Wednesday, June 02, 2010

Arguing Supply and Demand

Recently I got into a debate of sorts with some economist about supply and demand of single family homes.

I had argued that the recent jump in inventory for existing single family homes (reported by the realtors) was not only particularly notable in light of the whopping boost in sales driven by the government’s tax gimmick, but could also foreshadow a general up trend as holders of “shadow” inventory (individuals, investors and banks that have been delaying sales due to the distressed market conditions) begin to dump their units on the market.

Further, I suggested that if inventory does in fact trend up from the current levels (8.2 months of existing single family homes) it could put pressure on prices.

To this he suggested that I simply didn’t truly understand the supply and demand.

He went on to explain that since the new home inventory is low and since household formation continues to march on, the demand has to go somewhere.

Describing what amounted (to me at least) to a sort of fixed system, he went on to add that since a home seller generally becomes a home buyer, it’s only the marginal addition of new home inventory that really matters.

Further, he argued, that since new home inventory is now at a historic low, demand will be gobbling up existing inventory post haste thus no downward price pressure would materialize.

My take away from the argument (besides being another reason to avoid arguing with economists) was that this was simply another example of a sort of “perfect world” syndrome that appears to be rampant in economics.

Are our housing markets really as mechanically simple as he describes?

What about sellers (or those that have been foreclosed on) who move in with family? Or how about “accidental landlords” and the epic levels of vacancy? And what of bank owned property? What about those who lose their homes and simply go homeless?

And how about this paper from the Boston Fed chronicling an phenomena called “Homesharing” whereby persons with homes (generally the elderly) share their space with others in return for services and sometimes token rent?

The invisible hand is very angry and it’s complicating things for everyone particularly for economists not facing reality and recognizing that the housing economy at present is not a system of perfect self interested and educated individual rational choices but rather a web of severe even delusional mistakes, misallocations and malinvenstments that will take some time to work through.

In the meantime, increases in overall inventory will put downward pressure on prices.