Wharton Business School Weighs In On Home Values

The University of Pennsylvania's Wharton Business School has embarked on a series of interviews with seven Wharton professors on the credit crisis.

The first in the series is "Credit Crisis Interview: Todd Sinai on Home Values" and it's definitely a must read or view the video below. Give a nod to the smart guys at Wharton. What I appreciated about it was the objective and academic view of the issues which we are often too close to to view with crystal clarity.

I have included below a few short excerpts from the transcript for a flavor for the interview although the questions and answers are very interrelated and much more meaningful experienced in its entirety.



"The difference between housing and the stock market is that when you sell the share of stock and it's doubled in value or tripled in value, you can buy more stuff. If your house doubles or triples in value, you can buy the same amount of housing -- unless you're going to move somewhere else where houses' prices didn't rise quite as much. So it's a very different thing to think about in terms of an investment. And I think when people say that people are using it as an investment, what they mean is they're using it as a line of credit. "

Now, we saw prices just soaring in the early and mid part of this decade. What was behind that?

"The rest of it is due to a couple of factors. About two-thirds of the run-up, on average, for the country appears to be due to, essentially, it's cheaper to finance your house. And the way to think of that is that if you were to invest in stocks, by the time you went from 2000 to 2005, the kind of return or yield you would have gotten on the stocks would have gone down a lot. It's the same with bonds. Houses actually end up being priced a lot like bonds. When required yields are lower, bond prices go up. With houses, if the cost of your money, in terms of where else you could have invested it or the cost of borrowing for housing, goes way down, then the prices go up to compensate. Now, that's about two-thirds of it. A third of it just seems to be what we call momentum -- looking backwards and saying, 'Hey, prices have gone up.' It's going to go up in the future. And that's sort of a behavioral or psychological, kind of bubble story."

And on subprime...

"I think, in large part, the subprime problem came from the lending sector, banks and finance companies that were in a hunt for yield. They had capital they needed to put to work, and they needed to get yield. And you could take an abnormally low yield in traditional bonds, or you could put it into housing, and you could do it knowing that you were taking on risk. You might not have known exactly what the parameters of that risk were, but you knew that you were taking on risk, and it was still worth it, because then you could actually make a bit more money, or the same amount of money. I think whatever regulation the government had done, Wall Street would have found a way to circumvent it."


The second in the series, "Credit Crisis Interview: Susan Wachter on Securitizations and Deregulation" discusses the drive to securitize mortgages combined with deregulation that were key triggers of the credit crisis.