Ch 9: Time Value of Real Estate
Housing Depreciation has much of the same deflationary impact as writing down other financial asset, but with one big advantage: the time value of money is multiplied by 30 years of real estate appreciation.
Half the Debt then Counted
Let’s say a home dropped from $200,000 to a low of just $100,000 during this housing crisis. (The worst hit markets took a 50% hit.) This means we just removed $100,000 from the economy. Having gov’t replace this $100,000 in new debt is simply a wash - meaning it adds little to inflation. We discussed this above. The gov’t replaced this lost value with their banking bailout. This banking bailout is not new credit per say, but replacing an old one. We covered this point above as well. Hence, these banking bailouts have less impact on inflation then would be the case of similar deficits. Now to show how real estate can further expand upon these advantages.
1/300 Per Month
Real estate plays a further role in reducing the impact of these bailouts. Here’s how. If the homeowner keeps their home, the depreciation is spread over 30 years. The write-down is just $3,300 a year or $275 a month. The write-down is simply a fraction of the total mortgage as it is written-off over 30 years. Just a 30th of that cost is paid out per year (1/300 per month). Real estate offers the time value of money multiplied by 30 years. Few other assets have this advantage.
Inflation Equity
There’s also the rate of inflation. An inflation rate of 3% would double the homes value over 30 years. You now have this additional value being added back into the homes equity beyond the market or homeowners own efforts. You could call it Inflation Equity.
Hedge Against Inflation
Inflation Equity describes real estate as a ‘hedge’ against inflation. What this means is that property appreciation is often little more then the currency itself simple dropping in value rather then real estate actually adding any further value. We see this of gold. Gold is not becoming ‘more expensive,’ rather, the value of paper money keeps falling. This leaves gold looking as if it were gaining in value, but it hasn’t. This is generally true of real estate minus some periodic resets when bubbles get too far ahead the natural rate of equity appreciation and currency depreciation.
You also have the homeowner paying off the mortgage creating another layer of equity.
Triple Gain
These 3 things allow real estate to regain its value much faster then most other assets. Here’s why:
- The cost of the write-down is spread out over 30 years;
- The rate of inflation adds to the home’s value;
- Equity is added as the mortgage is paid off.
The nature of real estate can pay off liability 3 times ‘faster’ then most other (commodity) asset. It means a property that lost 50% of its value should be able to regain much of it within the decade. We are seeing this with most housing markets today. This would allow gov’t to recoup much of their bailout money sooner then the 30 year term of the mortgage.
Long Term Returns
This follows the same line of thinking as long term investing. The long term investor holds onto their stocks through ups and downs knowing that time evens out the lows with greater highs. This is more true of real estate.
Tax Break Against Depreciation
This long term approach is more affordable than taking a $100,000 write-down today - as recommended by free-market advocates. A better approach would have been for the gov’t to have offered a tax write-off of 70% to 135% of the homeowners property depreciation. This could be done through the monthly mortgage. Banks would receive the same federal ‘bailout,’ but it would have been directly paid by the homeowner to the bank. This bailout would build upon the time value of money paid out over 30 years. It would actually be much shorter then 30 years. Most markets will have recovered within just 10. We call it the Mortgage Depreciation (Tax) Credit or MoDe Credit. This would have been far more affordable than this upfront gov’t bailout for $5 trillion. Yet, today’s banking bailout still can work because of the extraordinary time value of real estate.
Party Count
Democrats get this round in their call for homeowner ‘bailouts.’ The tax-deduction against depreciation would actually have been a Republican response. This should have been the Republicans counter proposal to the banking bailout. It is a ‘free market’ based program and significantly better then the Democrats gov’t bailout program. I tried my hardest to get through to Republicans to tell them about it. Hard crew to get through to.
Editor’s Note
Economic Back to The Future
Real estate general builds an equity appreciation over the decades. This helps to clarify the value being tapped by the feds ‘banking bailout.’ It was not so much a banking bailout as it was a financial bridge to real estate’s future value. This bailout allowed real estate to tap the time value of money multiplied by the 30 year mortgage. Basically, the feds reached into the value of tomorrow’s real estate and leveraged it against today’s debts and financial turmoil. It’s the economic version of ‘Back to the Future.’ It has the appearance of voodoo economics, but it actually represents a legitimate ‘value.’ It works as long as the homeowner stays and pays against that home (as most have). The bailout was a much better option over the ‘free-market’ suggestion of letting these securities and industry collapse. The fire-sale would have gutted far more equity and hobbled the social economic infrastructure far more seriously then most realize. As such, it would have taken far longer to rebuild it then allowed by these bailouts.
Parity in 5
Clarifying this ‘value’ would resize the sense of impending doom we get from ‘deficit’ critics. This equity value will continue to grow the longer we hold these mortgage ‘debts.’ Most of the ‘liability’ will find parity in 5 to 10 years. Much of the ‘lost’ value will be recouped against rising market values in a (half) decade (as we are already beginning to see). Real estate will play its part in offsetting the impacts of inflation with each passing year.
Ch 10: Fed to the Rescue
This ‘recession’ had a lot of economic-firsts. They came together to off-set the implosion of the US dollar. The largest of these was the fed. The Federal Reserve issued money against itself to buy America’s ‘toxic’ real estate securities. Generally, the fed sells bonds to investors (credit). That capital is then lent to the US gov’t. This time, the feds stepped into that investor’s seat. The feds magically created this whole new sub-group of investor to buy US debt. That investor was the Federal Reserve itself. The feds have never before done this to the tune of multi-trillion dollar purchases. They did this without prompting from Congress or rather, in spite of it. This is but a dream for every other country to have faced a currency crunch. Had the Feds not done this, the US currency would have imploded long ago much as Republicans have been screaming would happen.
Deficits = Time
The funding we received in these ‘federal deficits’ bought us time and social economic stability – for now. As the Master Card saying goes: ‘Priceless.’ We see the turmoil wrought upon countries hit with currency collapse or high inflation. Much of the Arab Spring was brought on by these inflation spikes. This has been true for gov’ts from around the world. A similar collapse here in the US could very well lead to any of these same scenarios – or worse, because, Americans have a knack for doing things bigger then others. We would have everything from the 1930’s food lines to the Middle East like insurrection stirred by ‘gun totting’ anti-federalist or even civil war between national camps. Such turmoil could burry the US for decades. The feds saved us from this so far.
Lost Status
A US default would do more then lead to these ‘worse case scenarios.’ The US would lose its standing as the currency for International Trade. Losing this status is irreplaceable. This role has rarely been allowed any other country in history. None have attained the reach of the US dollar. It has provided the US with trillions in free loans as billions of people and hundreds of countries hold our notes of credit (currency). These deficits bought us time and stability to hold that rare and special status. The significance of this and its ramifications can not be overstated. This is what these deficits have bought for us so far. It would have been foolish to avoid tapping this life saver when so much rest upon its access. Discussed further below.
Party Count
Democrats are a bit more subdued about their distaste for the Federal Reserve but were happy to have the Republicans do the dirty work for them. They blasted Federal Chairman Bernanke and pushed a series demands for ‘reform.’ I was a strong supporter of Ron Paul and backed Republican calls for greater transparency with the audit of the Federal Reserve being a major victory. This patriotism was from years ago when America appeared to have been a puppet to the feds. The situation since then has changed - drastically. No one seems to recognize that we have been saved by the feds. In fact, we are now extracting trillions in free money from them. This is the first time the feds have been losing hundreds of billions in money to the US. This crisis has turned the table on the feds in way no one has recognized as yet. This does not include the international advantage and time they have provided us. We cover this in detail below. Neither party gets this right, but there was integrity for those that went after the feds much as their was economic validity in honoring them.
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