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Sunday, 18 October 2009

Property Rights and Wrongs

It Begins: The Magna Carta

In 1215, at Runneymede in England, King John set his seal upon the document known as Magna Carta and thus kicked off nearly a thousand years of property madness. The charter was the result of the King’s ruthless trampling over the rights of existing nobles and, extracted from him at the point of a sword, gave all freemen of England certain, inalienable rights.

One of these was the right not to be unlawfully deprived of their property and, such is the way of these things, this was to lead to the Anglo-Saxon obsession with housing which has been at the heart of so many recent financial debacles. It may be that “an Englishman’s home is his castle” but mistaking a heavily mortgaged property for a safe financial haven isn’t the cleverest bet you’ll ever make. Although it may still be better than investing in the stockmarket for most people.

Property Rights

At the heart of the Magna Carta were a number of provisions that echo down the ages:
"No free man shall be seized or imprisoned, or stripped of his rights or possessions, or outlawed or exiled, or deprived of his standing in any other way, nor will we proceed with force against him, or send others to do so, except by the lawful judgement of his equals or by the law of the land."
The document is, to be fair, rather a rambling read and at points gets oddly excited about making the King give back all the stuff he’d stolen from Wales including "the son of Llywelyn". Quite why King John had such a liking for the Welsh isn’t recorded, but they clearly weren’t happy with the attention. According to the charter he'd also acquired the sisters of the King of Scotland on his travels, so he seems to have been an inveterate Celtic kleptomaniac.

Although the charter enshrined a lot of rights, many of which are traceable into important future constitutional documents like the American Declaration of Independence, the English more or less observed it in the breech for a few hundred years. Kings may have nominally been as one with everyone else before God but in practice they had the biggest armies, the most secure dungeons and an awful lot of nasty looking torture implements.

Edward Coke and the Common-Law

By the sixteenth century, however, the jurist Edward Coke was using the Magna Carta as justification for the development of some of the most important aspects of the English common law – the haphazard set of case studies that determine precedent and hence guide judges and jurors. Coke in many ways wrote the book (actually four books) of common-law but is perhaps best known for refusing to kneel in the presence of the King, arguing that no man was above the law. Charles I later slung him in the Tower of London, which suggests that the authority of the law was somewhat more limited than Coke would have liked.

Anyway, between them Coke, the Magna Carta and common-law established many of the rights we hold dear today including the protection of real property rights. These are a critical issue for the development of democracy and capitalism – the Soviet Union thoughtfully provided us with a seventy year study of what happens when you deprive people of such rights: bad dentistry, rotten cars and a secret police state George Orwell would have been proud of. Despite all the other trappings of modernity the system buckled: when no one owns anything what incentive does anyone have to improve themselves?

Shakespeare’s Property Ode

In England, however, this had some odd consequences. For reasons that might escape us in these more modern times were it not for the fact that they haven't changed very much, mostly the English didn’t trust their government very much. In fact when annoyed they regularly rioted and strung up a few representatives to keep the others in their place. Way ahead of their time, they didn't put much trust in bankers or ye olde financial advisors either. It's amazing how little the world changes over the centuries.

On the other hand, the rights that the common-law protected provided everyone with a strong incentive to own a property. Unlike gold or coins a house was pretty darned difficult to steal during the night (although they did have a nasty tendency to burn down from time to time) and, to boot, could be relied upon for an income. William Shakespeare, for instance, invested his earnings extensively in property – including the then enormous sum of £320 for land in Stratford-upon-Avon in 1602 and £140 for the gatehouse of an old priory in London in 1613.

Empire and Housing

The English fascination with property gained a wider foothold as the spread of Empire took with it the English language and the common-law. Looking around the world at where home ownership is most popular and property booms most frequent you’ll find a pretty decent overlap with British historical involvements. Japan, of course, is the ultimate exception, but that’s what you get when an outsized population meets an undersized land mass. And, of course, the post-war Japanese constitution was modelled on the British system.

The Anglo-Saxon obsession with property means that many private investors prefer housing to stocks. People feel that they understand how to value a house whereas the movements of the stockmarket are unfathomable. Additionally there’s the added ‘benefit’ that a house is a hugely tangible thing, unlike shares. The visibility and speed with which share prices can move is frightening to the uninitiated, while the difficulty of valuing property makes the drop less scary: until such time you need to realise the investment when, as many people have been finding out, the downside can be pretty horrible.

Gearing, Property and Shares

The main advantage and downside of property over shares for the unsophisticated investor is gearing: by borrowing money to buy the effects of price gains and losses are magnified. In typical behaviourally biased fashion most people will buy in while markets are surging, not realising that prices can fall sharply and painfully. As usual (due to issues we saw in Retirees, Procrastinate At Your Peril) the short term focus on immediate costs over future ones leads buyers to worry only about the initial affordability rather than the long term liability.

In the end, of course, if property is undervalued compared to shares then the rational investor will sell shares and buy property. The problem is that unlike shares, where re-pricing can occur rapidly, it can take a very, very long time for house prices to adjust after either a boom or a bust. This too is simple behavioural bias – loss aversion triggering (as discussed in Loss Aversion Affects Tiger Woods, Too), meaning people won’t sell at less than some anchoring point: their purchase price, or the selling price achieved by the family next door at the height of the boom.

Behavioural Benefits of Housing

On the other hand the unwillingness of people to sell below their anchor price and the opaqueness of pricing does have the benefit that most home owners won’t get panicked into selling at the bottom, unlike many stock holders. In both cases there’ll be unfortunate forced sellers at the worst possible moment but generally if you have to hold one or the other most private investors would – psychologically – be better off holding housing.

Even so, at the height of the latest Anglo-Saxon inspired housing boom many ‘investors’ were buying second and third homes on which the rental income couldn’t even cover their mortgage costs. Just like with shares, relying on short-term capital appreciation to make an investment worthwhile is a dangerous gamble. A rental property with earnings that more than covers its costs is a safe bet no matter what markets do: if investors applied the same principles to shares they’d be a lot better off, in the main.

As Safe As Houses?

There is strangely little research into behavioural finance effects on the property market, although it's quite clear that the same sorts of biases that affect stockmarket investors also impact property speculators. What little there is, is surveyed in this this paper by Rohit Kishore. It's noteworthy, if not especially surprising, that the price achieved at the end of a negotiation is nearly always anchored on the initial price proposed. This isn't an especially remarkable finding, given that this is usually what the sellers are demanding, but it does suggest that getting your bid in first is the critical thing. However, the caveat is that if the price is set too high there are no offers at all – as many people have found out to their cost, recently.

Those eleventh century barons who were only interested in protecting their own rights have a lot to answer for, but at least the only thing depriving us of our homes these days is our own behavioural incompetence. Sadly no amount of legal precedent is likely to overcome that.


Related Articles: Gold!, Dear Auntie, Why Are My Bonds Bubbling?, Going Dutch, The Benefits of Sound Money

2 comments:

  1. fantastic piece. bravo.


    josh
    the reformed broker

    ReplyDelete
  2. Well said.
    The Magna Carta and common law also seems to explain why the majority of gold is mined from countries with a common law legal code rather than Roman law.
    Property rights become pretty important when you are thinking about spending hundreds of millions of dollars on a hole in the ground.

    ReplyDelete