aug 19
US Dollar Finally the Achillles Heel - 13th Aug 19
Financial Success Formula Failure - 13th Aug 19
How to Test Your Car Alternator with a Multimeter - 13th Aug 19
London Under Attack! Victoria Embankment Gardens Statues and Monuments - 13th Aug 19
More Stock Market Weakness Ahead - 12th Aug 19
Global Central Banks Move To Keep The Party Rolling Onward - 12th Aug 19
All Eyes On Copper - 12th Aug 19
History of Yield Curve Inversions and Gold - 12th Aug 19
Precious Metals Soar on Falling Yields, Currency Turmoil - 12th Aug 19
Why GraphQL? The Benefits Explained - 12th Aug 19

Market Oracle FREE Newsletter

The No 1 Gold Stock for 2019

Housing Market Boom and Bust According to Austrian Economic Theory

Housing-Market / Economic Theory Nov 30, 2009 - 04:25 PM GMT

By: Douglas_French

Housing-Market

Best Financial Markets Analysis ArticleIs Housing a Higher-Order Good? While reviewing a book about the financial crisis, a policy analyst of the free-market persuasion pooh-poohed the notion that housing constitutes a long-term project or "higher-order good," insisting that homes are instead a "durable consumer good," and thus he believes that examining the housing meltdown through the lens of Austrian business-cycle theory is illegitimate.


This discussion was had many times as the housing boom raged on mid-decade. When the boom continued longer than many thought possible the question became, Why is there no bust? Maybe houses are the equivalent of big refrigerators. Maybe home prices can go up forever. After all, houses don't seem to share any of the characteristics of mines or factories.

On the surface that seems true. Homes are a finished good that provide shelter. With labor and materials ready and available, a typical suburban tract house can be constructed in 60 to 90 days. There's nothing long term about that. And our skeptic doesn't see any evidence that production was directed away from consumer goods towards the production of higher-order capital goods. So, in his view, Hayek and Mises can just butt out of this debate.

However, there is more to a house than the sticks, bricks, and gingerbread that people see and buy. The building of homes starts with the purchase of land. And buying land is not like driving over to Best Buy, whipping out your credit card, and buying a big-screen TV. First the developer and his staff look for land to build on because ultimately the builder believes he can sell houses on that land. Consultants are hired to produce soil studies and environmental reports, and to determine the availability of utilities and zoning feasibility. These reports take time to produce and cost money.

If the land appears to be suitable for residential development, the developer will determine what can be paid for the land to make the project profitable, assuming his projections are accurate for the sales prices of his homes. After that, a price is negotiated and escrow is opened. A hot land market will dictate short escrows of 90 to 180 days, whereas in a typical market, escrows of a year or more are not uncommon.

A key factor in how much is offered in price for the land is the interest rate to be paid on the loan used to purchase the parcel. Low interest rates allow the developer to pay higher prices. Low interest rates also allow for the developer to take on more political and development risk. The political risk is the uncertainty that the builder will obtain the zoning necessary to build the number and type of units contemplated when the land was being considered for purchase. In most large urban areas, zoning approvals — which ultimately lead to maps legally describing the building lots that the houses will be constructed on — take months in the best of times; now they often take years.

Horizontal development costs can change dramatically during this process, as city hall may impose improvements that hadn't been contemplated as well as cost increases caused by increased demand for dirt moving, utility trenching, and street paving. And since most of the costs of developing finished building lots is financed, low interest rates make more projects feasible than high interest rates, not only from a cost standpoint but also from a time standpoint. The interest for development and construction projects is financed — it is borrowed — just like the soft and hard costs associated with the development, thus the lower the interest rate, the longer the project has before it must be converted to a consumer good.

In May of 2000, the federal-funds rate was 6 ½ percent and the prime lending rate used by most banks to price construction loans was 9 ½ percent. But with the recession of 2001 and the events of 9/11, a panicked Federal Reserve lowered the federal-funds rate to 1 percent by June of 2003 and banks lowered their prime rates to 4 percent. This lowering of rates made hundreds of housing projects around the country viable, and developers and their lenders reacted accordingly. Billions in development loans were made to finance projects with the contemplated payoff coming from home buyers.

In 2001, the Bureau of Land Management (BLM) sold government-owned land to developers for $26,672 per acre in Las Vegas, Nevada. Four years later, BLM acreage was going for $270,000 per acre. So while land prices were increasing tenfold, the medium new-home price shot from $130,000 in December 2000 to $350,615 in early 2006.

The raw land cost is generally 10 to 25 percent of a home. And it was low interest rates that were spurring these huge increases in hot markets like Las Vegas. "As in the case of any other good," Murray Rothbard explained in Man, Economy, and State, "the capital value of land is equal to the sum of its discounted future rents." The value of the land increases as the capitalization rate falls with interest rates. Thus when the Fed lowered rates, the present value of the implied future rents on land became more valuable. "Ground land, then, is 'capitalized' just as are capital goods, shares in capital-owning firms, and durable consumers' goods," Rothbard wrote.

Although there were increases in materials and labor during the housing boom, the primary factor that drove up housing costs was the cost of land.

Human resources especially were directed away from producing consumer goods and services towards the development of housing projects. People flooded into real-estate-related industries — the obvious being construction and real-estate sales. At the height of the boom, 11 percent of employment in Las Vegas was directly in construction, while at the same time one in every hundred people in Sin City had a real-estate license.

But jobs indirectly involved in real estate also boomed: title-insurance companies couldn't hire enough people, along with engineers, architects, appraisers, and the like. Plus, furniture stores popped up everywhere, because every new home needed new furniture and appliances.

And when houses are built, the signal is sent to commercial developers that more shopping centers are needed. It is thought more office space will be needed because of the increase in indirect real-estate-related jobs, and more industrial space will be required because contractors are expanding to participate in the home-building boom.

In mid-2004, the Fed began to raise rates and by June 2006, the federal-funds rate was 5.25 percent and bank prime rates were 8.25 percent. The punch bowl had been taken away, and the cost of interest for development more than doubled. And the land underneath these houses became less valuable as capitalization rates rose with interest rates.

Now there are said to be 2.4 million redundant homes in America — the result of real-estate developers being induced by low interest rates to undertake the long and risky development process. At the same time, while construction jobs in Nevada (for instance) peaked at nearly 150,000 in mid-2006, as of October of this year, there are now fewer than 84,000 construction jobs, according to a Nevada Department of Employment, Training, and Rehabilitation report — and this will only get worse when the gigantic CityCenter project is completed and 12,000 construction workers will no longer be needed on that job. Overall unemployment is 13 percent in what was once the real-estate boom city — far above the 10.2 percent nationwide rate.

However, Nevada is not alone. Construction employment has fallen in all but three states over the past two years.

And while home prices have fallen 57 percent in Las Vegas from their peak, land prices have fallen 76 percent according to the real-estate consultants at Applied Analysis. With land prices cut by more than three quarters, median home prices are back to levels not seen since before 9/11 and the Fed's massive intervention.

As the Austrian business-cycle theory dictates, the bust is now in process, clearing malinvestments and reallocating misdirected resources. Houses and buildings sit vacant, while construction workers and real-estate agents are looking for other types of work. The fact is that homes include the land they are built on, and land is certainly a higher-order good.

In the case of the current housing meltdown, the Austrian case is definitely right. Mises and the Austrians are more relevant than ever.

Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. See his tribute to Murray Rothbard. Send him mail. See Doug French's article archives. Comment on the blog.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules