theDirt Monthly: Burnt Steaks and the Economic Chef

September 2023

And the hits just keep on comin’.

-Tom Cruise as Lt Daniel Caffee, A Few Good Men

The Down and Dirty

The trend from last month continues with fewer closings, decreasing listing prices, decreasing closing prices, increases in inventory, and longer time on the market. Barring some extreme event, I expect this trend to continue over the next couple of months. However, I expect price decreases to moderate with a squishy floor around current levels as the Law of Diminishing Returns takes effect with additional interest rate increases.

le Chef de Cuisine

There are two axioms, Dear Reader, upon which we must agree in order for this relationship to work:

1. The modern US economy is a credit economy,

2. The modern real estate market is a derivative of the credit market.

Those being true, it is necessary that the Dirty and the Nerdy hang on the words of one man: Chef Jerome Powell. Well, bad news kids. There will be NO SOUP FOR YOU!! So sayeth le Chef from his lofty perch at Jackson Hole, Wy.

Dramatic? Maybe. But for those of us dealing in Dirt that is what August 25th felt like. To wit…

Good morning. At last year's Jackson Hole symposium, I delivered a brief, direct message. My remarks this year will be a bit longer, but the message is the same: It is the Fed's job to bring inflation down to our 2 percent goal, and we will do so. We have tightened policy significantly over the past year. Although inflation has moved down from its peak—a welcome development—it remains too high. We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.

Fed Chair Jerome Powell from Jackson Hole, August 25, 2023

Overdoing it

And now we get to the part of Hell’s Economic Kitchen where the Fed overcooks the meat. Again. Just like they did last time. If the Federal Reserve of the United States has one, lingering habit, it is defined as a patent INability to cook the meat just right. They almost always wait too long. Or not long enough. Or cook it too hot. Or not hot enough. Or some tragic combination of all of the above. The recipe is simple, Jerome - 350 degrees for 30 minutes! But he just can’t stop fiddling with it. Uncle Jerome cooks like a 10-year old - I thought if I made it hotter it would be done faster. Sigh.

The problem is, Dear Reader (and this is from my view right next to you in the cheap seats), I believe we are at the point where the steak is already burned and raising the heat yet again is perhaps a waste of energy. There is an economic phenomenon called the Law of Diminishing Returns where an additional input has little to no return. From the perspective of real estate in the trenches of Central Texas, those who are priced out of the real estate market due to the high cost of credit were priced out long ago. That ship is long gone. Another 25 basis points (or two) isn’t going to make much of a difference at this point. But sure, go ahead, cook it a little hotter. Who doesn’t love the taste of shoe leather?

If the steak is burned, demand a new steak

The good news, Dear Reader, is that it is the nature of Humans to be resilient. Chef Jerome can raise rates to the moon and cause the real estate market to be sick for a long while, but it will never truly die. One can dampen demand for real estate with a good beating, but unless you can fundamentally alter humanity and its basic need for shelter (and the desire for that shelter in the form of a nice 3/2 house in a neighborhood with a good school, or, more in my lane, a 50-acre homestead just outside of town) then you are only postponing demand. What’s more, humanity is adaptable. There is a reason that black markets become a thing when a desired good is outlawed. It is very difficult to stifle desire and demand.

The result: where there is a will, there is a way. I am confident that if my thesis of a long, slow, stubborn stagflation comes to fruition, people and markets will adapt around it to (eventually) clear the log jam of demand. Uncle Jerome may be le Chef, but you and I, Dear Reader, can always find a better steak somewhere else. I am already seeing it in fits and starts: rate buydowns; parents seller financing homes at favorable rates to their kids; Wise Investors becoming bankers and seller financing properties to maximize returns (if there is one thing that a further 25bps hike (or two) achieves, it makes becoming a money lender a profitable and very attractive prospect). Is the 40-year mortgage possible? Some other trick of the rules to get around the current affordability obstacle? We shall see. In the mean time, I hope the Chef has not forgotten that the consumer and market also get a vote. Oh, and so do their elected representatives in an election year.

The Absurd Curve

The Absurd Curve. Where short term money earns more than long term money. Chart compliments of USTreasuryYieldCurve.com.

The yield curve is still perverted inverted. This is bad. Incentives are skewed. The Price of Time is skewed. This leads to short term thinking, acting, doing. This is bad.

What does it all mean for real estate?

The long, slow slide continues. Real estate prices might