Creative Destruction in the Housing Market

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At a conference in Vancouver, Canada, last summer, a moderator asked apocalyptic analyst Doug Casey what the solution to our economic mess was. "Explosives," he replied. It echoed a theme put forth by former Treasury Secretary Andrew Mellon during the Great Depression. "Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate. ... It will purge the rottenness out of the system," Mellon famously said in 1931.

Casey wasn't alone. In 2008, then-Treasury Secretary Hank Paulson phoned former Federal Reserve Chairman Alan Greenspan, seeking his input on ways to stabilize the economy. Greenspan "suggested that there was too much housing supply and that the only real way to really fix the problem would be for the government to buy up vacant homes and burn them," according to the book Too Big to Fail.

Warren Buffett offered a similar approach in his 2009 letter to shareholders. There are only three ways to fix the housing crisis, Buffett wrote. The first, and most effective: "Blow up a lot of houses." Last year, Detroit Mayor Dave Bing took him up on it, proposing plans to bulldoze 10,000 vacant homes and empty buildings over three years.

What are these people thinking? Nothing crazy, actually. They've grasped the heart of what's crushing the housing market: There are simply too many homes.

Some numbers to chew on: From 2001 to 2006, 11.0 million homes were built in the United States. During that period, a net 7.8 million new households were formed. That 3.2 million-home gap represents the overbuilding that pushed housing into bubble territory. During the boom years, those extra homes were easily absorbed into the market because so many speculative buyers were purchasing two homes, five homes, 10 homes, just to flip them for profit. Now that that casino mentality has been deflated, demand for housing has returned to its roots -- buying just to have a place to live. That means those 3.2 million homes built in excess of people's living needs are now sitting idle. The nationwide home vacancy rate is currently 2.5%, up from about 1.5% before the bubble.

Which raises the question: What do you do with these vacant homes? Some have been following the advice of Casey, Greenspan, Buffett, and Bing. They're blowing them up.

Bank of America (NYSE: BAC) just announced plans to demolish 100 Cleveland homes, with similar plans already under way in Chicago and Detroit. Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM) have donated thousands of homes to local governments and nonprofits, many of which will likely be razed.

The incentive for banks to destroy homes is straightforward: Banks owe property taxes on homes repossessed during foreclosure, and some homes are so derelict that repairing them to a sellable condition is often costlier and a bigger hassle than just blowing the damn things up.

The trend will never get big. Even if tens of thousands of homes are destroyed, the effect would be trivial. But the fact that banks are merely considering demolishing homes underlines that the single most important factor holding the housing market back is excess inventory.

The good news is that inventory is being cleared out naturally, and quickly. New home construction has slowed to a pace not seen in recorded history, now at just one-third of 1959 levels, when recordkeeping began. Far more households are being formed today than new homes are being built. That has the same effect as blowing up homes -- in either case, excess inventory is being cleared out. Extrapolating from current levels, it's not hard to make the argument that we could actually face a housing shortage in another few years.

How crazy does that sound? About as crazy as someone telling you four years ago that banks would be destroying homes today. And yet, that's where we are.

Fool contributor Morgan Housel owns B of A preferred. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Bank of America and JPMorgan Chase. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (12) | Recommend This Article (16)

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  • Report this Comment On October 06, 2011, at 4:12 PM, feldie47 wrote:

    How perverse is that? Blowing up homes when New York city alone has 40,000 people a night in shelters. Makes you wonder if these demonstrators on wall street right now are on to something.

  • Report this Comment On October 06, 2011, at 5:32 PM, TMFDarwood11 wrote:

    In certain blighted Chicago neighborhoods, the politicians (an alderwoman got on the night news bandwagon last week, and local teachers also marched) are railing against the empty homes.

    These are really nice "brownstones" and it's a shame they are now "crackshacks."

    So does anyone have a better solution? Sell them for $1 to shelters? or to drug dealers and pimps?

    You see the problem?

  • Report this Comment On October 06, 2011, at 6:12 PM, rfaramir wrote:

    Mellon was right in 1931, but FDR did not follow his advice, so the Great Depression went on and on. Harding and Coolidge did follow similar advice in 1920-21, so we never hear of the Great Depression of 1920-21. It was over before people could name it.

    The destruction was caused by malinvestments during the boom, the bust is the painful return of health. It's not pleasant, but it's necessary. The alternative is pouring our money perpetually into zombie corporations that really just need to be liquidated, and zombie homes, as you note.

    End the Fed to end the cycle of boom and bust.

  • Report this Comment On October 06, 2011, at 6:17 PM, xetn wrote:

    Sounds sort of like "cash for clunkers" where you destroy the trade-ins or the "Broken Window Fallacy" from Fredric Bastiat.

    But the point is that these are owned by the folks that wish to destroy them. (I wonder if they will try to collect on the insurance) :)

    I am just curious how they will treat the destruction on their financial statements. Perhaps a rapid write-off now would be cheaper in the long run than the maintenance and deterioration of the properties.

  • Report this Comment On October 06, 2011, at 6:50 PM, rfaramir wrote:

    It's like how a loan represents a real house. Sometimes a bank has to "write off" a loan that won't ever be paid.

    But in this case, the mortgage was foreclosed on and the bank got the house back that the loan represented. "Writing off" the loan in this case literally means bulldozing the home, since they possess the loan no longer but the real house it represented. Sad.

  • Report this Comment On October 06, 2011, at 10:36 PM, MikeLitoris wrote:

    "They've grasped the heart of what's crushing the housing market: There are simply too many homes"

    They've grasped nothing but STRAWS because the underlying truth is that there are simply too many OVERPRICED homes. With the operative word in the previous sentence being OVERPRICED.

    This is NOT a problem of oversupply, it is a problem of ARTIFICIALLY high RE prices induced by the availability of overly abundant easy credit, artificially-low interest rates and a simultaneous nose-dive drop in lending standards.

    Not to mention some mortgage-derivatives-based MASSIVE FINANCIAL FRAUD as well.

    I find it INCREDIBLE that some can argue for DESTROYING perfectly habitable dwellings INSTEAD of expressing a willingness to SELL THEM at CURRENT FAIR MARKET VALUE, whatever that price may ultimately be. In fact I'd say that merely suggesting the idea of destroying an asset to prop-up the value of the remainder is IMBECILIC.

  • Report this Comment On October 06, 2011, at 10:38 PM, cmfhousel wrote:

    ^ Your caps lock is on.

  • Report this Comment On October 07, 2011, at 12:10 AM, sliderw wrote:

    Force the banks to sell their houses to the highest bidders. Only if no one buys them shall the banks be allowed to blow them up.

  • Report this Comment On October 07, 2011, at 12:12 AM, WoodyMF wrote:

    While I agree with the last comment from a social standpoint, as a homeowner, I cannot accept the valuation of my property being undermined by the greed of unscrupulous bankers that drove the market values so high in the first place. If in fact the homes are written down to actual values, the impact on the value of every legitimate homeowner, that pays full mortgage monthly without fail, would be astronomical. That is exactly what the banks want- for us to agree to the lunacy of oversupplied housing be rewritten to "real market" values. Would you accept your current mortgage payments for a house worth half as much because there are so many empty homes available? I've already paid my mortgage meltdown dues with my portfolio- don't want to lose more on my house to boot.

  • Report this Comment On October 07, 2011, at 2:48 AM, cfravel wrote:

    On October 06, 2011, at 10:38 PM, TMFHousel wrote:

    ^ Your caps lock is on.

    Snark, again. He has a valid point, whereas you do not.

    His point:

    Housing is overpriced and devaluation could fix the problem just as well as destruction. True: it could work, but investors would rather waste tens of thousands of hours of human labor and hundreds of buildings than face devaluation.

    Your point:

    Your caps lock key is stuck, making you look like an Internet newb with no credibility, so no one should pay attention to you. False: caps were clearly used for emphasis, as it was only applied to some words.

    Please respond to ideas instead of employing ad hominems for misdirection.

  • Report this Comment On October 07, 2011, at 8:13 AM, dag154 wrote:

    Blowing up homes is not enough. If you also killed all the poor people, the unemployed and the chronically ill, then the country would only be made up of rich people who pay taxes.

    Just like the idea above, it is a little unpalatable but boy does it make economical sense!

  • Report this Comment On October 14, 2011, at 5:10 PM, thidmark wrote:

    ^^^ Sadly, we are already heading in that direction.

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