Houses Are Consumer Durables, Not Investments

by Eric Englund
by Eric Englund

Over time, under a 100% gold standard, a house would gradually depreciate in value. A house, after all, is nothing more than a durable consumer good – it is a capital good if it is a rental property. However, when living under a fiat-currency regime, perceptions can be radically altered. For example, not only is a house believed to be an appreciating asset, it is considered to be an investment. Additionally, under conditions of rapid money and credit growth (which, for a period of time, leads to artificially low interest rates), people will come to think of themselves as real estate entrepreneurs – wisely "investing" in a house, to live in, with the confidence that a big payday looms ahead upon sale of same house. Presently, with lending standards so low – to keep credit flowing – the housing boom has become an outright speculative bubble in many parts of the U.S. I would argue, in fact, that a hyperreality has emerged in which real estate is perceived to be a one-way street to wealth. The bust will come, inevitably, and millions of Americans will be wiped out financially – and only the Austrian School of economics provides the correct explanation as to why the housing boom contains the seeds of its own destruction.

As Roger Garrison explains in The Austrian Theory of the Trade Cycle, the boom-bust cycle emanates from the Federal Reserve:

The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.

We certainly know, today, that Americans are saving little if any money. Thus, America’s housing boom has emerged directly as a result of Alan Greenspan’s easy-credit policies, not from savings.

For the time being, the real estate party is in full swing. Americans are clamoring to participate in this ride to "Easy Street." People are willing to take on punishing mortgage debt loads, "knowing" that houses will always appreciate in value and that the higher the leverage, the higher the rate of return. Moreover, as a house appreciates, home equity loans can be taken out to purchase consumer durables such as high-end kitchen appliances, granite countertops, a hot tub, and even a kit to build a backyard barbecue. Once these consumer durables are "attached" to a house, they magically become investments that add value to, and appreciate with, the house. With Alan Greenspan at the helm of the Federal Reserve, Americans have discovered investment Nirvana. Indeed, the house has been transformed into a perpetual wealth creation machine.

To be sure, a house is a more enjoyable investment to own than a dot.com or a telecom stock. Just imagine, you can throw a Super Bowl party in your investment. You can sip on champagne while relaxing in your hot tub investment. Neighbors can compete as to who throws the best barbecue bash on the block (oh, it was so wise to invest in that bricks-and-mortar backyard barbecue). It is important, naturally, to keep the yard manicured in order to have the best looking investment on the block – which is important, for curb appeal, should one decide to sell for the highest profit possible. Finally, you can even procreate in your housing investment – try that in your stock portfolio. All the while, the hottest topic of conversation in the neighborhood pertains to how everyone’s house is increasing in value. Every homeowner is brilliant and, in a sense, has become a real estate entrepreneur.

In the boom phase of the trade cycle, it is not predictable as to where the fiat money and credit will flow. In the late 1990s, we saw "Easy" Alan’s money and credit flowing into internet-related companies such as the dot.coms and telecoms. Correspondingly, individual "investors" threw trillions of dollars into the tech-laden NASDAQ with the belief that the internet would lead us into a bold new cyber-world where wealth would be created simply by sharing and transferring information. When this mania ended (as bank credit and venture capital dried up), the NASDAQ bubble burst – in early 2000 – and the once high-flying dot.com and telecom companies came crashing down to earth. It was all an illusion fueled by the Federal Reserve’s loose money and credit – with a notable clustering of entrepreneurial and investor error associated with internet-related companies. Hence, in 2000, the economic bust (recession) descended upon the U.S.

Alan Greenspan, of course, would not tolerate a recession. Accordingly, the Federal Reserve went on a money and credit creation binge and eventually brought short-term interest rates down to 1% (in 2003). The Federal Reserve, in total, cut interest rates 13 times between 2001 and 2003. With interest rates so seductively low, Americans went on a borrowing and spending spree which pulled Uncle Sam out of the recession – at least for now.

As Murray Rothbard explains, in The Austrian Theory of the Trade Cycle, America’s debt-driven "prosperity" is a mirage built upon the opiate of easy credit. Alan Greenspan’s multiple interest rate cuts, as Dr. Rothbard conveys, is nothing new in the field of central banking:

… the point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit.

Sadly, there will be a comeuppance. In this case, a clustering of errors will be exposed on the part of the high-flying housing developers, lenders, and homeowners. Mortgage lenders, eventually, will find that homeowners cannot handle such crushing debt loads, especially as rising interest rates cause defaults on interest-only and adjustable rate mortgage loans. As mortgage payment delinquencies and defaults rise, bankers and other mortgage lenders will begin to see the error of their easy-credit ways. This is where boom turns to bust, as described by Dr. Rothbard:

It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom…

Not to forget the housing developers: at this juncture, they will be caught with too much inventory on hand right when housing prices and demand are on the decline.

Just as night follows day, bust follows boom – as long as central banks exist. The housing bubble is merely another manifestation of the Federal Reserve’s reckless manipulation of money and credit. Presently, most Americans believe that houses are a sure-fire investment while adherents of Austrian economics know they are nothing more than consumer durables caught up in a speculative frenzy. When the housing bubble bursts, millions of Americans will find themselves buried alive in debt while living in their financial tombs.

June 8, 2005

Eric Englund [send him mail], who has an MBA from Boise State University, lives in the state of Oregon. He is the publisher of The Hyperinflation Survival Guide by Dr. Gerald Swanson. You are invited to visit his website.

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