Utility and Intrinsic Value

I was always fascinated by the economists’ definition of utility – the relative fulfillment that comes from ownership or consumption of a good. Given that different goods can have different values to different people at different times, the concept of utility drives economic interactions to optimize fulfillment. The classic question – what is a glass of water worth to a man dying of thirst in the desert?

Money is an exchange of universally agreed value against which all other financial transactions are compared. This works, except…. Recent events surrounding the Greek sovereign debt crisis have eroded this concept of money, or at least for the Euro. Today, rates are rising for the sovereign debt of not only Greece but Ireland, Portugal, Italy and Spain. The Euro is sliding. As reported July 12 by Bloomberg:

"Contagion is running amok," Bill Blain, a strategist at Newedge Group in London, wrote in a research note. "A sovereign default is now being discussed openly. We seem to have crossed that moment when chaos theory takes over and we get a price breakout into unknown territory."

And today, Suki Mann, senior credit strategist at Societe Generale SA in London, wrote:

As another D-day looms on Thursday, we have few soothing words. Greece appears beyond repair, Italy is on the brink and the chances are that the euro might be no more very soon.

Translation – things are going to [insert your favored pejorative]. The Brits always did have a way with words.

But what does this have to do with housing? The US could tip over into such contagion if we don’t get our fiscal house in order. Our debt ceiling crisis could result in the dreaded “self inflicted wound” if not resolved. While few expect the US would fail to rapidly cure any default conditions, the shock to the financial system would be frightening. With the preponderance of all mortgages backed directly or indirectly by the full faith and credit of the US government, mortgage origination would hit a wall.

Looking back, it is precisely this eroding concept of money which tanked housing values in late 2007 and beyond. Pre-crash values were based upon the availability of money, albeit at times recklessly available, to support high valuations. The reduced availability of funds, not the intrinsic value of a house, drove the price declines. (If the intrinsic utility of home ownership had declined, we would see a wholesale migration out of single-family housing independent of available financing. This is not the case. People still want to buy houses but cannot.) Further, the decline has produced a self-reinforcing ‘pain avoidance’ response from those who fear further declines.

The bottom line – the housing industry has EVERYTHING riding on the debt discussions unfolding in Washington. Erosion of faith in our sovereign debt would undermine both the value and availability of US dollars. Regardless of the intrinsic value of homes, the financing mechanism would be heavily impaired.

We thirst for housing in the US, but there is no funding to buy in the desert. Is there any good news? Yes….tomorrow.