The Financialisation of Housing – Two Sides

I am posting this publicly to give a little perspective. I know nothing about real estate, psychology, asset management, economics or financial markets. That will become apparent to you, as it was to me, in the lack of coherence in some of my arguments. So why does my opinion matter? It doesn't. The article represents a pool of mere perspectives and observations.

I bring into context the Statement by the Special Rapporteur on the right to adequate housing, Leilani Farha, during the Interactive Dialogue at the Human Rights Council – See (Farha, 2017) – and I account for either side of a possible debate on the financialisation of housing:

• Supporters of the financialisation of housing
• Opposition to the financialisation of housing

First, let’s not discount the fact that there is an indefinite number of factors to consider in this discussion; this article does not fully appreciate the complexity of the situation. Also, I deliberately did not define financialisation; that would make it easier for critics to refute the validity of this discussion based only on semantics.

As an assignment towards my Financial Markets certification, my original article favoured the Opposition. But that's just not the way to approach discussions around a plausible solution. If a solution is even what we want. An important premise when seeking to recognise either side of an argument is to understand the rationale of both sides. Their motivations are often not apparent at face value. Humanitarians may think why would a capitalistic market thrive globally, even in economies with glaring inequality? From where does the inequality stem?

1. Well, maybe I hold romantic views on good human nature, but I agree with Akerlof and Shiller’s view that “the cynicism of businesspeople” (albeit just one businessman or entity in the industry) leave their colleagues “trapped into following suit out of economic necessity” (Akerlof & Shiller, 2015). I add that cynicism may be substituted with any behaviours that restrict the entity’s actions to those which protects its interests. But if every entity plays by the same rules (i.e. In a regulated market that promotes the interest of economic growth), then discussions like this would have no place in our society. Then again, everyone is trying to protect their piece of the pie; a piece which seems to each bearer smaller than it truly is.
2. Some participants of a discussion approach all their conversations as a negotiation – where each one’s aim is to dominate the other and leave no money on the table. Negotiation, in that sense, has a time and place for it. It is therefore worth considering first, the explicit definition of each party’s needs, and second, how each party can come to terms with those needs. Without an attempt at empathising with both views, it is difficult for me to consider either side of the financialisation of housing based on its respective merits.

Why Housing? - An Opposition’s View

Consider the question from a property lease perspective: it is important to distinguish between purely residential tenants and tenants of property that is purely commercial. The interests of either party in a commercial lease are not fundamentally different – the owner and lessee are usually both drawn to the agreement by financial gain. The homogeneity of revenue-driven business interest makes any disagreements likely to attract fewer classes of dispute-resolution measures than may be necessary in a resident-owner case (such as bodies that serve to protect the interests of human rights). In most countries, the simplest argument for de-financialising (or any form of additional regulation) housing, as opposed to any other real estate category, is that everyone has a right to adequate housing. No explicit mention is made vis-à-vis the right to profit on the UN’s Universal Declaration of Human Rights. Fundamental human rights are the anchor to the Opposition.

There seems to be universal agreement that human rights serve the most fundamental needs of our existence and that everyone must exercise them. But as to what should be done to ensure that each person can exercise their rights, there seems to be much disagreement. With the above definition, the basis for a discussion becomes clear; “whether to protect the interest of financial capital or those of human rights”. This is the theme underlying the problem inquired by the Leilani and the rest of this article.

The Role of Financial Architects and Engineers - A Neutral View

The desperate housing crises of the past were catalysed by a surplus of self-serving banksters of otherwise-noble financial markets. Shiller writes that finance is essential in “managing the risk that enables society to transform creative impulses into vital products and services" (Shiller, 2012) – today’s professionals within finance who manage risk in housing markets could create solutions that empower societies to help manifest whatever creative impulses that are necessary to transform the housing market in a way that Opposition would be receptive of.

Maybe solutions that promote interest of social good would result in foregone profits within the finance industry – where these professionals are trained. That’s understandable. It follows, trivially, that innovation by professionals stimulates the profitability of financial products and services. But these goods do not always extend to aiding the optimal use of an economy’s stores in a way that encourages sustainable financial and economic systems.

Financial Markets - A Supporter’s View

Financial markets serve to finance economies. But why would you want to finance an economy? At the root of an ideal economy is the need for its participants to partake in the fair distribution of its resources. Does financialised housing help the above cause? Can an economy do away with financial markets that trade housing commodities? The de-financialisation of housing would come with several ripple effects on both public (for-listed) and private financial markets. The latter trades value between the respective (real) economies to which the buyer and seller belong. Regular exchange of over-the-counter financial instruments is seldomly converted into wealth that circulates the real economy. Much less within reach of those who need basic housing. De-financialisation would mean that trading on either market is forbidden. No arbitrage. No residential REITs. No residential mutual funds. And with the de-financialisation of residential real estate, housing supply by private companies slows down, as may the entire construction industry.

That said, maybe it would be easier for Supporters (who also support the attainment of the ideal economy) to consider the de-financialisation of only public-market residential real estate commodities, since private markets trade contributes explicitly to the real economy.

Regulation - A Neutral View

Suppose that free markets are needed to sustain any economy. Suppose also that this is especially true for growing capitalistic economies. Then, some regulation is necessary to restrict our degrees of freedom, if the economy is to grow sustainably. Corporate regulation exists to both protect businesses from malpractice between themselves and to discourage their poor behaviour against consumers. If the above is true (it may well not be) then it is necessary to define what “poor behaviours” are, in the pursuit of regulation. And to achieve unanimity on a framework that encourages “good” behaviours, exploring how capitalistic housing markets can exist in an ideal economy is of basic importance.

Market Size and Possible Effect on The Market - A Supporter’s View

According to Savills World Research’s 2016 publication, the world’s residential real estate asset class – with a value of $168.5T – contributed almost as much as equities and bonds, combined ($170.3T), and more than double the sum of every country’s GDP ($74.6T).

We can assume that the $168.5T is the sum of market values rather than arbitrary listing prices, and that the proportion that residential real estate contributes to the world’s total assets has not changed enough since 2016 to invalidate arguments that follow. Could an expert please give hints on what the $168.5T, in current USD, would drop to? If residential real estate were to cease trading at the current level of liquidity and price levels, the net effect of investment-withdrawal from housing is not unlikely to cause another market upset. If that happens, then at least it wouldn’t get much worse than that for decades to come. The upside for Supporters is that the economy may revert to commoditised housing, for better or worse, since Opposition would likely reconsider the above poorly-implemented hypothetical policy.

Bidding Wars - A Supporter’s View

Real assets are price-elastic and less liquid relative to intangibles. Other things controlled for, a significant housing price slump from the result in the above paragraph would leave very few willing buyers. Since we know that it is impossible to efficiently sell all the world’s houses and their derivatives (we tried with the mortgage-backed securities. We really did), current investors would have to hold onto assets they’ll likely feel are worthless. A bearish real estate market ensues. Perhaps governments, whose mandate is to serve its people, can purchase the houses at a discount to bail out investors. So how would the rest of the market react? On a leveraged put, you could make more than you could have on Leicester 5000:1. Surely, the lucky stakeholders who manage to get out of their investments to substitute for other assets will bid up the price of other asset classes significantly? I don’t know, but hear me out to the punchline. Companies will seize the opportunity to issue more securities (Editor’s comment: “Security” is an ironic name for unsecured commodities). It’s a lot to digest. The result of the above substitution effect combined with the issuance of new shares? DM me your CV for a chance to be cast in the resulting movie. Even though financial markets are inefficient, whatever value that manages to be shifted out of housing must necessarily be absorbed by at least one other asset class; and it is likely that such assets will settle at new price equilibriums.

A Seemingly Fair Perspective on the Affordability of Housing

It is apparent that market prices make residential real estate unaffordable, at least for the several homeless. Many argue that ownership of vacant spaces should not coexist, under the same government, with homelessness. Whatever the state of the economy. To understand why this is an important point, let’s refer to the primary objective of financial markets: “to finance an economy whose aim is to ensure that participants can partake in the fair distribution of its resources”. Without much deliberation, we can accept fairness, in the case of housing, to mean that each person should have access to at least one. However, the above simplistic definition of fairness, which may not correct in your eyes and may be riddled with caveats, in no way implies that there’s no room for investors. It seems like a plausible outcome that would favour the Opposition is for access to housing to be akin to access to cell-phones – for almost everyone to own one. But it is difficult to see how it could be entirely free to rent or own, especially for investors who are okay with the status quo. I should mention again that unanimity trumps all.

I can’t estimate how worthy this discussion is. Is any probable solution practical on a local scale? And globally? Your guess is better than mine. No cap, my thoughts on these questions are barely clearer than they were before I began writing.

 I really appreciate that you got this far:) I am open to discussions and thought experiments, so please reach out to me if you have ideas around real estate that keep you up at night.

References

Akerlof , G., & Shiller, R. J. (2015). Phishing for Phools: The Economics of Manipulation and Deception. Princeton University Press.

Farha, L. (2017). Retrieved from Office of the United Nations High Commissioner for Human Rights: https://www.ohchr.org/en/NewsEvents/Pages/DisplayNews.aspx?NewsID=21264&LangID=E

Shiller, R. J. (2012). Finance and the Good Society. Princeton University Press.