IF THE FALL IN THE PRICE OF HOMES IS THE ROOT OF THE ECONOMIC MELTDOWN, WHAT IS THE ROOT OF THE FALL IN THE PRICE OF HOMES?

By my age, habits have become pretty well etched into the pattern of my life.  However, I have to admit that I am joining that crush of people who are getting more of their news online.  I have grabbed The Washington Post at my front door every day for the past five decades or so.  For years, my day hasn’t really begun until I have a cup of coffee and The Post.  But more frequently these days, I find myself early in the morning moving seamlessly from emails to news on my own schedule without worrying about whether The Post has been delivered yet.  Now, I get my news most frequently by watching one or more cable TV news networks while balancing a laptop on my lap.  Usually, on my computer screen is an email from Seeking Alpha, which suits my needs for news and opinion better than anything else I’ve discovered.  They assemble articles from people with very high credentials who publish on the web, often on their own blogs or news services.  The people from Seeking Alpha bring their own substantial and credible editing to the process.  They allow their reader to specify the topics that interest them and send them a daily morning email with links to articles grouped by each area of interest specified.  One of the areas I monitor is Housing.  This morning (12/23/08), I was especially impressed by an article entitled “The Housing Blame Game, Redux.”   It was written by Paul Jackson, who is the publisher of “Housing Wire,” which is a respected source of news and interpretation of the residential real estate market.  In his article, Jackson makes a well-reasoned case that the Bush Administration’s “Ownership Society” policies, coming on the heels of similar goals of every Administration since Carter, must assume much of the blame for the crash of home prices.  That prompted me to leave a reply to Jackson’s article that articulated my view that blaming the crash on political policies still isn’t enough.  It’s a much deeper issue, in my opinion.  Below, I am reiterating the comments I posted at his article, in an extended and edited form.

The Crash Of Home Prices, Like The Crash Of The Stock Market, Was Not An Isolated Episodic Event.  It Happened In A Much Broader Context.

Although I think Paul Jackson’s article was enlightening, I also think his discussion misses the major point:  new and ill-conceived financial instruments and political policies certainly exerted major influence on the housing bubble, but they existed within the context of a cultural phenomenon.

From mid-1986 until the very end of 1990, I was VP at NVR, which grew from a small IPO of a Greater Washington regional homebuilding company called NVHomes to become the nation’s largest homebuilder when, in a classic minnow-swallowing-the-whale case history, NVHomes acquired Ryan Homes.  I worked closely with founder and then Chairman/CEO Dwight Schar, a brilliant businessperson who (at least from what I could observe) had an intuitive genius for real estate, how to market new homes, and how to operate a homebuilding business.  (As an aside, he also has become a close friend of George W. Bush, and he has been one of the major fund raisers for the Republican Party for a number of years.)  While working with (and learning much from) him, I attended four years worth of conferences where we and other public homebuilders made presentations to analysts and institutional investors.  In fact, I sometimes took his place making the company presentations at those conferences. 

In the process, I got to see all the other publicly owned builders make their presentations over a very dynamic four year period of boom-to-bust for the real estate business.  This combination of having a close-up view of the homebuilding industry as a part of the senior management team of the nation’s largest homebuilder and as an observer in the audience listening on a regular basis to CEOs of other homebuilders gave me the opportunity to see a fundamental change happening in the residential real estate market.

Product Product Product.

The fundamental rule of real estate had always been: location location location.  In the mid-80s, that rule changed to: product product product. Location did not become totally irrelevant in the marketing effort and it certainly influenced the price of the home, but if you take a look at the advertising and marketing of new homes at the time you will see that they were promoting product over location.  They stressed bigness, open and big volume space, tubs so big that the water got cold by the time the tub was filled, over-size kitchens with islands, master bedrooms with sitting rooms, extensive upgrades, customizing, etc.  In short, how the rich lived became the expectation of the non-rich.  More, in fact, than mere expectation.  Maybe closer to some weird sense of entitlement.  

Consistent and concurrent with this trend, the market began to be segmented so that there was no longer just a “move-up” market but there was a “first time move-up,” a “second move-up,” and then the McMansion market.  In other words, there was always a reason to sell your existing house and buy the next level up.  By creating a “next step up,” homebuilders increased the size of their market.  The consumer was lured to another sale.  Each segment of the market was defined not so much by location but by the features and look of the house itself.  Product became king.  So what if the house was located in the far suburbs requiring an awful commute?  Look what you could live in once you got home!  How great you would feel!  How impressed your friends will be when they see the house!  Worth the commute.

The real estate crash of the early to mid-1990s popped the market bubble for about seven years or so until people who bought at the market high saw their homes’ value recover to the price they originally paid.  When the market came back, it came back with a vengence, fueled by homebuilders who built and fed into the consumer’s appetite for more-and-better as defined by product.  The marketing that was used to turn-on the market could not have succeeded unless the market itself was susceptible to that pitch.  And that is my point: the market itself (our culture) also must assume a major burden for what has happened to home values.  And, because the crash in home values is a major reason for the crash of the equity and debt markets, you could say by a simple extension of logic that it was our culture that gave rise to our current financial condition.

The evidence of wealth became a priority to Americans, and the house became the most important evidence of wealth.  Even if you didn’t actually have wealth, you could still look like you had it.  Remember the TV commercial that showed the guy with all the props of wealth who admitted that he was “in debt up to my eyeballs”?  That was a perfect summary of the American Culture:  The appearance of wealth not only became more important than actual wealth, it became so important that debt would be assumed to the degree that it actually undermined the reality of (or prospect of building) wealth just for the sake of giving the appearance of wealth.  How perverse was that logic?  So perverse that it could be attributed to only one thing: a bandwagon mentality gone horribly off-track.

Although the consumer’s ability to get themselves into that fix was helped by new financial instruments and government policies, as Paul Jackson’s article suggests, the consumer’s decisions and priorities were fueled less by financial instruments and more by the culture that dominated our society and nation at the time.  

To dismiss the cultural issue when trying to identify the causes of the current financial crisis is a major mistake because if we are not sensitive to it as a cause, we will not observe cultural shifts as they occur as a necessary component of the solution.  I think those cultural changes will exert at least as much influence in how and when the residential real estate market is reshaped as any new mortgage instruments that may be appear on the scene.

What Cultural Changes Might We Expect?

If my premise is correct, then the question becomes: What sort of cultural changes might we expect?  I think that will be very difficult to predict correctly, but here’s my current guess as to attitudinal shifts in the American Public’s view of their homes:

• Resurrection of the importance of a home’s location.
• Acceptance of the concept that having a house that can be afforded is more important than having a house that is a financial stretch but gives you a certain image. 
• Rejection of the importance of the appearance of success and wealth as a priority in life.
• Willingness to at least consider the proposition that in some cases renting a home might be wiser than buying a home.

If …

If those cultural changes are made as part of the revitalization of the residential real estate market, there will probably be similar and related cultural changes in society as a whole.  As that occurs, the current American Dream of “Buy more … Buy bigger … Buy more expensive … Buy on credit even if you can’t afford it” will be transformed.  Perhaps the transformation will include a reversal, at least in part, to the traditional American values of liberty, freedom, and individual responsibility and opportunism.  We’d also be likely to see increased savings rates and decreased levels of debt.  But I think the cultural change on the horizon will be much more than an updated restatement of former ideals.  I believe new standards, priorities, ways of doing things and the basic definition of what makes for a “good life” will emerge. 

I do not think this will happen overnight, and I think many of the changes will begin to emerge in very small and maybe unnoticeable increments (which would increase the need for being sensitive to the issue so that we can observe changes as they evolve).  In the meantime, given the destroyed wealth that formerly existed in peoples’ homes, the ongoing southward direction of the equities and debt markets globally, increasing unemployment, and more dramatic stories of the Madoff ilk, it’s going to be very easy in 2009 for people to count their blessings.  But the blessings they count will be less of the materialistic variety – less tied to money (or even the lack of it).  And if “blessings” morph FROM things like the latest flat screen television in the media room with theater chairs TO things like reveling in family and non-capital-related assets, then the cultural change will be significant indeed.  After all, there won’t be another catastrophe in sub-prime mortgages if there is no market for sub-prime mortgages in the first place.  

THE GOOD PART ABOUT BAD NEWS:

SOME RANDOM THOUGHTS ABOUT THE ECONOMY FROM AN INVESTOR RELATIONS PERSPECTIVE

I spent ten years, beginning in 1981, heading the corporate communications efforts of three publicly owned businesses.  In each instance, my highest priority was investor relations.  In 1991, after leaving the third company, NVR, the large homebuilding company where I was Vice President, I started my own investor relations consultancy as a one-person business.  For about the next ten years, until co-founding Qorvis in late 2000, I stayed focused almost exclusively on investor relations.  That amounts to a total of about 20 years concentrating on investor relations, during which I worked with scores of companies, all of which were public or going public.  During that time, I got an up-close-and-personal view of the investment community, and the way I look at the world was changed as a result.  Much of what I learned rushes back into my thoughts as I watch and read about the current financial crisis.  Here are some random thoughts:

JUST WAIT UNTIL NEXT YEAR.

There is a really unique feeling only an IR person can relate to.  It’s that feeling you get when you wake up on the morning that you know your stock is going to get killed because you have to issue very bad news – and there is hardly anything worse than issuing disappointing earnings.

The IR person feels the heartbeat of a stock more intensely than anyone else.  That’s not to say that the stock isn’t a priority concern of others, especially the CEO, but the IR person thinks about it constantly.  It is the focus of their life.  You speak to the investors and the analysts on a frequent and sometimes lengthy basis.  You know what they think.  You know their expectations.  You know what will make them sellers and what will make them buyers.  And you do that in a very real-time world.  Issue a release.  Look as it crosses a screen and becomes public news.  Watch the reaction.

So you know what will happen when the news hits.  You may be off by some increment, but you know when it is going to get killed.

There is also a unique feeling the IR person has when they go to bed the night of the day of bad news.  It isn’t as overwhelming as what you felt in the morning – it’s more like a sigh of relief:  “Well, I get to compare against this 365 days from now.”

The economic news has been so bad since the October market meltdown that the statistics next year have to show an improvement.  There’s some good news there somewhere.  You might have to look real close.

ITS ALL ABOUT EXPECTATIONS

A basic rule that IR people live with is:  “Investors can take good news; they can take bad news; they can’t take surprises.”

Reporting a quarter that compares favorably against the same quarter in the prior year is positive, but if those results are under expectations, the benefit of reporting good period-over-period results is more than wiped out.  Thus, a general rule of investor relations is: “Create expectations so that you can at least meet them, and preferably beat them.”  I’d use that rule if I could set expectations for the national economy.  I’d set expectations as low as possible now and by so doing set the stage for good news by beating those expectations in the future.  It looks to me as if the Obama people understand this rule and are doing their best to keep expectations down.

But setting expectations isn’t as simple as it looks.  Set expectations too low and you have the chance of creating a self-fulfilling prophecy; set them too high and you put yourself in the position of issuing disappointing results in the future.

So, looking forward, the actual numbers that are released will be less significant than the actual numbers relative to the expected numbers.

EXPECTATIONS MUST EXIST WITHIN THE CONTEXT OF A VISION OF THE FUTURE

I’ve written previously about how investors are driven less by the present as they are by the future (if you follow the link, scroll down to the section that is headed: “An Investor Relations Pitch That Failed Taught Me About How To Create Ideas That Can Really Exist”).  Facts and past performance are important and I would never denigrate that importance.  However, people are turned on by visions of the future:  “The Story.”

Thinking about the nation’s economic situation makes me realize that the news and analytical coverage that dominates the nation’s consciousness is all about what has happened and what is happening right now.  Although President-elect Obama has defined some important priorities and a broad approach, he has not yet painted a very clear picture of what the future will look like.  In fact, that picture could be exciting:  a new national infrastructure … new healthcare system … closer to energy independence … a more viable Middle Class, etc.

The sooner we start envisioning a more encouraging future, the sooner we can see start building the more upbeat view of the future that will, in turn, translate into an increase in the confidence necessary to get the economy growing again.

Perhaps Obama will take the occasion of his Inaugural speech to focus less on topical events and much more on his vision for the future.  He could take the opportunity to paint a bold, opportunistic and empowering vision of what the nation can become.  That vision could then become the “story” of the Obama Administration so that all individual achievements can be cast in the context of how the achievement, regardless of how little it might seem today, moves us closer to the ultimate vision.  But to do that, you need the clear vision in the first place.

 THERE IS ONE ESSENTIAL INGREDIENT FOR BUYING-INTO THE FUTURE VISION:

CREDIBILITY

As vital as it is, a vision for the future isn’t enough.  It has to be a vision in which people can believe.  However, what if the economic situation has come on so steeply that we cannot yet believe in anything other than some wishful thinking that it won’t take much longer to find a bottom?  What sort of vision can you create with any degree of credibility at all if that were the case?

The irony is that in the case when things are so uncertain that you can’t even get your bearings, the vision that is bold and far off is often more credible than the less exciting vision that would be realized sooner.  That is because people expect a long series of modest achievements for the bold vision to come true while they expect to see less frequent but more significant achievements sooner to believe that the nearer-term vision will come true.  It’s relatively easy to report numerous small achievements and explain how they move the story forward; it’s relatively risky to place spotlights on less frequent but more significant events that have greater impact, especially when neither their timing nor consequences are highly predictable.

THE TREND IS YOUR FRIEND

Another maxim of the investment community is that things move in trends.  If you believe that (as I do), then you will also believe that the trend of the past will continue into the future.  The trend will continue until the trend flattens out.  Once it flattens out, it will continue to flatten out until the trend changes direction again.  Pretty obvious stuff.  One major problem: when will a trend change?

It is clear to see when a trend changes.  Plot it on a graph.  You can usually see it.  But inflection points become known for sure only when you are looking at the past.  When the inflection point hasn’t yet happened you can only guess when they will come.

That means if you want to get in early on the wave of a new trend, if you act on the basis of what you see when looking into the past, you are likely to act with greater certainty than if you are betting on some leading indicators of the future.  So, the best case scenario is to be able to read the trends accurately as soon as they have occurred and follow the trend from its very early stages.  If you do that, the trend will truly be your friend.

Right now, I think there are two disparate trends in our nation.  Economically, the vast majority of people believe things are very bad and going to get even worse.  On the other hand, politically, the vast majority of people (about two-thirds of the nation) express very strong confidence in President-Elect Obama.  I think it’s going to be difficult for both these trends to continue in their current directions for long.  One of them will have to hit some inflection point.  Either people are going to start getting more confident about the economy and maintain or even increase their support of Obama, or Obama will lose support and views about the economy will become even more depressed.  Which trend will change when?  We can make guesses now, but we’ll know for certain only when we look back.

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