“The underlying principles of sound investment should not alter from decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate.”
–Benjamin Graham, American Economist and Professional Investor (The Intelligent Investor: A Book of Practical Counsel, Harper & Row, 1949)
In the United States, the family home has represented both the single-largest household expenditure and the primary store of wealth for families over the past century. However, “gaming” the market (betting on and against Mortgage-Backed Securities) disrupted this general sense of equilibrium for many Americans as home prices rose to unaffordable levels before crashing down, wiping out family savings.
The book and recent film The Big Short gave us some of the true story behind the largest Real-Estate Bubble in modern history. Was this the end? No! Many matters did not unravel quickly and the recent course of time has presented many new challenges to us.
Some of us may remember growing up in an era when our parents explained to us that purchasing a home was a long-term investment. Unlike stocks or other speculative investments, the return on family real-estate was expected to be modest but solid. The common philosophy was that home values kept up with inflation and that we got to live for free in the house.
A review of the fifty-year average growth in home prices in the United States indicates that, through the 1990s, home values tracked the long-term rate of general inflation as measured by the Consumer Price Index (CPI).
The horse that upset the apple cart over the past two decades has been speculative house-flipping-buying and reselling quickly-along with bundling mortgages into investment securities that became highly speculative a decade ago. Though this bifurcation in housing investment has calmed down during the recent decade, it has not disappeared.
The continuing duality of housing investment was spawned by the massive number of Adjustable Rate Mortgages (ARMs) that followed the subprime mortgage craze that occurred twelve years ago. The inherent problem with ARMs came from their low teaser-rates (ones that would jump to higher rates), which were due to reset by 2012.
These rates were coupled with their down payments-ranging from small to zero– that caused many properties to slip underwater easily.
Market analysts such as Whitney Tilson of Tilson Mutual Funds expected a second mortgage tsunami by 2012 or 2013. As the ARMs reset at significantly higher rates, analysts predicted that these rates would make underwater properties even less purposeful to hold as monthly mortgage-payments escalated sharply. The result was the fear of a second great “walk-away” by mortgage-defaulters.
However, this event was subdued by an apparent (though somewhat covert) action by the banks. They reset mortgage-rates at acceptably low fixed-rates while restructuring many existing mortgages with some help from the Federal Government’s Home Affordable Refinance Program (HARP).
Along the sidelines, many analysts continue to suggest that this course of action necessitated holding down rates through intentional suppression of the London Inter-Bank Offer Rate (LIBOR). The LIBOR sets the standard for determining mortgage-rates used by major banks throughout the world. This episode led to the investigation of the dozen-and-a-half banks that are seated on the LIBOR board. The episode also resulted in Barclays Bank taking the bullet in the form of a fine that amounted to its profits for one morning from its opening until the first coffee break.
In concurrence with our Federal Reserve Bank (the FED) and other central banks, interest rates have continued to remain low. In support of the primary home-buying season of the year, the FED recently announced its plans to hold down mortgage-rates through at least June of this year.