2099: Insider Perspectives- Alex J. Pollock Unveils the Intricacies of Housing Markets, Predictions, and Central Bank Policies

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Hey Jason. So I thought I would share a hybrid management update.

I just had five back to back closings with five different investors in the same market. Three of them are self managing or.

Hybrid managing and they all have tenants already and the two that are using property managers do not. You are so right on all of.

That and I just wanted to share the progress and how boldly our clients.

Are starting to take management into their own hands.

Welcome to the Creating wealth show with Jason Hartman. You're about to learn a new slant on investing, some exciting techniques and fresh new approaches to the world's most historically proven asset class that will enable you to create create more wealth and freedom than you ever thought possible. Jason is a genuine, self made multimillionaire who's actually been there and done it. He's a successful investor, lender, developer and entrepreneur who's owned properties in 11 states, had hundreds of tenants, and been involved in thousands of real estate transactions. This program will help you follow in Jason's footsteps on the road to your Financial Independence Day. You really can do it. And now here's your host, Jason Hartman with the complete solution for real estate investors.

Welcome to episode 2099. Yes, our next episode will be 2100 and it will be a 10th show and a flashback Friday all in one. So look forward to that in a couple of days. Today we've got a great show for you. We've got Alex J. Pollack on the show. He is an expert in financial cycles affiliated with the Mises Institute and other great institutions. So we'll get to that in a moment. But since it is a new year, I thought we should just take a look at inventory to mark the occasion and see where we are and how we ended the year. So we ended the year very strong, actually. It is amazing, as I always say, how incredibly resilient the real estate asset is with the cost of money literally tripling. And now we see that coming down. We saw housing affordability during the last year reach its lowest point in four decades, but it is improving. We see mortgage rates coming down already and affordability increasing and the Fed's promise to increase affordability even more this year. Now, the interesting thing is, I say increasing affordability, but I need to bite my tongue when I say that. Why? Because of course, if you lower the cost of money, you lower the cost of mortgages in a low inventory housing market. That is a recipe for what well, it's a recipe for price increases and that's probably what we're looking at, probably fairly significant. We'll see what happens with the broader economy. Will we finally go into that recession the Fed has been trying to push us into? Unsuccessfully. This economy just is like the. What is it? The little engine that could. Right? It just keeps on going, keeps on going. It is amazing the power of people wanting to go out and chase their dreams. As I have said for quite a while now, what the gloomers and the doomers don't realize and why they're mostly wrong, 98%, 99% of the time, they're just wrong, wrong, wrong. What they don't realize is that every morning 8 billion people wake up and they think one dominant thought, how can I improve my situation? And by improving their situation, they stimulate the economy and they make the machine work. So inventory, well, we are still about 700,000 homes below normal. Inventory is extremely constricted and we have 700,000 fewer homes than we should have to be at a normal market. We ended the year with 513,000 homes for sale. Just 513,000. And comparing that to prior years, we look at 2019. Here we were at about 850,000, depending on what time of the year we were at almost a million. Back in 2015, we had well over a million homes, about 1.2 million homes for sale. And now we only have 513,000 homes for sale. But looking at a couple of charts from just maybe about a month ago or so, these are pretty telling and I think they're very interesting. This is the weekly inventory changes. So we've, of course we have 52 weeks in a year. And as we kind of looked at that from, you know, the last, maybe the last quarter of last year, we see that inventory was down 10.3% on a year over year basis. But get this down, a staggering, a whopping in unbelievable 49.3% from the pre pandemic era in 2019. So inventory last year, when inventory was actually slightly higher than it is now, was still off by 50% from 2019 and by a lot more than that from 2018, 2017 and of course 2015. So inventory tightly constricted in a market where we are lowering the cost of mortgages. What do you think's going to happen? This is simple supply and demand, the most fundamental law of economics, folks. That's all it is. It's, you know, this is not rocket science. It's just supply and demand. Okay, so join us for Our upcoming Cruise. Go to empoweredinvestorlive.com get your tickets for our upcoming cruise. We're really looking forward to that. And we are going to have last call on that pretty soon because we've got to make some big deposits to Celebrity Cruises for those rooms. So last call is coming up. I don't know the exact date because I got to check with our travel agent, our cruise planner on that. But as soon as I talk with her about it, I will know that last call date. But it is right around the corner. So if you want to be included on this, you want to go on a vacation that is a learning vacation, a networking vacation and I'm not a tax advisor, but I think it's a tax deductible vacation too, at least part of it. So check with the appropriate professional for that. A five day cruise on the beautiful brand new Celebrity Apex. This is in a gorgeous Edge class ship. When I was in Europe last year, I went on the Celebrity Edge and wow, absolutely my favorite cruise ship ever. I've been on about 20 cruises. I've been on really high end cruises like Crystal Cruises and this is better. Okay. So sometimes, you know, paying more money does not necessarily get you more. I liked this one a lot better. Really going to be awesome. So join us for that now, a couple other charts before we get to our guest today. And this is from just maybe, I don't know, a couple about two months ago, but it's really telling. And I showed you this one before, but again here when we had 535,000 homes for sale. Again now we only have 513,000. And you know, the question is always compared to what? Right. And that's compared to what is it compared to? Well, let's compare it not just to prior years, but let's compare it to the overall housing stock. That's about 140 million units in the United States. 140 million. And right now only just a minuscule 513,000 of those homes is for sale because people are locked in. They don't want to sell their homes because they've got such a good deal and they've got 28 years left on that incredibly good deal. So they're unlikely to part with those. Now some of those will peel off because as the Delta gets smaller, that Delta shrinks between existing mortgage rates and the incredible deal they got of the super low rates during the COVID era. Right. As that Delta shrinks and that gap narrows, some of those people will trade. But remember how that'll increase inventory, but we have demand that will obviously increase as well. And I, like I said before, maybe last week, I think I said this, I've got some incredible data on shadow demand coming up. So look for, for that on a future episode. You're going to love this. It really just shows you how the demographics coming at the housing market are just undeniable that this is and will continue to be the most historically proven asset class in world history. And remember, it's multidimensional, so it's not just dependent on prices going up or down. That's such myopic thinking. But I talk about it a lot because that's what everybody talks about. I don't want to talk about that, honestly. I'd rather talk about all the multidimensional ways you earn return on your real estate investment. There are so many ways you get returns on this beautiful, wonderful asset class. And at this time, when I published this chart, inventory was moving a little bit higher. But as you can see, we finished the year with inventory much lower than this at only 513,000 homes. So here was one where we were 508,000 homes and again, just slightly higher than that ending the year. So, I mean, you just can't deny the data, folks. Regardless of what all of the Chicken Littles are saying, the sky is just not likely to fall, barring some black swan event. I mean, you know, war, famine, another crazy kind of economic collapse that comes out of a pandemic, whatever it might be. But you know, the simple supply and demand numbers, the hard data shows a really, really strong case for income property continuing to be the most historically proven asset class in the entire world and of course, the most tax favored asset class in the United States. All right, without further ado, let's get to our guest, Alex J. Pollack. Let's get to him. But remember, go to Empowered Investor Live and get your cruise tickets right away so you can join us. Two days of education on the high seas and three days of pure vacation time on a beautiful, wonderful cruise together. So looking forward to seeing you there. And here is our guest.

It is my pleasure to welcome Alex J. Pollak to the show. He is a senior fellow with the Mises Institute. We've had lots of Mises people on over the years and they're always really interesting. He's also the author of several books including Finance and why We're Always Surprised and his later book called Surprised Again. So we're going to look at the financial markets and why we can't really predict Them and why they surprise us. Alex, welcome. It's good to have you.

Thank you. It's good to be with you.

Where are you located?

I am now in my home office in Lake Forest, Illinois, north of Chicago.

Fantastic. So, Alex, let's talk about the books first. I know you do a lot of work on the housing market and the Fed and Fed policy and political economy and so forth with the books. You say that financial markets are not like reality and they're not like math. What do you mean by that?

I start off the book Finance and Philosophy, and I. I should say that in my youth I was a student of philosophy and actually taught it briefly. And the further I've gone along in finance, the more philosophical finance seems to me. So the book starts off by contemplating why financial forecasts are so often wrong. Why the most prominent, best informed people get it exactly wrong, including Chairman of the Federal Reserve and Secretaries of the treasury and various finance ministers around the world. And we contrast physical reality, let's say astronomy, with finance and economics. And in astronomy you can make completely accurate predictions thousands of years in advance, let's say of eclipses or the path of planets thousands of years in advance. But in finance and economics, you can't make reliable predictions even three months in advance or may or one month or two days for that matter, depending on the circumstances. And we all know that that's right, especially with respect to central banks. We know their forecasts, as they're supposedly managing the economy, are just as bad as everybody else's. It's really notable how bad they are, just like everybody else. And the book starts off with the philosophical question, why is that? Why, in spite of all the effort, and is it that we can't get the forecasts of the financial and economic future to be reliable and no one is consistently good at it. There is a. Is a good story which is a favorite of mine, which is what's the difference between economics and engineering? And the answer is, in economics, if somebody gets the right answer once, it makes his career in engineering, if he gets the wrong answer once, it ends his career.

Yeah, okay.

And that, that in turn, in my view, indicates a fundamental difference in the, the type of reality we're dealing with. The, the economics and finance are not determinative, mathematically deductive, physical like or mechanical systems. Actually, the silliest thing that people say is when they talk about the mechanisms, you know, the mechanisms of monetary policy. These things aren't anything like machines and they're not anything like mechanisms. Well, what are they like the Book asks how would we characterize them? What they're like is interactions of human ideas, intents and strategies where the ideas become reality and the reality changes the ideas and the ideas change the reality. They're interactive or recursive and therefore we say not only unknown when it comes to the future. Not only unknown but unknowable for somebody like me especially. Fascinating.

So you do a lot of work on the housing market and I want to take some of these ideas that you've just mentioned and let's apply them to some of your work on the housing market and see if we can learn. God forbid. I don't want to say forecast or predict maybe after what you just said, but what can we learn from this and maybe where are we now with the housing market and where do you think it's going for whatever it's worth?

Yeah. Well, as far as predicting goes, an old boss of mine used to say predicting is hard. To which I replied no, predicting is really easy. We can all predict all the time. It's only predicting correctly. That's hard.

Right.

And that's lucky for all the people in the business of predicting because keeps them talking and writing and even being paid for doing so I think, well, we can apply it in the sense that they're in housing or in anything which is, is has wide social and political importance as well as economic and financial importance. There is of course always a tendency to want to create some kind of central direction what's going on, like maybe set up some government sponsored enterprises to dominate the financing, say Fannie Mae and Freddie Mac. And we should be trying to get ourselves away from that view of centralized control and make housing as much market like as possible.

Sure.

Consider that of all of the residential mortgage risk in the United States which let's, let's call it $11 trillion, 11 or 12, the vast majority of it, 9 trillion or so is guaranteed. The credit risk is guaranteed by the government in the form of either Fannie Mae, Freddie Mac or the combination of the Federal Housing Administration and Ginnie Mae.

Right, right.

Just think about that. Say let's call it 3/4. 3/4 of all of the credit risk is guaranteed by the government. Why should that be? That's ridiculous.

Right, of course. And look, you're not going to get any disagreement on free markets from our audience too much. Except for those who are very confused about how things. But look, we have some, you know.

You may have some loyal listeners who loyally sell their loans to Fannie and Freddie.

Sure. Well, you know, there's it's one thing to practice what makes sense for you as an individual actor and another thing to philosophically disagree with it at the same time, which is completely possible. And, and that's, that's where I stand. But, but look, we have what we have, so let's not worry too much about what we have and that kind of stuff.

Yeah, let's, let's talk about the housing crisis. Actually, I'm just writing, read something on this right now. So it's, it's on my mind. I have been involved for a long time, I guess 30 years in the International Union for Housing Finance, which is an international trade association in housing finance. I mentioned this because America is such a huge market that it's very easy for American actors in residential real estate or American actors in anything to become really provincial and not pay a lot of attention to what the rest of the world is thinking and doing. And that's certainly true in housing finance. And I have found my association there very valuable for the, the fact there are lots, lots of other smart people in the world equally unable to correctly forecast, but nonetheless smart with insights. And I have enjoyed that interaction with them a lot. The International Union for Housing Finance puts out a journal, a quarterly journal of international housing finance, which I write a column in. Well, I'm just writing my current one right now, thinking about the interaction of central bank and housing finance, which is extremely important and for better or for worse. Very often for worse. So we had, in the 21st century, I'm just thinking about this, the first great housing bubble of the 21st century. And now we've had the second great housing bubble of the 21st Century, promoted and financed and stoked by the central bank, by the Fed, both by abnormally suppressing interest rates in the short, short term rates and long term rates by its buying of long term fixed rate assets, both government bonds and mortgages. So the Federal Reserve, as I like to say, made itself into the all time biggest savings and loan in history by buying more than two and a half trillion dollars in mortgage assets and financing them short, thereby feeding this astonishing bubble. When you look at the graph and you think that the peak of the second great housing bubble of this century is 67% over the peak of the first housing bubble.

Yeah. So now tell me Alex, define bubble. What does bubble mean?

Bubble is an expansion in price and in credit which is self feeding and puts prices and credit exposures to unsustainable levels which, which must. Correct.

Okay, so let's talk about that for a moment.

I've got a little joke on that because you're, you're up on an important point. You remember the, I guess it was Potter Stewart who said he couldn't define pornography.

The Supreme Court justice, but he knew.

It when he saw it.

Saw it. Yeah. That's a, that's a, that's a fantastic quote.

When it comes to bubbles, we may be able to define them, but maybe we can't recognize them when we see them.

Right.

But Alex, we talk ourselves into the fact that everything's okay.

Here's the thing, though, when someone uses the word bubble, I think it implies that it's going to pop. And what we, I think, have to consider is that we've got about 140 million housing units in the country and only about 5 million of those have transacted since the massive rate hikes. So 135 million people or units, housing units have mortgages at historically low rates with 28 years left. And of those 135 million, 42% of them have no mortgage at all. They're free and clear.

Yeah.

So how do you get something to pop when it's not about the 5 million people that transacted since the rate hikes in, you know, just over a year? It's about the 135 million who are extremely comfortable.

That's, I think you're onto a really important point and it could be rephrased in any market as the market prices are perhaps more made by the holders who aren't doing any buying or selling. We always think about the buyers and the sellers on the market.

Right.

But it's the holders who aren't doing anything and who, if they ever did start to do something, they, the market would, would move very dramatically. So at the big, big moves, the holders to, let's say, to want to sell. And we all know if very many people at once want to sell, that's the end of that price level.

I agree with you. The problem is these holders have a giant incentive to keep holding for 28 years. And that makes me worry that this inventory shortage that we have may be quite long and severe. And people are calculating the housing inventory shortage at anywhere between two and a half million to five and a half million. That's where most seem to sit. You, you may have a different opinion on that. Feel free to tell us in a moment. But what they're not talking about or calculating into that inventory shortage is the obsolescence factor of all of these older decaying homes that have, you know, numerous problems, including mold issues. Regardless of where you stand on the climate thing, certainly flood zones are a problem and these older homes are especially susceptible to floods. So this seems to be quite a big shortage. And if the holders don't sell, which they don't seem like they're going to have any reason to anytime soon, will the shortage just continue and could be.

I mean we have this really fascinating situation, don't we, where the mortgage rates more than doubled. They went from abnormally low, created low by the Federal Reserve's making itself into the biggest savings and loan in history. As I said, artificially low, sir, to up to 7% or so. Well, that's to normal. So everyone ran around saying, look how high rates are. Rates just were normal. 5% short rates, 6, 7% mortgage rates, that's normal. But it seemed like a big change. And then we said, well surely that will take house prices down. And house prices on a national basis fell for about six months, modestly, and then they've started rising again modestly, sort of on average at about the rate of consumer price inflation, 3 or 4% at least. If you, if you believe numbers like the Case Shiller Index, their house prices are now back at an all time high after their little correctional. Why wasn't your answer, you're, you're giving a reasonable answer to the question why wasn't that correction bigger? So what happened, I think was one of the surprises, at least to me was there was a huge impact on volume of transactions and on volume of mortgages. And we got the whole mortgage banking, the independent mortgage banking industry in a steep recession, if not a recession with no volume to speak of and of course no refi business to speak of, which a lot of them depend on. But they're in a recession. The, the, the sales volumes have dropped dramatically and offhand you would have said well that will make prices come down, but it hasn't. So we get this sort of bifurcated, interesting situation where the prices of those who are transacting, which are the prices we observe, as you rightly say, are hanging up there. But the volumes have dropped. Now of course, Newhouse prices are falling, which is important to note, and the builders are having to throw in all kinds of incentives and stuff to move their inventory as they complete it.

Let's talk about this new.

It's the split between kind of a, as I say, a bifurcated reaction to the, to the return of mortgage rates to normal. Excuse me.

Let's talk about the new home market for a moment. What's interesting is, you know, when you really peel the layers of that onion back on the new homes. Is that really true that new home prices are dropping or are the builders just addressing the affordability problem by building cheaper houses?

Yeah, well that's happening too. You're right.

Yeah.

And when we look at medians or averages, of course you always get these mix problems and that's completely rational. I guess the builders are doing that and it's a completely rational, rational thing to do. If you look back in time, let's say in the 1930s, the high hope of, let's say the Federal Housing Administration was to put people into houses and the kind of houses that were the dream houses. Yeah, well they were eight or nine hundred square foot bungalows and people were thrilled to have them.

And now they're 23.

The size of the, of the house issue in there. In there as well as you say on the. At least when we're looking at the median numbers.

Right, absolutely. So you know, in 1970, the typical house was about 1500 square feet. Now it's over 2200 square feet. And so I think what we're seeing is the builders trying to address the fact that for well over a decade entry level housing just hasn't been built in this country in any numbers to even speak of it. So.

Well, what would be entry level housing if interest rates were normal?

So the reason, I think an indicator of the fact that new home prices aren't really dropping is that when you look at a stock of an entry level builder like Dr. Horton, you see their stock is at an all time high. Okay. And it is $127 today. Now when the rate hikes happened, they thought the housing market would cool a lot and the stock was down at like, you know, in the 60s was the, was the lowest. So that has bumped way back up in just a year. And if you look at the gross margin for builders when they sell a home, their margins are holding up. And I'm not talking about high end home builders like Toll Brothers. I don't look at them because that's not our market for investment properties. We look at Dr. Horton, KB Homes, you know, maybe Lennar a little bit. Those are the market of the entry level, you know, new home, which is dramatically nicer than the entry level home was, you know, even a decade ago and certainly better than it was 50 years ago. So those are hold up quite well. So your comment was it wouldn't be entry level if interest rates were normal or what did you just say? That was an interesting.

Well what is what is entry level of interest rates are.3% is not entry level. If interest rates are 7% on mortgages. And entry level might be something which we would think of as a more modest house, which in a long term perspective looks like a very luxurious house. As I say, relative to the, to the bungalows built say post World War II that still are a lot of them around.

No question about it. You're absolutely right. You know, I'm going with maybe looking at the way Freddie Mac defines it of, you know, entry level is 75% of the median price and higher end is like what, 150% of the median price or something like that. You know, it depends on the given market. And it's all by comparison, of course. So it's, it's, it is hard to define a little bit.

But let's come back. Can we come back to this really interesting issue of the people who've got the 3% mortgages and don't want to give them up?

Right.

They have a great asset which is a liability, which is on which they have a huge gain. They're short a mortgage whose price is maybe 80 or 85 instead of 100. Now the problem is there isn't any way they can realize that gain except by holding on and keeping on and paying the low rate. I suppose if we still had assumable mortgages, you could in effect get the economic value of your old mortgage by passing it along. But the last time interest rates when they went really high in the 80s, if you remember this history, the mortgage lending business then put in due on sale clauses. Ultimately, in 1982, the Congress passed a law to assure that these things were enforceable legally so that the lenders could get at the lenders who of course have enormous losses on these mortgages, could get out of them as they want to. But we do have this funny situation. You, you've got this really valuable financial thing which is your mortgage, which is your liability as the borrower. And there really isn't any way under current American circumstances that you can realize the gain that you've got. When you're short something, it's down 15 or 20 points. So are there ways? Well, assumability historically was one way. They have in the English and Canadian markets portability of mortgages, which is you can take your same mortgage to a new house and keep it, keep it with you. Things like that would, would loosen up, I would think this sort of frozen part of the market, which seems to me, everybody says this, which ought to make you doubt it. But it seems to me it's right that you've got this great mortgage and you want to sit on it. Your house is fine. Why keep it? And so you get this, as I say, this bifurcated situation where the volumes are way down but the prices keep holding up. And part of it seems to be the problem of how inadequate ways to realize the value from the borrower's point of view of this great mortgage you have. The only way you can realize it is by sitting in the house you've got.

Right.

Or I guess you could rent that house, reowning that house.

Yeah. You know, to your point, the only way you really realize the benefit of that mortgage is by just owning that house. And you realize the benefit on a monthly basis because your debt to income ratio is so favorable. And you realize the benefit by having a lot of extra spending money compared to new entrants in the market that won't have that luxury. Alex, this has been a great conversation. Give out your website. Of course the books are available in all the usual places. But I think you have a website you want to mention as well.

Well, it's alexjpolak.com which has all my work of the last six or seven years. You could also buy the books through that website if you wanted to. Thank you.

Excellent. Alex, thank you so much for joining us.

Great to be with you. I really enjoyed it.

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