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Wishful Thinking on House Prices and the Economy
Howard Richman, 5/20/2010

A nursery rhyme goes, "If wishes were horses, then beggers would ride." The wishful thinking of beggers continues to dominate American policy making circles as was apparent in two predictions made yesterday, one made by housing market experts and the other by the Federal Reserve:

Prediction 1: House Prices will soon be off to the races again

The above graph from  the businessinsider.com website shows the Case-Shiller index of inflation-adjusted sale-and-resale prices of the same homes. To its credit, Business Insider is skeptical of the expected rise in house prices shown by the dashed line. It reports:

The consensus of analysts surveyed by professor Robert Shiller's MacroMarkets is that house prices will soon resume their steady upward climb.

Of course, the vast majority of the analysts in the survey didn't see a crash coming (ever) in 2007. So tuck this away in the "for what it's worth" file.

The prediction that house prices will go up now is based upon the fallacy that capital gains can be expected. But if capital gains could be expected, they would be built into the current price. Capital gains can only be expected when they are based upon reinvestment of profits.

The Federal Reserve has just wasted over a trillion dollars, and the US government several hundred million, trying to change people's expectations about house prices. Yet despite the huge amount of money pumped into price manipulation, house prices have declined for the last three months, as shown by the downward trend of the solid line at the end of the above graph. Now that the Federal Reserve and the federal government are ending their house price manipulations, house prices will fall toward pre-bubble levels.

The fact is that capital losses, unlike capital gains, can indeed be expected. They occur whenever an asset bubble pops and asset values return to their pre-bubble inflation-adjusted level.

Prediction 2: The Economy will grow by an average of 3.7% over the next year

The Federal Reserve revealed that it has upped its expectations of US growth from the previous estimate of growth of 3.2% over the next four quarters to a new estimate of 3.7% growth. Meanwhile the stock market is falling rapidly because of the growing realization that the fall in the euro will send the U.S. manufacturing sector reeling again and worries that U.S. banks won't get bailed out from their bad loans to bankrupt governments.

Perhaps the Federal Reserve is counting on the rise in house prices, as predicted above by the house price experts, to really happen. This would enable American consumers to borrow again on their homes to buy consumer goods. The Fed doesn't have any other strategy for enhancing U.S. demand. With the dollar rising vs. the euro, exports will likely decline and imports rise. With the U.S. government debt becoming a problem, the federal government will not be able to continue its high level stimulus. With the Fed's board of governors consisting of unilateral free traders, they won't even give consideration to the possibility of actually solving our problems by balancing trade.

Since October 2008, the Federal Reserve has been testing out the idea that you can solve a problem caused by trade deficits without reducing the trade deficits. They think that they are applying John Maynard Keynes' prescription for solving a depression, yet they appear to be blissfully ignorant of the fact that Keynes had a different prescription for trade-deficit countries -- balanced trade -- as I noted in a September 22, 2009 commentary (Keynes Prescription for the U.S.: Balanced Trade).

If only wishes were horses, they would be riding a recovery right now. Instead, as the stock market decline indicates, we are headed toward more rough times. Perhaps they will finally start advocating balanced trade. (Now I am starting to engage in wishful thinking!)

Comment by never ending skeptic, 5/21/2010:

if all those rushing to buy homes in the last decade are unable to now, and people loosing jobs are unable to, and people in the stock market are loosing money, and forclosures are still making new records.

Who will buy these Homes?

Didn't Ross Perot call this a long time ago when he ran for the presidency over a decade ago? and yet they can still get away with saying nobodey saw this coming?

Comment by Jesse, 5/21/2010:

This site has some pretty nice graphs of housing prices both inflation adjusted and non inflation adjusted by city.  http://mysite.verizon.net/vzeqrguz/housingbubble/  I'd also add that although you can anticipate some capital gains due to inflation, the present discounted value of those gains should already be priced in.  Looks like buying in Chicago or NV might make sense.  Don't buy in Seattle though!