The Housing Crash: Examining a Misguided Class Analysis of Foreclosure Sales

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Things change. One thing that does not change is the predictable commentary about things changing. Catherine Rampell gives an excellent example in New York Times Magazine , " Boom, Bust, Flip ." She repeats the ancient charge that change benefits "the upper class while brutalizing the middle class."

In generic form, the story focuses on how well the rich did during the boom. Of course, everyone did well, but the rich benefited the most in proportionate terms. Incomes might have gone up 10% or 20%, but the stock market might have gone up 100%, and the rich own most of the stock.

The bust wipes out some of the rich, but then they're no longer "upper class." They become part of the victim group. Most of the rich lose more in proportionate terms than the middle class for the same reason the rich benefited more from the boom. However, they're still better off in absolute terms. A billionaire who loses 90% of his wealth and has to sell his second yacht is still a hundred millionaire and better off than a white-collar worker who lost a lower percentage of her wealth and income.

Finally, the recovery helps everyone, but some sooner and more than others. Many of the people helped the soonest and most either were rich already or became rich due to the recovery. Most of the people helped last and least are middle class or poor. So again, it appears that the rich are being helped the most.

The story relies on shifting standard of comparison, but nevertheless contains a core of truth. Being rich is better than being poor. The glaring logical omission is why the rich doing well "brutalizes the middle class." But for some people that's an article of faith too basic to question. It's the entire reason to speak of "upper class" and "middle class" in the first place, rather than, say, "people whose income comes primarily from investments," versus "people whose income comes primarily from wages," which could lead to more precise insights about the economy.

It's generally true that change favors the rich and poor at the expense of the middle class. Some people are rich because they are smart, and smart people exploit change. Some are rich because they are government cronies or criminals, or have other savory or unsavory connections. Their organizations protect them. Some are rich because they own things, and it's easier to redeploy investment assets to take advantage of change than it is for middle class workers to retrain or move. The poor are also nimble, in that they have less to lose than the middle class. If you don't have a job, layoffs don't hurt you, and you might pick something up in whatever growth areas drive the recovery. Of course, many poor people will not be able to take advantage of the recovery directly, but they can still benefit indirectly if things get better for poor people as a group. Their friends and relatives may do better, and there can be more resources available to them with less competition. A fall in home prices, for example, hurts middle-class homeowners while making housing less expensive for people who could not afford to buy houses (of course, it hurts rich homeowners as well, but a primary residence is likely to be a smaller fraction of net worth for a rich person than a middle-class person).

Real events are more complicated than the generalities above, and sometimes it takes a little nip and tuck to fit facts into a clarion call for class warfare. Rampell's article goes beyond the usual massaging of data to full confabulation. It does not rely on actual sources for its main points. Instead you get, "observers have noted, it was disparately the wealthier investors who bought [foreclosed homes]. . .up at bargain prices," and "research suggests the financial crisis has benefitted the upper class while brutalizing the middle class." These are not minor sidelights, they are the key points the article makes, and the author cannot find even anonymous or unqualified people to support them, much less hard facts. They're not even well-defined. "Wealthier" than whom? Is "bargain" based on objective contemporaneous valuation metrics, or just a home that went up in value after purchase? What defines "upper class"? If it includes Princeton graduates, as I think most people would assume, then the author should insert an apology for brutalizing people, unless denouncing her classmates absolves her of responsibility for the moral crimes of her class.

There are a few attempts at facts. "Rents have risen at twice the pace of the overall cost-of-living," for example. If Rampell had included a time period and source, that would be a fact. But according to the Bureau of Labor Statistics, housing prices are up 8.9% since the end of 2008 while the cost of living has increased 10.5%. The only way to support the statement in the article is to use a much shorter period. Over the summer of 2013, for example, housing prices are up 0.61% while the cost of living has increased only 0.25%. But while that is more than twice as fast for housing, it's only 0.36% relative increase, hardly enough to support the harsh charges in the article.

A more basic problem is the statistic has little to do with housing. Short-term moves in the consumer price index are dominated by volatile food and energy prices. If housing prices are increasing faster than overall prices over any period less than, say, three years, it's likely because food and energy prices are declining, not because housing is getting relatively more expensive. This has indeed been the case recently. Also, over short periods housing-price-change statistics are problematic because rents are sampled only once every six months, so monthly changes depend on sometimes shaky statistical adjustments.

Rampell thinks the surge in rents is driven by "landlords" exploiting "middle-class families," who "can't get the credit they need to buy" and free themselves of upper-class exploitation. One problem is most landlords are middle class, and middle-class families are less likely to rent than poor, rich, and single people. Another is that the Bureau of Labor Statistics tracks the owner's equivalent cost of primary residence. Unless homeowners are exploiting themselves Rampell's explanation doesn't fly, because their costs are up 0.45% since June, also faster than the cost of living.

The poster children for the article are Tim and Jenni Earll, who seem like nice people who had some bad financial luck. They bought a house in 2007. Jenni lost her job and Tim's income declined and they were unable to keep up payments. In 2011 the bank foreclosed and sold their home at auction for $155,000 to a small real estate LLC. The following year, the house was sold for $290,000. The article does not say how much the LLC paid in expenses, but it tells us the house was a "fixer-upper" in 2007 and that the Earlls were unable to make their planned improvements. Given five years of age and depreciation that usually accompanies foreclosure and sale, rehabbing the home could have been expensive. In addition to rehabilitation costs there are taxes, insurance, interest, brokerage fees, and other expenses. So we really have no idea if this investment was good or bad for the LLC. We also have no idea if the owners of the LLC were middle class or rich (they probably weren't poor, although that is not a certainty; there are a lot of real estate investors with negative net worth, and the LLC could be owned by a pension fund or charitable organization).

We do know that the Earlls suffered, but not because the LLC got a bargain on their house (if it did). The primary cause of their ills was income loss, which led to a secondary cause: loss of their home. If the LLC had paid $290,000 for the home at auction, the Earlls would not have been any richer, nor would they have kept their home. The only difference is the Earlls might have been able to save their credit. If that's what "brutalizing the middle class" means, the solution is more accurate credit scoring, not stopping rich people from buying foreclosed properties.

An ironic sidelight is the article hints that the Earlls may be part of the nimble class that manages to benefit overall from change. Although they lost their home and jobs, it appears they were able to walk away from the debts, rely on family support and (in Tim's case) go back to school. They also appear to have the resilient, realistic, optimistic outlook that helps navigate rough waters. Ten years from now, they may well be better off as a result of the crash. I don't mean I am unsympathetic to their troubles; I certainly understand the pain the events caused them. However, the clearer victims are people trapped in debts they cannot discharge, without family support or perhaps with children they must support, without realistic options to retrain and improve their prospects, and without the psychological resources to rethink their lives. Change favors the unconstrained nimble people of all income levels, and hurts those whose situations strand them in backwaters.

Is there a general problem with investors making too much money buying foreclosed properties? Here is the closest thing to a fact in the article. It is sourced to Redfin, an "online real estate listing site." That's not as good as a person, or government agency, or an expert, but at least it's identifiable. Of course, you wonder why the reporter went to an obscure website, given the huge amount of public data on real estate transactions and the intense interest in studying them. "Of the 87,062 foreclosures in the last five years that were bought by corporate investors and have been flipped, about a quarter were sold for at least $100,000 more than what the investor originally paid."

What does that tell us? First of all, it represents a tiny fraction of the 17 million foreclosures and 5 million repossessions from 2008 to 2012. Second, it doesn't include the houses that were purchased and not yet sold, nor the three-quarters sold at smaller profits or losses. It does not include any expenses associated with the purchases and sales, nor the money that could have been made in alternative investments (investing in stocks over the last five years, or bonds, would almost certainly have done better). Given only the information above, my guess is corporate investments in foreclosed properties has not been a good business in the last five years. Moreover, there's nothing to suggest that "corporate investors" represent the upper class, nor that the victims of foreclosure were disproportionately middle class.

In fact, the author claims just the opposite, apparently failing to notice the contradiction. In another unsourced departure from accuracy she writes, "There's a popular perception that so-called McMansions and Garage-Mahals brought down the housing market." Just the opposite is the case; people call it the "subprime" crisis. In fact new construction of high-end homes bought by middle-class people who did not intend to live in them really was the biggest part of the problem; poor and lower-middle class people buying inexpensive homes to live in have been blamed unfairly.

Having invented a popular perception, Rampell tries to refute it with, "more than half of all homes that went into foreclosure between 2007 and 2012 were actually in the lowest price tier when they were purchased, and most were located in middle- and lower-income areas." Without a source, or definitions of "price tier," "middle-income," and "lower-income," there's not much substance. Anyway, the key statistic is losses on sales, not number of homes that go into foreclosure. Only about a quarter of homes that went into foreclosure have been repossessed and sold, and in many cases the losses were small and in line with statistical expectation. Many homes that never went to foreclosure were sold at distress prices, which helped bring down the housing market.

However, just because this article mangles the facts to support a clichéd narrative doesn't make it entirely wrong. There are reasons things become clichés. Every change creates winners and losers. The winners will be found disproportionately among the people who started poor, and among the people who ended rich, but they will also be found among the people who started rich, and among the smart, the nimble, the connected, the unconstrained, the lucky, the resilient, the optimistic, and the energetic. It can make sense to tax the winners to compensate the losers, especially those who became winners or losers unfairly.

The problem with this article is ideological blinders; shallow thinking (despite immodestly claiming her prose represents her "deep thoughts" this week) and shoddy facts blur the definitions of winners and losers, and fairness and unfairness. The housing crash was not a tactic of the upper class, however defined, against middle-class families. It was an economic restructuring after an unsustainable bubble, which had been inflated by many things, over many years. Not all of it is bad. No one can sort it all out; no one can predict its implications for the future. What we can do is sift carefully for its victims, especially the most damaged and the most innocent, and try to help them. That's done best without a lot of ideological baggage or preconceived notions of blame. With the same spirit, we can look for its profiteers.

Back in 2007 I wrote, "The problem with bailouts is they are attempts both to prevent change, and to compensate losers from change in advance. But no one knows if the change will be good or bad, in fact virtually all changes have large portions of good and bad. No one knows who the eventual victims will be. No one even knows how the bailout will affect the course of change, but we do know it will cost resources: money, credibility, borrowing capacity. Rather than throw resources into the malestrom based on theories being proven wrong every day, save them until we know the outcome. Then we can compensate losers for actual damage, and make sure we're not bailing out winners (a simple rule is no one of above-median wealth gets any direct or indirect bailout funds-if you're better off than average, you don't need collective help). Neighbors pitch in to rebuild houses after the storm, they don't take up collections beforehand and give the money to politically connect people based on official guesses about the storm path. Okay, actually they do, but they shouldn't."

Of course, we did spend the bailout resources and, partly as a result, we have a lot less ability to help people in need. That makes it even more important to be careful in how we define winners and losers. "Boom, Bust, Flip" is a bust in that regard.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Real Estate

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