Saturday, June 14, 2014

The Generational Short: Banks, Wall Street, Housing and Luxury Retail Are Doomed

If Gen-Y cannot afford to buy Boomers' houses at bubble-level prices, then what will keep housing prices at these elevated levels?


Mish recently posted excerpts of a Brookings Institution study on changing generational values: How Millennials Could Upend Wall Street and Corporate America. The gist of the report is that Gen-Y (Millennials) view money, prestige, adversarial confrontation and managerial methods differently from the Baby Boom and Gen-X generations, and that this set of values will change Corporate America, the economy and the culture as Boomers exit managerial positions and their peak earning/spending years.

Though we have to be careful in characterizing tens of millions of individuals as all reflecting one set of generational values, the basic idea is simply one of context: people who grow up in a specific milieu are naturally prone to sharing broadly similar perceptions and values.

The Brookings authors claim that Millennials do not favor the adversarial style of the Boomers (competition and confrontation as means of advancing one's cause/position) nor do they place great value on luxury goods as evidence of exclusivity. They actively distrust/loathe the banking sector and are financially conservative, preferring cash to investing in Wall Street.

Asked to choose their ideal (corporate/state) job, their choices reflect preferences for a mix of security, idealism and technology. The big flaw in this career questionnaire (as far as I can discern) is that it did not offer the alternatives of self-employment/ entrepreneurship. Anecdotally, it seems clear that there is a strong entrepreneurial drive in Gen-Y--for example, What I’ve learned in my first year as a college dropout.

One factor the report did not address fully is real estate/housing, which depends on bank-issued debt (mortgages) and the belief that a lifetime of paying a mortgage will magically result in financial security, based on the greater fool notion that someone in the future will be willing to pay more for an asset that hasn't changed either qualitatively or quantitatively (other than needing more maintenance as it ages).

This raises two issues: if Gen-Y cannot afford to buy Boomers' houses at bubble-level prices, then what will keep housing prices at these elevated levels? Answer: nothing. Without strong demand for housing at sky-high prices, valuations will drop to whatever level demand can support. That level can be far lower than conventional housing analysts believe possible because they are still extrapolating Baby Boomer preferences and earnings into a future which will be quite different from the housing bubble decades.

The second issue is a question: how much of the Boomers' housing wealth will trickle down to Gen-Y when they actually need housing, i.e. when they're starting families?

The answer may well be: very little. If Gen-Y is unwilling or unable to take on enormous mortgages to buy bubble-priced housing, we can project a housing market in which Boomers are unloading millions of primary homes as they seek to downsize/raise cash for retirement but there aren't enough Gen-Y buyers willing or able to buy these millions of homes at bubble valuations.

In this scenario, home prices must decline to align with Gen-Y's salaries (i.e. their ability to qualify for huge mortgages) and their willingness to shoulder bank-based debt.

If Gen-Y essentially opts out of the belief that financial security depends on buying a house with a large mortgage, then the U.S. housing market will have no sustainable foundation for price appreciation. Housing could easily decline by 50% in highly inflated markets.

The same dynamic will shred stock market valuations. If Gen-Y opts out of supporting the banks and Wall Street, the demand for Wall Street's products will plummet, bringing stocks back down to historical levels--once again, perhaps 50% of the current bubble valuations.

The funny thing about core values is that they are resistant to arguments such as "you should get a mortgage and invest all your money in Wall Street." Once people opt out of the fantasy that buying a house and entrusting one's capital with Wall Street leads to guaranteed financial security, no amount of cajoling or propaganda will change their values-based decisions.

For example, those who have decided to eschew debt will never take on debt, even if the banks (or the banks' pusher, the government) offer debt at 0% interest. Those who have lost trust in Wall Street or actively hate it and everything it stands for (neofeudalism, unbridled greed, the corruption and collusion of the revolving door between the state and Wall Street, etc.) will never change their minds and hand their money to Wall Street to play with.

If the primary assets held by Boomers (houses and stocks) both decline for these fundamental reasons, there may be relatively little wealth left to pass on to Gen-Y. There is a peculiar irony in this: if Gen-Y avoids bank debt/mortgages, buying conspicuous consumption luxury goods on credit and investing in Wall Street's scams and skims, this generational lack of demand for housing, stocks and luxury goods will effectively crash the sky-high valuations of these assets.

That will reduce the value of whatever generational wealth the Boomers have left to pass on. Since many Boomer households are currently paying for three generations--soaring college costs for their Gen-Y offspring, care for their elderly Silent Generation parents and their own expenses--how much wealth they will have left once Gen-Y is dominant is an open question.

These factors suggest a generational bet against banks, Wall Street, housing and luxury retail stocks. I am not recommending such a bet, mind you; it's just one potentially interesting speculative consequence of the changing of the generational guard.


This essay is drawn from Musings Report 22. The Musings Reports are sent weekly to subscribers ($5/month) and major contributors ($50+/year). The Reports include an essay, market musings and other features.






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