What goes up

One of my blog readers wrote me this morning:

Just read your articles on luxury goods and Steve Jobs.

What prompted you to write the luxury goods article? How about the FNM and FRE take over by the Feds this morning?

OK, I’ll bite.

Today Feds finally revealed how they plan to clean up the Fannie Mae and Freddie Mac mess. As government bailouts, free market interventions and rewarding losers go, it’s relatively encouraging. The managers are getting fired and the shareholders who enabled their failures are also getting wiped out. If the Feds can turn the firms around, perhaps it will enjoy the lion’s share of the financial rewards.

Perhaps next time there’s a government guarantee, the employees won’t assume they have a lifetime right to feed at the trough — or shareholders will ask for an honest accounting and accountability out of the top management.

However, there was one line in this morning’s NYT preview story that demonstrated remarkable economic ignorance, even by newspaper standards:

But the plan to bail out the firms will probably do little to stop home prices from falling further. And foreclosures are almost certain to rise.

The problem is, any financial investment has risks. They go up and they go down. If housing prices overshot due to cheap money and recent speculation — or pressure from Congress to make more loans to risky borrowers — then prices still have a ways to fall before the market corrects itself. As someone who’s long in California real estate, this is not a result I seek, but it’s a realistic outcome given the circumstances. And if housing prices have risen too much, then a market correction will make houses more affordable for first-time buyers.

Two types of people buy volatile assets: long term investors and speculators. If there are temporary drops in housing prices, it doesn’t matter to long term investors, because over time — in most parts of the country — housing is a reasonable, tax-advantaged investment.

Some people buy a house hoping for a quick kill — expecting rapid short term appreciation to bail them out of a purchase they can’t afford. Or they take risks they can’t afford to take. So if next time, perhaps people who can’t afford risky real estate investments — or brokers or lenders who should know better — will make decisions more consistent with such risk.