Financial Cycles and Real Estate

Alex J. Pollock
REALTOR University Lecture
October 16, 2014
1
Financial Cycles

About every ten years, we have the biggest crisis in 50 years.
-Paul Volcker

The banking failures for the current year have been numerous,
greatly aggravated by the collapse of unwise speculation in
real estate.
-Report of the Comptroller of the Currency, 1891


2
Political and Regulatory Overreaction
In 1360, Francesh Castello, a failed banker, was
beheaded in front of his bank.

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4
Cycles of Prices and Leverage
What is the collateral for a mortgage loan?

How much can a price change?
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50
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100
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200
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I
n
d
e
x

The U.S. Housing Bubble:
Case-Shiller National Home Price Index Values
1987-2014
S&P Case Shiller U.S. National Home Price Index
Case-Shiller Trend (3.3% Annual Growth Rate)
2006 Q2, 189.93
Trend Line
6
7
0
50
100
150
200
250
300
350
400
450
500
-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5
International Comparative
Housing Bubbles
Ireland
UK
Spain
US
Denmark
Canada
Years After Peak Years Before Peak
Source: Bloomberg
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50
100
150
200
250
300
350
400
450
500
550
600
650
-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10
P
r
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e

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x

(
1
0
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=
6

y
e
a
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s

b
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f
o
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e

p
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a
k
)

Comparative Bubbles: NASDAQ v. House Prices
Years Before and After the Peak of the Bubble
NASDAQ
Case-Shiller Home Price Index
NASDAQ: Peak to Trough= 71%
Case-Shiller: Peak to Trough= 32%
+ 2.5 yrs
+3.00 yrs
-3.25 yrs
- 2.75 yrs
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0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
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4
10-YR Treasury Note Rate
Fearful Symmetry
1950-2014
Its Easier to be Brilliant than Right

The mercantile community will have been
unusually fortunate if during the period of
rising prices it has not made great mistakes.
Such a period naturally excites the sanguine
and the ardent; and the ablest and cleverest
the most.
- Walter Bagehot, 1873

10
Its Easier to be Brilliant than Right 2
There is nothing so disturbing to ones
judgment as to see a friend get rich.

I can calculate the motions of the heavenly
bodies, but not the madness of people.
-Isaac Newton

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Risk is the price you never thought you would have to pay



For example:
Fannie Mae and Freddie Mac

Total Profits 1971-2006: $106 billion

Total Losses 2007-2011: $256 billion

Net Results 1971-2011: $150 billion loss
13
Housing Busts

Recent authority:
The duration of housing price declines has been long lived, averaging
roughly six years.
-Carmen Reinhart and Kenneth Rogoff

Ancient authority:
Pharaoh had a dream: out of the river there came up seven cows,
sleek and fat, and they grazed among the reeds. After them, seven
other cows, ugly and gaunt, came up out of the NileAnd the cows
that were ugly and gaunt ate up the seven sleek, fat cows.
-Genesis 41

Loans which cannot be repaid will not be repaid.
-Pollocks Law of Finance
14
Failures of Imagination

Many things which were considered impossible nevertheless came to pass.
-Freeman Dyson
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46%
62%
64%
65%
20%
30%
40%
50%
60%
70%
80%
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: United States Census Bureau
100-Year U.S. Homeownership Rate
1910-2014
23%
68%
64%
20%
30%
40%
50%
60%
70%
80%
1918 1939 1953 1961 1971 1981 1991 2001 2011
Source: United Kingdom National Statistics
England Long-Term Homeownership Rate
1918-2011
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20%
30%
40%
50%
60%
70%
80%
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: United States Census Bureau
100-Year U.S. Homeownership Rate
1910-2014
U.S. Housing Finance Eras


First
Homeownership
Campaign
Golden Age of S&Ls
Age of Fannie
and Freddie
Collapsing
Bubble
Years
?
18
The Role of Government

The subprime mortgage problems are contained.
-Common official statement, 2007

We had no choice but to fly by the seat of our pants, making it
up as we went along.
-Secretary of the Treasury Paulson
about the financial crisis


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The Role of Government in Housing
Finance (and in general)

Two Theories
Adam Smith
J.M. Keynes
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The Pollock Proposal
Adam Smith90%
Normal Times
J.M. Keynes10%
Times of Crisis
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The Cincinnatian Doctrine
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Adam Smith
90%
J.M. Keynes
10%
Normalcy
The Cincinnatian Doctrine
The Key: Withdrawing after the crisis

The Model: The Roman Hero Cincinnatus
(flourished 5
th
century B.C.)

The Modern Cincinnatus: George Washington

Contrast: Dodd-Frank, Fannie-Freddie, Fed
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0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
G
e
a
r
y
-
K
h
a
m
i
s

d
o
l
l
a
r
s

Source: Maddison Project
U.S. Per Capita Real GDP since 1900
24
In Sum

The capitalist process progressively raises the standard of life of the
masses. It does this through a series of vicissitudes.
-Joseph Schumpeter


A period of transition is a period between two periods of transition.
-Jacob Viner

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