Wednesday, October 24, 2007

Are Burning Homes Good For the Economy?

That's the question Mark Lacter poses over at LA OBSERVED (Business). But even with all the many options he presents - there are several critical points he and the people he quotes do not address. First, read all he does address and then I'll add a few more points to ruminate over....

Economists starting to assess the impact of this week's fires are pointing out that this kind of event can actually stimulate growth, perverse as that may seem. Keep in mind that the Malibu fire in 1993 destroyed 268 homes and almost all of them have been rebuilt (or the owners have rebuilt nearby). They all had to hire a contractor and buy furniture and maybe even use an interior decorator or landscape architect. All those businesses got extra revenue that they otherwise wouldn’t have gotten, which explains why you often see a jump in economic activity in the months after a fire. That's not some crazy theory - it's just the way things work.

So MarketWatch's Tom Bemis takes that prospect and suggests how the stimulus "could at least act as a brake on the housing crash." That’s probably pushing things, but it's not an altogether crazy idea - rebuilding after the 1994 earthquake provided a crucial jumpstart for an area had been mired in recession. Anyway, Dealbreaker's Joe Weisenthal calls this "one of the more ludicrous things we've ever read in our entire lives" (a ludicrous comment unto itself). He then suggests that reading about the broken window fallacy "would spare anyone from writing articles such as this." Ouch.

The broken window fallacy was the work of a guy named Frédéric Bastiat in the 1800s, and it basically refers to an action that has unintended costs attached to it. (It's used in the first chapter of Henry Hazlitt's 1946 classic, "Economics in One Lesson.") To illustrate his point, Bastiat tells the story of a shopkeeper whose window is broken by a little boy. The window has to be replaced, of course, which means there will be work for the glazier, who in turn will be able to buy bread that will benefit the baker and so on. To make a long story short (I know, too late), the fallacy is that these supposedly positive benefits are offset by the costs faced by the shopkeeper - not only for the price of the window but for lost business.

It's an interesting theory but not everyone agrees with it. And it certainly has questionable relevance in determining the economic impact from the fires. The "shopkeeper" - in this case a homeowner - isn't out the cost of a new house because much, if not all, of the rebuilding is covered by insurance. (I know, I know, he has to pay for that insurance, but he would have had to pay for that even if his house was not damaged.) Homes that were damaged but not destroyed will get a new coat of paint, new flooring or whatever, and be worth more money than before the disaster. All this economic activity won't necessarily shake up the real estate market, but it will provide for more opportunities once the market opens up, as it surely will.

First, Tom Bemis's claim that taking 1500 homes off the market in an area where one million people were evacuated will at all change the market - clearly makes little or no sense; particularly when only a comparatively few of those homes would have been on the market for sale. The point he completely misses is that there are now 1500 families suddenly in the rental or purchase market for a home who were not in the market the week before - and that will actually have some impact.

Not huge - but very real as the number of buyers will dramatically increase in each area particularly hard hit. And when a lot of homes are lost in a single school district, as was the case in Malibu in 1993, in my experience, the only way we were able to meet the demand was when many people agreed to rent out their weekend beach houses to families who needed homes.

In addition, other buyers will come into the area since it will be years before the area will have a major fire again (assuming the area is not in danger of flood, of course) and other buyers will come to the area to buy 'bargains' in the now distressed neighborhoods. And I know this because every time a fire or a flood hit Malibu - my business selling houses would boom.

Joe Weisenthal's even bigger blunder, though, is that while the broken window theory would propose a decrease in national wealth - the hundreds of millions of dollars that will flow into the pockets of Southern Californians to rebuild their houses are not coming from their neighborhoods.

That money comes from insurance policy holders all over the country just as the federal aid will come from tax payers all over the county. So not only will most people get a newer and more valuable home in the end (which may in itself partially contradict the broken window theory, since an old window and a new window would have the same value) - but all the contractors and all the other people paid to rebuild and refurnish those houses will still have their money, too.

It is a perfect example of having your cake and eating it too. So while there may be a national financial hit - there will be a local financial boom, contradicting Weisenthal, but doing so for different reasons than given by Bemis.

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