Wednesday, October 16, 2013

Deposit Insurance Doesn't Cover The Market Value of Your Home

One often hears that paying back a mortgage is a form of saving. And I won't argue against that. What I will argue is that it's far from the same thing as putting your money on a savings account, a mistake which many people seem to make when they analyse the costs related to renting vs. buying.

Again, it helps to understand this if you see that it's possible that house prices will one day decline. Yes, you save by reducing your debt to the bank. And after each payment, you might think that you now own a slightly bigger portion of your own home, and that it's the home where your savings go - like into a huge piggy bank. But it's a piggy bank you one day might find empty, reminding you of the time when your big brother was badly in need of some cash.

Many people accept the rule that you should not see your home as an investment, and you should not look at the market price and calculate how much "profit" you have made. You anyway have to live somewhere, so it's hard to take any profits out, given that you're not willing to start renting. So if you have bought your house for $300,000 and now the market price is somewhere at $400,000, you should not conclude that your net worth / savings have increased by $100,000. The market price might not be at that level when you're going to sell, or your next home might cost $600,000 whereas the price of the same dwelling was $450,000 when you bought your first home. So you might actually be worse off because of the overall price increase in the market. In that case it's hard to see how your savings would have increased due to the increase in the market value of your home?

If this is so, then surely the same logic has to apply to your oversized piggy bank? It would mean that its financial value to you is not connected to the market value in any straightforward way. And this is why you should look at your mortgage amortization rather as honoring the promise to pay the bank the borrowed sum in full, and keep that balance separated from your savings balance. After all, when the market value of the house equals the amount you still owe to the bank - which was reality for many Norwegians last time in early 1990s - your piggy bank is empty.

It's good to have savings when the rainy day arrives. But when dark clouds start hovering over Norwegian housing market, the savings you thought you had in your house might not be there.


  1. Hi there! I really enjoy reading this blog. I just moved to Norway from the USA this year, and I'm a little shocked at the similarities I see between the housing market here and the market in the USA before the crash in 2008. You seem to be one of the few voices of reason in this country.

    One thing I've heard many Norwegians tell me is that even if there is a housing bubble, the market won't crash because if people can't pay their mortgages, then the government will step in to help them. Any thoughts on that? It seems pretty naive to me, but then again I'm new here and there's a lot about this place that I don't understand.

    1. Thanks for the positive feedback, Patrick! I appreciate it.

      To your question. I hadn't yet heard the excuse you mentioned, but I did hear already two years ago when I first questioned the house prices that "If there would be a risk of a bubble forming, Norges Bank and the government would act to prevent it - so we're safe.". (The funny thing is that both Norges Bank and the government commented soon afterwards that they are worried about a bubble.)

      Of course the government will get very active if things get totally out of control. There is a lot of infrastructure investments to be made, for example. But didn't the U.S. government do a lot as well, and still the prices crashed?

      If no one can prove the opposite (which I doubt), I would assume that all these explanations and excuses are already "priced in". Norwegians are willing to pay MORE because they think that the government will anyway come to rescue with "oil money". They are willing to pay MORE because they've been told that supply will not meet demand in the near future. They are willing to pay MORE because of this and that. So people end up paying TOO MUCH, like in any other bubble.

      Makes sense? It's the same as a real estate agent talking about how centrally-located, small apartments will never decline in price - failing to notice that the eventual price decline has already been built in the prices because everyone thinks the same. These are all arguments that would support basically ANY price no matter how high, and that's just silly.

  2. Hi,

    I also find your blog very interesting. And I think you are correct with your analysis: There is a housing bubble in Norway. But you are wrong in explaining the bubble if you refer to economists like Shiller or Kahnemann who belong to the field of Behavioral Finance.

    It is true that for instance Shiller predicted the US housing bubble in 2008 (and this one). But these economists are wrong about the causes of these bubbles. The fundamental cause isn't psychological like they claim (Keynes: "animal spirit"). Of course, these bubbles are driven by expectations of higher prices. But the fundamental cause which increases the supply is the expansion of credit by the norwegian central bank.

    I recommend this article on the topic:

    A look into the theories of the austrian school of economics and especially the austrian business cycle theory might also be helpful...

    1. Hi Anonymous,

      I suggest you read two of my early posts (from Sep'12):

      I can't say I'm that erudite when it comes to Austrian school (have just started reading Hayek's Road To Serfdom), but not totally rude either. In addition, "Austrian" thoughts seem to match well with my common sense.

      Actually, in the article you link to, Mark Thornton (see last 6 paragraphs) seems to echo my thoughts from Sep'12? I take it as a good omen that his article has been published on my birthday :-)

      So I agree that too low interest rates are behind all this. But what I find most interesting, and have devoted many of my posts to, is the whole phenomenon: a common belief in housing as ever-safe investment no matter what the current price level, a cult of home-ownership, the extent to which people can fool themselves when trying to justify current prices no matter how high, and the total lack of learning from history, instead pronouncing "This time / Norway is different".

      It just amazes me how hard it is to find even a smart, educated Norwegian who would think that this looks clearly like a bubble. Either I'm delusional, or then this is a very strong sign of a bubble - there are very few standing on the sidelines.

    2. Hei Huple's cat,

      yes, I also think that your analysis matches very well with the austrian school. I read your entire blog and this is my favorite quote:

      "Why would Norges Bank want to throw petrol in these flames by lowering the interest rates and keeping them at record lows?"

      This is exactely what central banks do in my opinion- they cause these bubbles by setting interest rates artificially low (they throw petrol into the flames). You argued (and also Thornton) that the norwegian central bank wants to support the oil and export industry (I agree).

      But I had the feeling that you don't really connect these two phenomena: Money is printed -> Housing prices rise. For instance in this article, you wrote:

      "A financial bubble (in house prices, in stock prices, in tulips - you name it), or what I'd like to call simply too high prices, is always a result of high demand against a supply that doesn't fully meet the demand (supply that fails to keep the prices stable)."

      This is correct. But why is the demand so high? Is it because of psychological reasons (Keynesians)? Or is there no bubble at all, but just a change in real factors, e. g. population growth or technological shift (Chicagoer school of economics/belief by most of the people)? Or because of low interest rates established by the central bank (austrian school of economics)?

      I can also recommend a youtube video if you have the time:

      Schiff makes a lot of jokes but he also talks serious about his own experiences with the behaviour of the people during the housing bubble in the USA and about the causes of this bubble.

      How is the current situation in Norway? A look into the political and public debate would be interesting. Maybe you can also write about your own experiences with housing there and the attitude of the norwegians...

      There is a very famous quote in the book "Biedermann and the firebugs" by Max Frisch which goes like this in english (I added the german original for those who speak it):

      "Joke is the third best cover. The second best: sentimentality. But the best and safest cover is still the bare and naked truth. Nobody believes it."

      „Scherz ist die drittbeste Tarnung. Die zweitbeste: Sentimentalit√§t. Aber die beste und sicherste Tarnung ist immer noch die blanke und nackte Wahrheit. Die glaubt niemand."

      Best wishes,

    3. Thanks, Eric!

      Isn't there always a combination of reasons behind these bubbles? But in the end it usually comes to cheap and easily accessible money. Not just the low interest rate, but also the credit standards banks apply. Loose credit.

      Btw, what do you mean with money printing in this case?

      I'm happy to write more about the public debate in my coming posts, thanks for the suggestion!

      When it comes to Peter Schiff... I don't know him that well, but my feeling when watching these videos is that he's not coming up with something I wouldn't have heard from other, perhaps more balanced, sources. So yes, when you listen to him you nod, and you feel smart (like he obviously does) because this is common sense to you. Pretty much similar feeling you get from watching some idiotic reality-tv, where you can set yourself above "these stupid people". But do you really learn something new from him? And can the people on the other side of the argument (I assume Paul Krugman, for example?) be really as stupid as Schiff thinks / makes them look like? I doubt it, although I don't set much store by Krugman.

  3. To me (and I have a master's degree in economics), it seems that only people without formal education in Economics are seduced by the likes of Peter Schiff, Mark Thornton and other proponents of the Austrian school.

    Please, Hupple's Cat, don't listen to them!

    Peter Schiff is considered a clown by serious economists.The main criticism from these guys seem to be that real economists are not able to accurately predict the future. They don't understand that what economists try to do is to model the world with mathematical models, that is the economic science. Everybody, also economists, can give predictions about this and that without having a model of any kind- no doubt, but it's not going to give much academic relevance. Disregarding well-respected economists like Shiller just because it doesn't adhere to the Austrian school of thought seems arrogant and ignorant.

    Don't let this blog become a Peter Schiff fan blog - it deserves so much better!

    1. Hi,

      From my own experience, I would say you are correct about Schiff beeing considered a clown by "serious economists." However, having graduated with a masters in finance myself, and having worked in the financial sector for several years, I would say Schiff makes more sense than most other economists. The intellectual climate in the western world is heavily biased towards the ideas originating from Keynes. The favouring of cheap money economics is universal in mainstream economics.

      I was once of a similar opinion as you, but have since read up on Austrian Economics, and must say, to me, it is much more common sense and logical than most other economic thoughts.

  4. Thanks for an interesting blog.

    The world economy is intertwined and complex (and therefore interesting!), so trying to untangle the web of causes and effects can soon lead to confusion, but one has to try, I guess;)

    Why are interest rates in Norway kept low? Because they are low the world over, high Norwegian rates would drive the krone up to unsustainable levels, so Norges Bank keeps them low.

    Why is the (western) world in recession/facing low interes rates all over? Here´s where it gets interesting. Many say it´s because the Fed and other central banks keep QE´ing (printing money, buying bonds) like there´s no tomorrow. But is this a cause, or an effect? What would happen if they didn´t do it? We would probably see banks tighten even more, and the reason for QE in the first place is of course to inject liquidity into banks, so that lending and investment gets going again.

    But alas, it barely does. So it seems that something else is going on here. And here´s where I think the economy meets the real world, so to speak. My hypothesis is that a lot of it has to do with energy limits. Energy, and not least the master energy resource: oil, is what keeps the wheels in a modern industrial economy going. When energy gets expensive (check out the record 140$ a barrel just prior to the american housing crash), consumers have to cut down on other expenses, spending and income drops in a variety of economic arenas (the first to go is often discretionary spending, holidays, restaurant visits, culture), and the effects ripple across the economy. If there at the same time exists a latent bubble and/or a high level of private debt in general, this is when the bubble pops.

    To me, the ongoing recession in the western world is a doomed fight against energy constraints. It is impossible to get the glory days back, when we - compared to today - could get our master resource, oil, almost for free (20 dollars a barrel, anyone?). Globalisation and outsourcing of production have helped a bit, but now even that is reaching limits. One can only import so many chinese toys ;)

    Think about it, all we do, eat, buy, is in someway connected to oil. Trucks and ships deliver goods, agriculture is done with machines and petroleum fertilizers, commuting to work, maintaing of the infrastructure, machines that (build machines that build machines that) build houses, factories, the list goes on. With expensive oil, the industrial train has to slow down. In many ways the so called financial bubble of 2007 was caused by expensive energy, it was just that it was postponed by debt and financialization, and thus hidden.

    But if the 2007 crisis had been purely financial, we would be back on track by now, and we´re not. Oil rich Norway has managed to sidestep many of the problems so far, but - with reference to my introduction - one of the effects even here, has been artificially low interest rates, and thus the makings of a prolonged housing bubble. That media is awash with shallow thinkers and sheep mentality that makes consumers believe we´re on a train to heaven, and that debt is unproblematic, doesn´t help the case (puh! Just had to say it ;D).

    What will happen if we are to experience - during the coming few years - a massive drop in norwegian housing prices, with subsequent defaults in household after household? Will some banks be allowed to crash, ie not getting bailouts from the state? Will demand fall and unemployment soar in Norway, like it has done in the EU? Is the Norwegian bubble in a sense our version of a financial camouflage over, and postponement of, an inevitable norwegian crisis, caused by a world crisis, caused by energy constraints?

    Am I pushing things too far here? Any thoughts?

  5. Tarjei, have you been reading Chris Martenson? :)

    I haven't paid too much attention to this thinking around energy constraints ("peak oil"?), and I can't reject it totally, but in my opinion this threat could very well be overblown due to the rapid, credit-driven growth and investment boom around the world - not least in China. I don't think it's economically sustainable, and if it's not, then the energy constraints are less of a problem. At least in the shorter term. And in longer term, we can always try to adapt.

    So, population growth and energy constraints are important longer term issues, but there is a huge timing problem related to them, and so they can mislead us when it comes to economic cycles. Again, this is my current view, but I'm not an expert. I don't know much, but I still try to form an opinion around all of this, instead of relying on any "gurus". I think one should be very careful with any gurus and stories formed around issues that we all know are not straight-forward. And we know they are not straight-forward because so many very wise and intelligent people disagree on them.

  6. Hehe, yes I´ve read Martenson, and I feel he tends to predict imminent disaster with a frequency that is a little too high.;) But he has valid points as well.

    By the way, you strike me as having a sound scepticism towards the multitude of experts and opinions out there, I try to have that myself also. Not always easy!

    In regard to your comments:

    Yes, some aspects of the problems facing the west (I will speak less of China, of which I know so little, my bad;D) are purely financial, for instance the straitjacket of the euro, which to me at least seems like in retrospect a bad idea, seeing as it now prevents the PIIGS-countries from devaluing, locking them in endless cycles of austerity and recession. (And a good argument can be made that it was precicesely the introduction of the euro that led to the debt spiral in PIIGS-countries in the first place)

    And many energy constraint/("peak cheap oil")-spokesmen would precisely agree that debt driven growth in China, and a debt driven fight against debilitating recession in large parts of the west, not least the EU periphery, is unsustainable. And it is unsustainable (they say) simply because cheap energy is like having manpower for free, which make growth and debt repayment easy. Now that we have entered an era of (barring a price fall caused by extreme global recession) permanent 100+ dollars a barrel of oil, that extra manpower is gone, and the credit bubbles will be seen for what they are, a futile fight against an inevitable recession, not least because societies founded on cheap energy (think of the American suburbia, can they tolerate 5, 6, 7 dollars a gallon for gasoline?) need cheap energy to persevere.

    If I should try to sum up in a slogan: The future is now. Deep structural problems in our economies are being swept under the rug at our peril. And maybe, just maybe, an appreciation of the energy problems at the center of this back and forth of bubbles and austerity can make us realize in time the steps we need to take in order to avoid a bleak future. As always, the devil is in the details. And here is one: There is approximately 100 times more energy in a kg of gasoline than in a kg of fully charged car battery. ( An adequate replacement for cheap, energy-dense fossil fuels is, as of today, way, way beyond us.

    We sure live in interesting times.... ! :D

  7. Hei again,

    I will express my opinion about one post that came after my last one because I find it very misleading:

    "To me (and I have a master's degree in economics), it seems that only people without formal education in Economics are seduced by the likes of Peter Schiff, Mark Thornton and other proponents of the Austrian school. Please, Hupple's Cat, don't listen to them!"

    Your master's degree or education doesn't give you any reputation at all. You don't learn anything at university in this day and age if you study economics. You learn how to solve derivations, that's for sure, but that's it.
    There are a lot of economists (also in the mainstream) who are supporters of Hayek or von Mises for instance (look for Cato Institute, Friedrich August von Hayek Gesellschaft or Ludwig von Mises Institue). And even from the view of a mainstream economist, you have to admit that the Austrian School made important contributions to economic theory in general.
    Huple's cat: I think it's best if you listen to all and then pick what seems to be the most valid for you!

    "Peter Schiff is considered a clown by serious economists. The main criticism from these guys seem to be that real economists are not able to accurately predict the future."

    I think there are much better economists than Peter Schiff out there. He's an entrepreneur, not a scientist. But he gets a lot of publicity and that's a really good thing for all of us.

    "They don't understand that what economists try to do is to model the world with mathematical models, that is the economic science."

    Again, not all economists do this. One learns at university only a small part of the whole science of economics. This is mainstream economics what you describe...

    "Everybody, also economists, can give predictions about this and that without having a model of any kind- no doubt, but it's not going to give much academic relevance."

    This is right, you won't get much attention in the mainstream if you don't present a model. But this is not a serious argument. Just because nobody listened to Galilei when he claimed that the earth is not the centre of the universe didn't proved him wrong, right?

    "Disregarding well-respected economists like Shiller just because it doesn't adhere to the Austrian school of thought seems arrogant and ignorant."

    There is not any authority in science. I wouldn't give much credibility to reputations or titles in academia. Because it means nothing, everybody and everything must be questioned.

    "Don't let this blog become a Peter Schiff fan blog - it deserves so much better!"

    Let this blog become a place for people who are looking for truthful answers. What is wrong with Peter Schiff? Remember: It is not about the messenger, but the message!