2013-09-03

The Disconnect Between Macroeconomics And Me

I do not want to be too hard on this post at Idiosyncratic Whisk, because it outlines an idea that I agree with almost completely; namely, that the so-called "housing bubble" was not really a housing bubble, but rather a liquidity crisis caused by Fed policy. Read the whole thing. It is a very good, and very well-documented article, as is typically the case with Idiosyncratic Whisk.

But the following quote stands out to me as being a good example of why I think sometimes macroeconomists arrive at the correct conclusions with some very strange (to me) reasoning (emphasis mine):
The overwhelming factor justifying a higher Home Price to Rent (PTR) is the real interest rate. That is because much of the value of owning, versus renting, is as a hedge against future nominal increases in rent. And, the present value of those relative gains is very sensitive to real rates.
I agree that "the overwhelming factor justifying a higher PTR" is the interest rate. What surprised me about Kevin Erdmann's post was the reason he gave for this: that home owners choose to be home owners as a hedge against future nominal increases in rent. That is not the case, at least not in my experience. I do not know very many home owners who chose to purchase a home in order to hedge against future rent increases. There are many reasons to own a home, and hedging against higher future rents is not a very common one.

To me, this sounds a lot like the suggestion that people only purchase cars to hedge against higher expected future leasing prices. In general, leasing is cheaper per month than financing a car, just like renting an apartment is generally a bit cheaper per month than paying a mortgage + insurance + escrow + all the other expenses associated with home ownership. Not surprisingly, lower income individuals tend to be tenants, while higher income individuals tend to own their homes outright.

Now, it could be that I'm just being thick. It's possible - heck, it's even highly likely - that Erdmann was really just writing about the PTR number in isolation. That is, maybe Erdmann's only point in saying the above was that the only relevant economic information with respect to the ratio of home prices to rent is the relative benefit of owning versus renting, or vice versa. This is obviously a fair and accurate point to make.

Even so, it highlights the remarkable disparity between how economists and financiers view these issues, versus how decision-making actually occurs to laymen like myself. The decision to own a home comes down first to affordability; that has some relevance to PTR, but my point is simpler than that. Some people simply do not have enough money to even think about buying a dwelling. The ratio is irrelevant to such people.

Once owning a home becomes affordable, the decision is not so much about hedging against rent as it is about building equity. That is, rent is not a leverageable asset, but property is. Now, it's possible that savvy finance-types who live in urban areas would prefer to rent and then invest the money saved in the stock market, thereby earning a greater return. But this is only the kind of decision that appeals to people who are comfortable with self-directed investing. For the ordinary person, their reasoning is more like, "I'm paying rent money every month anyway... I might as well get a home out of it."

Now, obviously Erdmann's reasoning is more economically savvy, but it's possible that he's giving the economy too much credit by assuming that everyone else is as savvy as he is. As for myself, I'm not fully convinced that the average person thinks of it that way.

But maybe this is why I'm not a real economist. At least I agree with Erdmann's bottom line, which implies perhaps a close enough for rock-and-roll approach to economic analysis.