Why are US Home Sales so Bad?

This week, many US news agencies reported that home sales are down, prices are weakening, and it's all deeply confusing. Since interest rates are falling, shouldn't home sales be rising? Isn't that what Economics 101 teaches us?

Pundits give many possible reasons for this strangely low level of sales: lack of available credit, bad seasonal weather, weak consumer confidence, weak jobs outlook, tough mortgage lending standards, and more. I believe all of these excuses are nonsense.

Banks are willing to lend, and have the cash to do so. Consumers have the highest credit ratings they have had in years. And, bad weather doesn't account for nationwide weakness.

The reason US home sales are low is because people with excellent credit and good jobs simply have no reason to buy. This explanation is far too simple for economists to embrace, yet it is true. Take, for instance, the conversation I heard on Friday:
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Banker: "I haven't seen you in a while. Did you buy that property in Phoenix you were looking at?"

Client: "No, not yet. Prices are great down there! But, they're not going up. I heard on the news they might still be dropping. I don't think there's any rush. I think I'll just sit tight."

Banker: "I agree."

Client: "The prices sure are great, though."
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I hear conversations like this every day.

Thousands of investors are waiting to "jump in," but there is simply no incentive to buy right now.

At some point, of course, prices will take off like a rocket ship - that is, slowly at first, gaining momentum steadily (once people realize prices are rising again) until going at full speed. However, no one knows when that point will be. It could be years.

Strangely, and counter-intuitively, I believe that in order to spur home purchases, the Fed should do exactly the opposite of what it is doing. That is, it should steadily increase interest rates. Last year, when the Bank of Canada announced that it would be raising rates, there was a frenzy of buying activity (which has since slowed, since they are now lowering rates). Contrary to every economics paper every written, I think the reality of rising rates would kick-start a home buying recovery.

In any case, my advice (as I have pointed out previously), is that if you want to buy real estate and are able to do so, do it now. Interest rates are extremely low, prices are extremely low, and with a large number of homes on the market you can choose whichever property your heart desires. Buying at a time like this will never be a bad investment.

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"Space is big. You just won't believe how vastly, hugely, mind-bogglingly big it is. I mean, you may think it's a long way down the road to the drug store, but that's just peanuts compared to space."

Douglas Adams

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See also:

If Mortgage Rates Keep Falling, Why Are Home Sales So Bad?

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Lessons from Aristocrats - Income

In Boswell’s London Journal of 1762-1763, he writes extensively about his annual income and necessary changes in budgeting.

At the time (as a youth), Boswell’s personal income was 200 pounds per year - about $400 - which was just enough to live as a gentleman. He tried to obtain a military commission which, depending on his rank, might have added another 20 or 30 pounds per year. Book sales (most aristocrats write books) may have added a bit more.

A client visited my office last year whose profession is to take care of the North American finances of an aristocratic European family. After asking many questions I realized that, aside from the figures, the aristocratic idea of “annual income” or “annual allowance” for has changed little since 1763.

When one asks about the wealth of an average person or even a wealthy businessman, the response invariably turns to net worth. For example, “He is worth 5 million dollars.” However, if you ask an aristocrat what he is worth, his response is never about net worth (which he probably doesn’t even know), but rather about the income that his assets produce. For example, “My income is 80,000 pound per year” This focus on income – as opposed to net worth – reveals fundamental differences between how aristocrats and commoners think.

For most Americans, investment preoccupation takes the form of a home – an American’s primary source of wealth. Homes are (except for recent overpriced years) good long-term investments.

First, there is the forced savings that comes with paying down a mortgage, which requires no mental effort. Then, there is the fact that when one sells a home, there are no capital gains taxes. And, despite brief periods to the contrary, homes have increased steadily in value over time. If the same funds were invested in bonds or dividend-paying stocks, the result would be taxable income, which to Americans is therefore the inferior form of investment.

Consider the following example:

Prosperous American Family
U.S. property worth $2,000,000, which increases in value by 3% ($60,000) per year
$500,000 in U.S. Venture stocks, which increase in value by 10% ($50,000) per year

Young Aristocrat
UK property worth $2,000,000, which increases in value by 3% ($60,000) per year
$500,000 in German corporate bonds earning 5%, or $25,000 per year.
$500,000 in Canadian preferred shares earning 5%, or $25,000 per year.

On paper, their annual change in net worth is exactly the same - $110,000. But, the American family employs $500,000 less to achieve the same gain, will pay no taxes on the capital gains of the property, and will pay no taxes on their shares until they sell. The aristocrat, on the other hand, will pay taxes on $50,000 of income every year. Why then, do aristocrats prefer large amounts of income-producing investments? Isn't the American way better?

It must be understood that aristocrats earn their money not only for themselves, but also for posterity. That is, they expect their wealth to improve the fortunes of their family for hundreds if not thousands of years to come. It also must be understood that they hope for the best but prepare for the worst.

In the example given above, the American family’s gain in net worth is completely a “paper profit,” which does not make daily life any easier. And, paper profits have the rude habit of evaporating just when you need the money most.

Aristocrats know that governments and laws change, that wars disrupt wealth, that revolutions change established order and that bubbles burst; therefore, they diversify their investments. At any given moment, they might be invested in rental properties, bonds, antiques, metals, and factories. And, these investments are never concentrated in a single country, but instead spread throughout the world, thereby minimizing political risk. Finally, most investments are expected to produce real income.

Years ago I visited one of the Rothschild manors in England, and was surprised to find that the huge estate has its own cricket pitch and pub. Just as interestingly, local residents are welcome to use both. The resulting cricket games and post-game celebrations not only create goodwill toward the wealthy family, but also presumably pay for a substantial portion of the estate’s annual taxes.

Since aristocrats don’t intend to suffer the ignominy of physical labor, passive income is a necessity. Passive income, though it is taxed, is tangible and real. Passive income can be used to conduct new business, to provide funds for additional investment, or simply for adventure. Passive income makes life easier today.

If you want to get ahead faster, think beyond your annual change in net worth. Think also about how much income your investments are earning. Ideally, over time your money (not you) should be providing the majority of the cash flow used for additional investing.

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“Gentlemen Prefer Bonds.”

Andrew Mellon

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The Glencore IPO

Swiss-based commodity trading company Glencore is set to reveal the pricing of its IPO this week for the dual markets of London and Hong Kong. Glencore’s IPO will be one of the largest ever, with an estimated value of $12 billion dollars.

What makes Glencore fascinating is what the company is, and how it came about.

Glencore was founded as “Marc Rich and Company” in 1974. As described by Vanity Fair magazine in 2001, Marc Rich is "defined by his money, the kind of wealth that moves governments and transcends borders.”

Marcell David Reich obtained his wealth through being a highly skilled commodities trader, unrestricted by moral or ethical boundaries. That is, he got rich by what most people would consider immoral and/or criminal behavior.

Marc Rich is an avowed fan of writer Ayn Rand, a Russian-born American whose primary philosophical ideas are that greed and selfishness are good (called “rational self-interest”); that a person can decide for himself what is moral and what isn’t (no one can tell you what to do); and, that weak people do not deserve to be loved. For obvious reasons, Ayn Rand’s philosophies are favorites for those with narcissistic and borderline personality disorders.

Rich is known for doing business with dictators and zealots throughout the world, and in fact admits as much (his theory is that if he didn’t deal with them, someone else would). Most famously, he traded oil with Iran during the Iranian hostage crisis, thereby disobeying the US embargo. He later admitted that it was his most profitable business transaction ever.

As a result of this action and others, Rich soon found himself on America’s “most wanted” list. He renounced his American citizenship, and has since held Bolivian, Spanish and Israeli citizenships.

When Marc’s daughter Gabrielle contracted leukemia in 1996, he was reportedly distraught at not being able to visit her in the US. When she died at age 27, he pleaded with the US government to be allowed to attend the funeral, but was denied.

Powerful people – including Rich’s ex-wife Denise - lobbied the Clinton administration and eventually had Rich pardoned for his crimes (on Clinton’s last day in office), but Rich has nonetheless never stepped foot in the US since. He believes that although he has received an official pardon, if he were to actually go back to the US he would be arrested on some new charge.

In 1994, Rich was forced out of his own company - for endangering the firm through risky trades - and sold his stake in the company now known as Glencore.

Still working as a commodities trader, Rich now spends most of his time in Switzerland. He enjoys skiing at St. Moritz, collecting impressionist art, and drinking champagne. According to biographer Daniel Ammann, he still cries whenever his departed daughter’s name is mentioned. Like many in his situation, Rich is also active in charity work.

Glencore’s official “history of the company” website doesn’t even mention Rich’s name; it is apparently a connection they would rather forget.


On a personal note, I owe a great deal to Marc Rich. When I first read about Marc Rich and his ideas, I was so appalled that it served partly as the inspiration for the “Morality and Ethics” section of my book, The Intelligent Investor’s Mind.

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“Justice is unrelenting. Creative individuals and undeviating purpose and rationality achieve joy and fulfillment. Parasites who persistently avoid either purpose or reason perish as they should.”

Alan Greenspan, defending the philosophy of Ayn Rand in a 1957 letter to the New York Times.

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Ayn Rand - first of a two-part interview with Mike Wallace, 1959

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