The Difference between Gold and Real Estate
by Alex Merced
Is there a gold bubble? This seems to be the questions that media pundits are pushing more and more now, so I thought I'd like to discuss some of the fundamental differences between Real Estate and Gold as far as it's bubbliness (I'm making up words). Many people critique gold proponents saying that saying that gold will continue to go up is like the real estate proponents pre-bust saying real estate will always go up so here are somethings to think about.
Asset Mobility
Gold is a very mobile assets, I can have it stored and I can carry it around with me no matter where economic activity is moving people geographically. Homes on the other hand are not easily mobile, I just can't pack up my house and take it with me wherever I go. In this case if economic activity moves somewhere else geographically it's hard for me to sell it so I can pursue where growth and jobs are because others are doing the same driving down demand for my particular house. This is a problem that's non-existent with gold.
Supply
During the height of the housing bubble there was a lot of housing construction going on which increases the supply which lowers the price of any good, and despite all the inflation from the central banks these last few years the supply is still repricing itself versus the money supply. You can't manufacture gold, it can only be mined and the amount that can be mined is essentially fixed so this kind of inflation of the gold supply is not possible as it was in housing so it's relationship versus the money supply is a one sided relationship mainly changing when money supply changes since the gold supply grows slowly and stable.
Liquidity
Gold is fungible (one ounce of gold is generally no different than the next), which makes Gold much easier to trade in markets and base futures, Funds, and other investment vehicles on. This creates a liquidity in the gold market when combined with it's other features makes it a very appealing store of value. Houses on the other hand is a heterogeneous good, meaning every house is a unique product which must find a particular buyer which can be difficult depending on several geographical factors outside of the house itself (neighbors, local schools, local economy).
Growing Demand
More and more of countries we thought were part of the third world are becoming industrialized so the access to medical professionals like dentists are increasing and so is the demand for luxuries like jewelry both which use large amounts of gold. Not only is there a growing consumer demand, but also many central banks are beginning to purchase gold and strengthen their reserves as the US Dollar undermines it's reserve currency status which central banks will most likely hold indefinetly reducing the supply of gold effectively for other uses. Houses on the other hand have shrinking demand since there is a glut in the supply from the excessive construction during the boom, and many people rather rent or share living space till economic prospects allow people to expect the ability to maintain a bigger home.
Overall, in the future some of these factors may change, this the current state of things and as long as this is the case I'll continue hold and purchase gold and other natural resources.
Showing posts with label Real Estate. Show all posts
Showing posts with label Real Estate. Show all posts
Saturday, October 16, 2010
Friday, September 3, 2010
Real Estate, Canada, and the Economy oh my!
Real Estate, Canada, and the Economy oh my!
By Alex Merced
In this article what I’d like to discuss is the problems with the logic put forth as the justification for all the government intervention in the economy primarily in real estate. So first let’s discuss the reason why the government thinks it’s prudent to prop up housing prices.
Small Business is the driver of job growth, most small businesses expand based on loans backed by assets such as houses, so by propping up house prices it helps businesses borrow and expand to create jobs.
As usual, mainstream economists and politicians babble out half truths based on bizarre assumptions. Yes, it’s true small business drive economic growth (analogy: who’s going to grow more, an adult or child, similar logic), and yes it’s true small business usually need personal guarantees and collateral to get loans as they establish credit for their company.
So now that we see on what we agree, let’s talk about the weird assumptions. First off, housing aren’t the only assets that can be used as collateral, this emphasis on housing has caused some business owners to not have a diverse portfolio of assets with which to secure a loan for their business. If their wasn’t so much incentives to invest in housing some of their investment capital would go into other assets such as securities, commodities and other things that can be borrowed against and hedges the business owner in case of a dip any particular asset class.
Also, it’s weird to assume banks won’t realize that if prices are propped up and that they'll just be completely ignorant to the fact the prices are unsustainable and the collateral obviously insufficient for the kind of loans people took out before prices collapsed. If anything, having this knowledge and not being able to determine it’s true market value due to intervention would make banks even more hesitant and worried to make the loan fearing the eventual depreciation of the assets.
If prices were allowed to fall, eventually other prices in the economy would drop and the lower amount of money you can borrow against real estate at current prices would still have a similar purchasing power over time.
INTERESTING FACT: Canada allows for short term mortgages with recourse, and doesn’t have many of the incentives to invest in housing as the US yet has higher home ownership rates than the US.
While it’d be hard to say definitely why, I would theorize that due to all the investment incentives artificially placed on the US market drove speculators to have an unhealthy advantage in buying lots of property. So while many investors accumulated large swaths of the American real estate supply, this had pushed up the price so much deterring the ability for other non-speculators to participate. Once again, Canada shows how it surpasses the US with less intervention. Another similar scenario is in the early 1900 when both countries had no central bank and the US had frequent bank panics yet Canada did not, the major different being the US imposed severe branching restrictions on its banks while Canada did not. So while many focus on Canada’s universal healthcare to claim it as a “socialist” country, it’s much more free market than the US in terms of banking and real estate and has had more sustainable and stable economy for it.
By Alex Merced
In this article what I’d like to discuss is the problems with the logic put forth as the justification for all the government intervention in the economy primarily in real estate. So first let’s discuss the reason why the government thinks it’s prudent to prop up housing prices.
Small Business is the driver of job growth, most small businesses expand based on loans backed by assets such as houses, so by propping up house prices it helps businesses borrow and expand to create jobs.
As usual, mainstream economists and politicians babble out half truths based on bizarre assumptions. Yes, it’s true small business drive economic growth (analogy: who’s going to grow more, an adult or child, similar logic), and yes it’s true small business usually need personal guarantees and collateral to get loans as they establish credit for their company.
So now that we see on what we agree, let’s talk about the weird assumptions. First off, housing aren’t the only assets that can be used as collateral, this emphasis on housing has caused some business owners to not have a diverse portfolio of assets with which to secure a loan for their business. If their wasn’t so much incentives to invest in housing some of their investment capital would go into other assets such as securities, commodities and other things that can be borrowed against and hedges the business owner in case of a dip any particular asset class.
Also, it’s weird to assume banks won’t realize that if prices are propped up and that they'll just be completely ignorant to the fact the prices are unsustainable and the collateral obviously insufficient for the kind of loans people took out before prices collapsed. If anything, having this knowledge and not being able to determine it’s true market value due to intervention would make banks even more hesitant and worried to make the loan fearing the eventual depreciation of the assets.
If prices were allowed to fall, eventually other prices in the economy would drop and the lower amount of money you can borrow against real estate at current prices would still have a similar purchasing power over time.
INTERESTING FACT: Canada allows for short term mortgages with recourse, and doesn’t have many of the incentives to invest in housing as the US yet has higher home ownership rates than the US.
While it’d be hard to say definitely why, I would theorize that due to all the investment incentives artificially placed on the US market drove speculators to have an unhealthy advantage in buying lots of property. So while many investors accumulated large swaths of the American real estate supply, this had pushed up the price so much deterring the ability for other non-speculators to participate. Once again, Canada shows how it surpasses the US with less intervention. Another similar scenario is in the early 1900 when both countries had no central bank and the US had frequent bank panics yet Canada did not, the major different being the US imposed severe branching restrictions on its banks while Canada did not. So while many focus on Canada’s universal healthcare to claim it as a “socialist” country, it’s much more free market than the US in terms of banking and real estate and has had more sustainable and stable economy for it.
Wednesday, June 30, 2010
Regulating Enterprise
Regulating Enterprise
by Alex Merced
Time and time again we hear in the news that we need stronger regulation on Oil, Housing, and Banking to prevent all the problems we've seen over the last few years. Today, I'd like to make the argument that the problems with all three of these sectors has everything to do with government intervention in the market and that the best regulation would be the natural regulation of natural risk in the markets. In the name of populism much of this natural risk has been removed from these enterprises in the name of "promoting business", "job creation", and "economic growth".
The initial problem with this rhetoric is that growth is always good, so rushing growth or artificial growth must be good too. For example, if I want to bulk up quicker I could begin to take steroids, although while that is growth it's not sustainable since I haven't built the discipline and lifestyle needed to maintain that bulk, so I become dependent on the steroids to maintain it.
So let's take a look at three types of natural risk that effect the entrepreneur when they are making the decision to enter an enterprise, and on how to run the enterprise. We'll see that these policies remove the aforementioned risks and like steroids prevent the kind of discipline needed to create sustainable businesses and growth.
Risk # 1 - The Ability to Raise Capital
Arguably, if an entrepreneur can't raise the money then he may never start the enterprise at all. Why would raising capital be difficult? This could be for a variety of reasons that all have to deal with he viability of the business and if potential investors/lenders see a demand for product/service, are the potential liabilities addressed, are the margins too thin, is it profitable in the short term? If government were to intervene to make capital easier to raise for such enterprises, it's easy to see how more of them would exist despite these typical investor concerns.
Oil - Oil is a very difficult business without government aid, because investors aren't typically very optimistic about the chances of finding oil when doing exploratory drilling. So to encourage investment into oil in the 60's and 70's tax shelters were created for oil investment in the form of Direct Participation Programs, and during a time of 70% tax rates one can see how a tax haven can be quite a benefit, you'd actually profit from the tax savings alone. So capital was being sucked into oil cause of the tax benefits, not cause of the merit of the enterprise... actually you'd lose money if they found oil cause it'd create a paper gain which you'd pay taxes on. So the capital raising issue was now done away with for Oil drilling at the expense of driving capital away from technology, medicine, alternative fuels that would've meant that the BP spill might've never happened cause the oil rig would've never been there since we would have divested from oil long ago.
Banking - Banks can be a risky proposition with tight margins. The problems being if the bank takes too much risk then depositors begin to take money out to move it to a safer bank, which would cause a bank run since banks don't have enough money to cover all their deposits in the FRACTIONAL RESERVE banking system we have now. On the other hand, if they practice safer banking practices and keep their depositors then their margins are very low and the growth of the company is low which is not what investors want to hear. So if we could prevent investors from worrying about risk that the banks taking, then the bank take on the risk necessary to get all the investment they need, so FDIC/SIPC are born. By creating a mandatory deposit insurance depositors feel at ease and become less concerned with moving their deposits, allowing banks with those deposits to get bigger and bigger by taking on more risk, while making hard and near impossible for newer banks to compete for those deposits without taking more risk as well.
Housing - Houses are a great investment but a house can take a long time to turn over, especially these days. If you factor in all the maintenance costs it can require a lot of upfront capital and not much in return in the mean time. Countless institutions were created to encourage investment in housing:
- Fannie and Freddie were created to buy mortgages from banks, so banks could keep making more and more mortgages which solves the demand/turnover issue that made investment in development weary.
- Housing which by all means is a capital good doesn't get taxes as a capital gain when sold for a profit, maximizing it's after-tax return versus stocks or bonds which are more liquid.
- REITS which are just real estate company shares get special Subchapter M tax treatment getting the same tax exemptions that mutual funds get.
- Mortgage Tax Credit
- Tax Shelters like the ones created for oil were created for housing, which actually allowed you invest non-recourse loans (loans in which they CAN'T garnish your wages or repossess your assets if you don't pay)
... a lot lot more...
Risk # 2 - Liabilities
Liability is a huge issue to any investor or entrepreneur, the more likely the chances of being sued or a disaster occurring that would incur lots of liabilities the less appetizing the reward becomes versus the risk. So if the liabilities aren't mitigated through government intervention, needless to say a lot of these risks would drive entrepreneurs and investors to more safe sustainable ventures where they can make a similar return. Even if the if they do decide to go into the enterprise, liability will keep the entrepreneur disciplined or else lose his hard work and more.
Oil - Everyone has heard about the liability cap set on Oil companies, on top of it you had tax incentives to drill farther off shore then drilling on shore (less royalties needed to be paid the father out you drilled) which combined makes the risk/reward calculation on drilling offshore a no brainer.
Banking - Once again you had very huge liability in the case that a risky investment didn't pan out, or if depositors suddenly began withdrawing money despite the the cover of FDIC. To prevent the liability of these scenarios the Federal Reserve was created as the lender of last resort, originally created in 1913 to address problems from severe branching regulations in the early 1900's. So with FDIC and keeping depositors feeling safe and the Federal Reserve coming to the rescue when excessive risk catches up with the banks... owning a bank is great idea, especially since it's the bankers who are the entry point of new highly powered money.
Housing - The major liability in investing in housing is well... not being able to sell the house or the person you lend to not making their mortgage payments. Fannie and Freddie combined with loose monetary policy from the fed really fed the demand so that these houses were more liquid and that mortgages could be affordable to the least qualified of borrowers. If you don't have to worry about these factors well... then why not invest in housing.
Risk #3 - Attracting Talent
In order to grow a large and ever growing enterprise one must attract the talent to do so. The problem if your business isn't very sustainable cause of excessive liabilities or low margins then compensation becomes difficult to afford for good talent. Also, the best talent seeks to be somewhere that the job seems safe and secure so if you decide to run a high risk business this may detract talent cause the risk of unemployment becomes to penalizing and the cost of private unemployment insurance would lower your wages you'd make more paying a much smaller premium for a safer company. In this Free Market environment the best talent would gravitate towards sustainable enterprise unless government reduces the risk of working for risky unsustainable enterprise.
For All Industries - Government Mandated Unemployment insurances creates non-variable cost for working for anyone, so it doesn't matter how safe the job is the payment into unemployment is the same, so then you might as well work for the high risk taking high salary company. Worse comes to worse you will not get a fraction of a larger salary for the next 6 months, so you get rewards for taking the riskier job since you benefits key into what you made before becoming unemployed.
Conclusion
If the government makes it easier for capital to gravitate towards riskier business, makes it easier to take more risk without incurring large liabilities, and allows these firms to easily make grabs at all the greatest talent around the globe... what do you expect to happen? Overpriced Housing, Overleveraged Banks, Oil Spills
Greed is not alone powerful enough to cause these kinds of problems, but with the helping hand of government big business can have all the roadblocks removed from becoming... "too big to fail" or better put "too big to succeed"
by Alex Merced
Time and time again we hear in the news that we need stronger regulation on Oil, Housing, and Banking to prevent all the problems we've seen over the last few years. Today, I'd like to make the argument that the problems with all three of these sectors has everything to do with government intervention in the market and that the best regulation would be the natural regulation of natural risk in the markets. In the name of populism much of this natural risk has been removed from these enterprises in the name of "promoting business", "job creation", and "economic growth".
The initial problem with this rhetoric is that growth is always good, so rushing growth or artificial growth must be good too. For example, if I want to bulk up quicker I could begin to take steroids, although while that is growth it's not sustainable since I haven't built the discipline and lifestyle needed to maintain that bulk, so I become dependent on the steroids to maintain it.
So let's take a look at three types of natural risk that effect the entrepreneur when they are making the decision to enter an enterprise, and on how to run the enterprise. We'll see that these policies remove the aforementioned risks and like steroids prevent the kind of discipline needed to create sustainable businesses and growth.
Risk # 1 - The Ability to Raise Capital
Arguably, if an entrepreneur can't raise the money then he may never start the enterprise at all. Why would raising capital be difficult? This could be for a variety of reasons that all have to deal with he viability of the business and if potential investors/lenders see a demand for product/service, are the potential liabilities addressed, are the margins too thin, is it profitable in the short term? If government were to intervene to make capital easier to raise for such enterprises, it's easy to see how more of them would exist despite these typical investor concerns.
Oil - Oil is a very difficult business without government aid, because investors aren't typically very optimistic about the chances of finding oil when doing exploratory drilling. So to encourage investment into oil in the 60's and 70's tax shelters were created for oil investment in the form of Direct Participation Programs, and during a time of 70% tax rates one can see how a tax haven can be quite a benefit, you'd actually profit from the tax savings alone. So capital was being sucked into oil cause of the tax benefits, not cause of the merit of the enterprise... actually you'd lose money if they found oil cause it'd create a paper gain which you'd pay taxes on. So the capital raising issue was now done away with for Oil drilling at the expense of driving capital away from technology, medicine, alternative fuels that would've meant that the BP spill might've never happened cause the oil rig would've never been there since we would have divested from oil long ago.
Banking - Banks can be a risky proposition with tight margins. The problems being if the bank takes too much risk then depositors begin to take money out to move it to a safer bank, which would cause a bank run since banks don't have enough money to cover all their deposits in the FRACTIONAL RESERVE banking system we have now. On the other hand, if they practice safer banking practices and keep their depositors then their margins are very low and the growth of the company is low which is not what investors want to hear. So if we could prevent investors from worrying about risk that the banks taking, then the bank take on the risk necessary to get all the investment they need, so FDIC/SIPC are born. By creating a mandatory deposit insurance depositors feel at ease and become less concerned with moving their deposits, allowing banks with those deposits to get bigger and bigger by taking on more risk, while making hard and near impossible for newer banks to compete for those deposits without taking more risk as well.
Housing - Houses are a great investment but a house can take a long time to turn over, especially these days. If you factor in all the maintenance costs it can require a lot of upfront capital and not much in return in the mean time. Countless institutions were created to encourage investment in housing:
- Fannie and Freddie were created to buy mortgages from banks, so banks could keep making more and more mortgages which solves the demand/turnover issue that made investment in development weary.
- Housing which by all means is a capital good doesn't get taxes as a capital gain when sold for a profit, maximizing it's after-tax return versus stocks or bonds which are more liquid.
- REITS which are just real estate company shares get special Subchapter M tax treatment getting the same tax exemptions that mutual funds get.
- Mortgage Tax Credit
- Tax Shelters like the ones created for oil were created for housing, which actually allowed you invest non-recourse loans (loans in which they CAN'T garnish your wages or repossess your assets if you don't pay)
... a lot lot more...
Risk # 2 - Liabilities
Liability is a huge issue to any investor or entrepreneur, the more likely the chances of being sued or a disaster occurring that would incur lots of liabilities the less appetizing the reward becomes versus the risk. So if the liabilities aren't mitigated through government intervention, needless to say a lot of these risks would drive entrepreneurs and investors to more safe sustainable ventures where they can make a similar return. Even if the if they do decide to go into the enterprise, liability will keep the entrepreneur disciplined or else lose his hard work and more.
Oil - Everyone has heard about the liability cap set on Oil companies, on top of it you had tax incentives to drill farther off shore then drilling on shore (less royalties needed to be paid the father out you drilled) which combined makes the risk/reward calculation on drilling offshore a no brainer.
Banking - Once again you had very huge liability in the case that a risky investment didn't pan out, or if depositors suddenly began withdrawing money despite the the cover of FDIC. To prevent the liability of these scenarios the Federal Reserve was created as the lender of last resort, originally created in 1913 to address problems from severe branching regulations in the early 1900's. So with FDIC and keeping depositors feeling safe and the Federal Reserve coming to the rescue when excessive risk catches up with the banks... owning a bank is great idea, especially since it's the bankers who are the entry point of new highly powered money.
Housing - The major liability in investing in housing is well... not being able to sell the house or the person you lend to not making their mortgage payments. Fannie and Freddie combined with loose monetary policy from the fed really fed the demand so that these houses were more liquid and that mortgages could be affordable to the least qualified of borrowers. If you don't have to worry about these factors well... then why not invest in housing.
Risk #3 - Attracting Talent
In order to grow a large and ever growing enterprise one must attract the talent to do so. The problem if your business isn't very sustainable cause of excessive liabilities or low margins then compensation becomes difficult to afford for good talent. Also, the best talent seeks to be somewhere that the job seems safe and secure so if you decide to run a high risk business this may detract talent cause the risk of unemployment becomes to penalizing and the cost of private unemployment insurance would lower your wages you'd make more paying a much smaller premium for a safer company. In this Free Market environment the best talent would gravitate towards sustainable enterprise unless government reduces the risk of working for risky unsustainable enterprise.
For All Industries - Government Mandated Unemployment insurances creates non-variable cost for working for anyone, so it doesn't matter how safe the job is the payment into unemployment is the same, so then you might as well work for the high risk taking high salary company. Worse comes to worse you will not get a fraction of a larger salary for the next 6 months, so you get rewards for taking the riskier job since you benefits key into what you made before becoming unemployed.
Conclusion
If the government makes it easier for capital to gravitate towards riskier business, makes it easier to take more risk without incurring large liabilities, and allows these firms to easily make grabs at all the greatest talent around the globe... what do you expect to happen? Overpriced Housing, Overleveraged Banks, Oil Spills
Greed is not alone powerful enough to cause these kinds of problems, but with the helping hand of government big business can have all the roadblocks removed from becoming... "too big to fail" or better put "too big to succeed"
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