Fixing Wall Street: "So, What Do You Do NOW?"

Looking for the New Volcker's

Regular readers of this blog know that I could hardly be a harsher critic of modern-day Wall Street: its practices; its obscene pay for little or no economic contribution ("Wall Street is Worthless"); and its corrupting influence on our government and society generally.

And I've got plenty of company.

As the fog lifts on the cause(s) of The Crash of '08, more and more people -- dare I say a consensus -- now share that viewpoint.

But as the "Wall Street-as-culprit" narrative gains traction, it logically begs the (entirely fair) question: "So, what do you do now?"

Next Steps

My answer is to go back to the airplane metaphor in "Wall Street's Uncontained Failure."

When trying to save a hijacked plane, however badly disabled, the first order of business is always to . . . replace the pilots.

Only once that's done, do you turn your attention to the altimeter, air speed, flap settings, etc.

And only once the plane has been stabilized do you turn your attention to longer term tasks like redesigning the defective engine(s) that just exploded.

Volcker 2.0

So, my starting point would be to look for the next Paul Volcker -- ideally, lots of them.

That is, people who are very bright (but by no means brilliant), honest, public-spirited, etc.

Plus two more things: 1) they're not tied to Wall Street ("Bye, bye, Tim Geithner, et al"); and 2) they're financially sophisticated -- but not too.

Fidelity Magellan guru Peter Lynch famously advised investors to put their money in businesses that "any idiot can run -- because sooner or later, any idiot is probably going to run them."

The next generation of Paul Volcker's will intuitively understand the government equivalent, and oversee financial reforms simple enough that they can be implemented and enforced without Wall Street "expertise."

And exactly who will find and appoint these new, enlightened financial stewards?

Try, elected officials whose campaign money didn't come from Wall Street.

P.S.: One more example of how some problems don't yield to direct solutions, especially when they're symptoms of a bigger problem: my notoriously unreliable garage overhead light -- a real headache when it gets dark before 5 p.m., as it does in Minnesota this time of year.

Over the last few years, I have experimented with every type of bulb there is, including "industrial" bulbs that have more durable filaments.

Result? A little extra use, perhaps, but no long term solution.

Then, this Fall, my garage door opener finally breathed its last, and needed replacing.

The new one is whisper-quiet and vibration-free -- and doesn't eat light bulbs.

SuperFreakonomics on Realtors

Still Casting Stones . . . But Now With (Lots of) Caveats

An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.

—Laurence J. Peter

[Editor's note: to see my rebuttal to Freakonomics, the predecessor to SuperFreakonomics, click here]

So, I finally finished off the (surprisingly short) section on Realtors in SuperFreakonomics.

Two things jumped out at me: 1) the authors, both economists, clearly have bored with attacking Realtors, and have moved on to other, fatter targets; and 2) they still think people who hire Realtors (as opposed to selling their homes themselves) are idiots, but this time they offer a lot of caveats.

Five, to be specific.

Here they are (my commentary follows in italics):

One. Even though Realtors don't do anything you couldn't do -- this seems to be the authors' mantra, by the way -- you still may want to hire one, anyway, if you don't have the time.

I spend anywhere from 40 to 100(!) hours per listing professionally staging my clients' homes, advising on disclosures, putting together professional marketing materials, doing pre-list networking -- and literally 37 other things.

And that's before their homes ever come on the market!

The professionals (and non-professionals) I work for would literally have to take a leave of absence from their day jobs to do what I do. Assuming they knew how.

Which leads to Caveat #2 . . .

Two. "Realtors don't do anything you couldn't do for yourself."

Oh, really? I've been selling real estate for almost 9 years. Before that, I was a corporate attorney and CPA, and have a Stanford economics degree. I have been successfully buying and selling stocks since I was 12 years old, and have started 3 companies.

I say none of that to brag (OK, a little), but to make the point that I'm not a dummy.

And yet every deal I do -- and I've now done about 70 -- I invariably learn something new.

It can be a contractual fine point; a negotiating insight; some arcane feature of a home that comes up on inspection; or even something as simple as "upgrading" to an especially talented, new photographer I heard about through the grapevine (in real estate like other fields, "who you know" can matter as much as "what you know").

The bigger point?

Suggesting that a novice could handle all the phases of a real estate transaction as expertly as a seasoned Realtor can is: a) uninformed; and b) insulting.

How much better?

It depends on the deal, the market, and who the ultimate Buyer is (assuming that I'm the selling, or listing agent).

But industry statistics (and common sense) suggest that the swing between having superior counsel and none at all (or poor counsel) easily exceeds 10%.

Which makes my commission -- substantially less than that -- a bargain.

Three. Madison, Wisconsin -- the market the authors cite as evidence that FSBO ("For Sale by Owner") Sellers do as well as Realtor-assisted ones -- may not be representative (call it the "your mileage may vary" caveat).

Yuh think!?!

Madison is a highly educated, college town with a metro population just over 200,000. It is about as representative of broader America as Manhattan is -- or Hollywood.

Notwithstanding Madison's experience with FSBO's, no other metro area has followed suit.

And even in Madison, FSBO's only account for 26% of home sales. That means almost three-quarters(!) of all homeowners there still list with traditional brokers.

In my experience, if something truly is a "better mousetrap," sooner or later people tend to discover it . . . and switch (assuming they have a choice, i.e., there's no monopoly provider).

Instead, FSBO's are now declining as a percentage of the market place nationally (about 12%).

Four. Self-selection. Or, as the authors put it, "the kind of people who choose to sell their own houses without a Realtor may have a better business head to start with."

At least in my experience, that statement is categorically wrong -- which, ironically, actually supports the authors' argument that FSBO's can do better, net of commission, selling themselves.

From what I've observed, what invariably characterizes FSBO Sellers isn't a "better head for business" -- it's a simple (if uninformed) desire to net more on the sale of their home, coupled with having some "extra time" on their hands (in economic-speak, their perceived "opportunity cost" is low).

Unfortunately, the vast majority of FSBO's don't have a clue as to how to go about doing it.

So, something like 9 out of 10 FSBO's egregiously overprice, while the 10th literally gives their home away (then brags that they "sold without a Realtor").

Which gets to caveat #5 . . .

Five. The authors' data and conclusions may be flawed.

To recap, the authors allege that Realtors selling their own homes (vs. clients') are more patient waiting for a deal, and (therefore) sell for more. They base that conclusion on a study of 100,000 homes sales in suburban Chicago -- 3,000 of which were sold by owner-agents.

Charge #2 is that FSBO Sellers fetch the same price that Realtor-listed homes do -- they just take a little longer (20 days on average) to sell. That's based on the aforementioned study of FSBO Sellers in Madison.

I couldn't find the Chicago study the authors refer to (anyone who knows, please feel free to point me in the right direction).

However, the study of FSBO Sellers in Madison was conducted between 1998 and 2004 -- a Seller's market there (and most of the rest of the country, too).

I doubt that FSBO sellers in Madison today would fare nearly as well.

Meanwhile, the authors' contention that more market time equals higher price contradicts what I've observed over thousands of deals covering the better part of a decade -- namely, the longer a given home is on the market, the lower the selling price. Period.

And that relationship holds whether the Seller is an owner-agent, a FSBO . . . or the man from Mars.

But the most significant weakness in the authors' argument is their assumption that it's possible to isolate differences between Realtor and non-Realtor sold homes by "carefully controlling along several dimensions -- price; house and neighborhood characteristics; time on market; and so on."

Unfortunately, that's notoriously difficult to do in practice.

Precisely to avoid such an "apples-to-oranges" problem, the housing market's leading price index, Case-Shiller, opts in favor of tracking "sale pairs" -- the same home across multiple transactions.

Echoes of Peter Lynch

The arguments in Freakonomics and now SuperFreakonomics ultimately recall Peter Lynch's best-selling book, "One Up on Wall Street," in which Lynch disingenuously tells retail investors -- "Mom & Pop" types -- that they can outsmart the pro's.

How?

By following their spouses and kids to the mall, being the first to notice the hot new, retail trends, then buying the companies positioned to profit.

Unfortunately, for every Apple Computer discovered that way, there are 10 -- or 100 -- "Krispy Kremes" (busts, flame outs, and one-hit wonders).

What Lynch omits is that, in his hey day, he traveled 300-plus days a year, personally talking to senior managers at thousands of companies; checking out their facilities; quizzing their employees and competitors; and relying on a battery of Fidelity analysts to analyze thousands of companies' financial statements.

Level playing field, indeed.

"If You Don't Know Who the Patsy Is . . " *

The authors of Freakonomics (and now SuperFreakonomics) perpetuate the same myth about real estate -- namely, that amateurs who do their homework can outsmart the pro's.

Who ultimately profits from that misconception?

Just as in the stock market, in the housing market the beneficiaries are the pro's on the other side of the transaction.

So, on behalf of Realtors everywhere, I suppose I should say: 'Thank you, Freakonomics!'

*It was Warren Buffet who said, "if you've been playing poker for 30 minutes, and you don't know who the pasty is . . . it's you."

How Peter Lynch Would Reform Wall Street

Too Big to Fail? Try, Too Complex to Reform

Banks are like the heart that pumps blood — credit — to our country’s corporate muscles. If that heart is malfunctioning, any recovery will be anemic. But heart surgery is a very complex thing. You wouldn’t want yours done by a plumber or a politician.

--Thomas L. Friedman, "When Economics Meets Politics"; The New York
Times (2/3/10)

Of all the canards Wall Street has sold to would-be reformers, regulators, and at least one NY Times columnist, the biggest (and most self-serving) is that it is . . . inherently complex --"a beating heart," if you will.

Because Wall Street finance is so complicated, you need a Wall Street financier to oversee it. Or lots of them.

Eventually, *Wall Street insiders (vs. public-spirited civil servants, in the Paul Volcker mold) are running the Treasury Department, policing the securities markets, and serving as senior advisors to the President.

Sound familiar?

"The Complexity Canard"

The solution to Wall Street excess only partially lies in making too-big-to-fail firms smaller.

The other piece is to make the financial system simpler ("boring," if you prefer Paul Krugman's term).

Famed investor Peter Lynch famously advised, "invest in a business that any idiot can run -- because sooner or later, any idiot probably is going to run it."

My corollary for reforming Wall Street would be:

"Design a financial system that any idiot can regulate -- because sooner or later, any idiot is probably going to regulate it."

*Of course, FDR appointed a quintessential Wall Street insider, Joseph Kennedy, to head the newly created Securities and Exchange Commission. But Kennedy wielded his power on behalf of investors, not Wall Street. Imagine that . . .

Real Estate & Inflation -- Updated

A *Macroeconomic Overview

Back in April, I ran a post called "Real Estate & Inflation" that isolated wage growth as the key to whether any inflationary outbreak would help or hurt real estate (incidentally, that post is now ranked 18th in the world, according to Google).

Specifically, if inflation spilled over into workers' wages, it would drive up real estate; absent that, inflation would hurt real estate.

That's because static wages plus rising prices for everything else (food, gas, health care, etc.) would "crowd out" consumers' ability to spend on housing.

Six months later, how do things look?

Clearly, there is no inflationary pressure on wages. In fact, with unemployment at about 10% nationally and still rising, there is more downward pressure on wages than upward.

However . . . two other developments have come into clearer focus.

Coming Into Focus

The first is the Fed's apparently indefinite commitment to an easy (free?) money policy -- at least to banks that borrow from it.

Second, while wage inflation is nowhere to be found, asset and commodity inflation -- at least outside of housing -- appears to be rampant. (Hmmm . . . maybe the two are linked).

The Dow Jones is well over 10,000, gold smashed through 1,000 an ounce weeks ago, and oil appears to be poised for another run at $100 (and beyond). Meanwhile, the dollar is plumbing record lows against the Euro, yen, and other major currencies.

So, to return to the original question, what will an outbreak of inflation mean for real estate -- and specifically, the housing market?

Based on the foregoing, I've shifted into the camp that believes that rising inflation elsewhere in the economy will ultimately spill over into real estate, as well -- even if wage growth is flat (or negative).

If the economy can simultaneously experience recession and inflation -- a phenomenon dubbed "stagflation" in the '70's -- there's no reason why houses can't appreciate in a lousy economy, given what's happening to other asset prices.

P.S.: Peter Lynch has a famous line that if you spend 15 minutes a year trying to figure out macroeconomic factors . . . you've wasted 13 minutes.

Housing: How Much Further to Fall?

Why People Hate Wall Street --
And Wall Street Analysts, too

When stocks are going up, the airwaves are full of Wall Street analysts and other pundits chock-full of stock picks sure to make you money.

So what can you expect to hear after stocks plummet 50% or more?

All the reasons why stocks "are still historically expensive and have further -- much, much further -- to fall," notwithstanding their sickening plunge to date (call this phenomenon "prediction by extrapolation").

Thanks a lot.

Analysts' housing predictions have been much the same.

To be fair, Barron's Alan Abelson, who cites the charts above, has been bearish on housing all along. In his most recent column, "Double Trouble," Abelson makes the scary point that, despite the housing market's chilling fall to date, it still is well above historical trend lines.

Playing Devil's Advocate

Setting aside the counter-arguments for another post (See, "Waiting for Cheap Housing . . . Since 1997"), what if Abelson's right?

Should every prospective Buyer simply wait it out in a rental, until prices are more appealing? Should every growing family squeezed into a too-small house or apartment make do for another 5,6,7 years -- or longer, according to some bears -- until housing prices return to their long-term trend line?

There are more variations on this theme, but you get the idea.

Unless you: a) believe the prognosticators (always a dubious proposition); and b) are very patient, you're better off making housing decisions based on your current life situation, finances, and job opportunities.

My investing background and Realtor experience tell me that no one -- not Robert Shiller, not Nouriel Roubini, not Warren Buffett -- has a crystal ball accurately telling them what housing prices will be next year -- let alone 5 or 10 years from now.

To quote another investing guru, Peter Lynch, "If you spend 13 minutes per year trying to predict the economy, you have wasted 10 minutes."

Substitute "the housing market" for "the economy," and you'll have it about right . . .