outcome-making more money in real estate than in income-is similar to that of many Americans.

In fact, Americans have come to rely on the housing market for financial gain. While the stock market has gone nowhere for almost half a decade, housing prices have steadily increased. Accordingly, U.S. real estate values are at all-time highs both in pure dollar terms and also as a percentage of our wealth.5

Can we continue to both live in and profit from our homes? Can we continue to make our money where we dont have a comparative advantage? Alternatively, is it likely that home prices will stabilize or even decline?

The Harvard Economist versus the Gutsy Immigrant

With the 2005 version of King Kong (starring Jack Black, but not as the monster) coming to theaters can it be long before we have more super monster battles on the big screen? In 1962 King Kong fought Godzilla, who in turn has fought many other beasts. Perhaps the most surprising was the defeat of Godzilla by the caterpillar children of Mothra ( Mosura in the original Japanese).

When it comes to housing prices, there was an interesting-albeit unknown-superbattle that took place in Massachusetts back in the late 1980s. On the one side stood world-famous Harvard economics professor Greg Mankiw. In opposition was Fatima Melo, a Portuguese immigrant with no college education. In the battle to predict housing prices whom would you bet on?

In 1989, Professor Mankiw and David Weil (who was a graduate student at the time, and is now a professor) published an article entitled, The Baby Boom, the Baby Bust, and the Housing Market. 6 In it, these two esteemed academics concluded, real housing prices will fall by 47% by the year 2007. They went on to write, indeed, real housing

prices may well reach lower levels than those experienced at any time in the past forty years.

The academic duo speculated on the spillover effects of their predicted housing bust. They write, Even if the fall in housing prices is only one-half what our equation predicts, it will likely be one of the major economic events over the next two decades. These professionals predicted that housing prices would decline substantially and seriously harm the economy.

Not too far away from Harvard University, our young immigrant was facing a decision. Should Fatima and her husband buy a small house or a much larger one? Their family was growing and faced the decision of buying a house for their current needs, or something a bit roomier (and more expensive) to expand into. Fatima urged her husband to buy the biggest house they could afford.

Fatima anticipated that housing prices would rise (she was fortunate to never have taken an economics course). If prices were to rise, the bigger the investment in real estate, the more profits. Fatima advocated taking a risk, and she convinced her husband to swing for the fences. Accordingly, the young couple took their savings and borrowed as much money as the bank would lend them. They bet big in anticipation that a rising real estate market would make them money.

So who was right about housing prices? Was it the book-smart academics with their complex mathematical equations, or was it street-smart and gutsy Fatima putting her family fortune on the line? Figure 9.1 shows the answer. U.S. housing prices have soared. The price index is calculated by using repeat sales of the same property. This is a perfect measure as it compares apples to apples and exactly tracks changes in housing prices.

The professors predicted a 47% fall in housing prices after adjustment for inflation. In reality, housing prices-even after adjusting for inflation-have risen dramatically.

The professors were exactly wrong.

Furthermore, the professors predicted that the decline in housing

* annualized rate from first part of year

FIGURE 9.1 U.S. Housing Prices Have Surged

Source: Office of Federal Housing Enterprise Oversight

prices would put a drag on the economy. Exactly the opposite has occurred with rising housing values contributing to rising wealth and supporting the economy during a period when stocks have not risen.

The U.S. housing boom has been nothing short of amazing. Not only have prices risen dramatically since the professors issued their dire predictions, prices have been rising continuously since World War II. Furthermore, U.S. housing prices rose in every single year since at least 1975-no down years for three decades! That is absolutely stunning.

How did our dueling pair of forecasters perform? Fatima has parlayed her real estate investments into some serious wealth. She put $5,000 down on her first house and borrowed $90,000. She sold the house for $358,000. With the profits, Fatima and her husband bought a house that was three times larger. The new house has appreciated considerably so the couple has accumulated household equity in excess of half a million dollars. In spite of their modest incomes ( jobs that pay shit, in their words), Fatima and her husband have become rich by aggressively buying real estate.