Rethinking the REThink Future Program, Part 2: The Ostrich Scenario

In part 1, I began to tackle the REThink Future program that is currently underway. I have posted Nicole-Anne Boyer’s gracious response to that post here. And now, we dive into the Scenarios themselves… because… well, because it’s fun for me.

Let me reiterate my agreement with the idea that if the purpose of these scenarios is simply to stimulate thought, then no critique of them is valid. It wouldn’t matter if the scenario began with “A dimensional portal opens up in the sky through which the Norse god Loki leads a horde of alien invaders into Manhattan – what is the effect on the midtown condo market?”

Nonetheless, I think there are solid ways to improve the REThink Future program by thinking about the Scenarios once again. So we will delve into each one in turn to examine how such a thing might be done to make each scenario more plausible, more impactful, and ultimately, more useful to the attendees and to NAR.

The Scenarios

There were five Scenarios that we were asked to consider in San Francisco. Nicole-Anne Boyer, the Managing Director of Adaptive Edge, was kind enough to forward the link to the full Scenario Report (PDF) and I urge you to read through the whole thing. The rest of this series assumes that you have read that report, as reproducing enormous parts of it would result in a post too long even by Notorious standards.

To start, we must understand the purpose of these Scenarios. They are not meant to be predictions, but as thought-stimulation devices. Kinda like coffee. Of if you’re addicted to other chemicals, um… those things. From the Report:

Possibilities not probabilities.

The scenarios are not designed to predict the future but rather to open our thinking to new strategic possibilities at multiple levels—for the industry, for the NAR, and for individual leaders. Resist thinking about the most probable scenario, since most game-changers start out as improbable or hard to imagine (e.g. the Arab Spring, the Internet, etc.). Instead, ask: what strategic questions does this scenario raise? What can we learn from it?

Simplifying a complex landscape.

While we could have explored a large number of futures, these particular scenarios were selected because they help rehearse the most important strategic opportunities, challenges, and “what ifs?” facing the NAR and the industry as whole. These include stories we are telling ourselves about possible futures, and they include more novel or uncomfortable stories about emerging realities that we may be missing or not talking about yet. [Emphasis added]

It is on these terms, then, that I will review the five Scenarios. They are:

So since you’ve read the full report, and know what these entail, let’s dive in. I’m going to do this in the order that was presented to us in San Francisco. I’m going to do this in five parts, since the whole thing ends up being a small book. Of course, maybe I should publish that book at some later date… but that’s another thing altogether.

So in this Part 2, we’ll tackle the Ostrich Scenario in depth.

Ostrich Scenario

The basic premise of Ostrich is the following:

• Slower, incremental changes especially at the association level.
• Driven by institutional inertia, political gridlock, industry fragmentation, and slower pace of housing market recovery.

Much of the discussion in San Francisco therefore revolved around the “Value of the Association” at our table, which naturally led to the “Value of the MLS” question. (Association leaders should think really long and hard about that phenomenon, that any discussion of Association value today even amongst industry people “in the know” automatically defaults to a “Value of the MLS” discussion.)

The story of the Ostrich goes something like this:

The housing market recovery is “tepid and uneven” because consumers are debt-laden and “recovering from the Great Recession”. The election of 2012 results in greater gridlock in DC, which freezes Federal housing policy as it is today. So with things pretty much the status quo as it is today, the Associations, brokers, agents and everybody else kinda bury their collective heads in the sand — hence “Ostrich”.

The Scenario is critical of the industry’s lackadaisical attitude, writing:

Associations, however, were just as much to blame for this climate of incrementalism. Many leaders were unable or unwilling to change because of organizational inertia, perceived entitlements, outdated ideas about the future of the business, and a mindset of complacency. Indeed, some willful wishful thinking was going on: that the worst was over; that soon things would go back to “business as usual;” and that the job of the association was to defend the business model at all costs by keeping key technology players and others at bay.

The story continues, suggesting that despite the industry’s willful ignorance of what’s going on, change comes nonetheless. Technology companies, such as Zillow (mentioned by name in the report), transition from being information providers to “being part of the transaction”. Plus, consumer expectations have shifted, with younger buyers and sellers wanting a “different kind of relationship” based on cost-saving alternatives.

The end result of all this, then, is a Doomsday scenario for Associations. Membership numbers plummet both because the young agents get sick of the slow-play, status quo mentality of Association leaders. Plus, big brokers leave in droves as they see no value in the Association. And political lobbying becomes a liability instead of an asset:

Yet another trigger for this was a lobbying scandal, a backlash against the Super-PAC era, which ignited public outrage for a full year and implicated large advocacy groups. Guilty by association, the sterling reputations of trade organizations like the NAR were tarnished overnight, catching many leaders by surprise because this kind of criticism didn’t happen after the subprime crisis. Memories, however, were long, and many folks didn’t forget that it was agents who encouraged them to buy houses they couldn’t afford.

There is mention of a “silver lining” at the end. The folks who left the traditional Associations all band together to create “innovative solutions” that result in some sort of an unspecified rebirth of the industry.

My Issues with the Ostrich

My primary issue with the Ostrich scenario is the assumption of the status quo. The basic theme of Ostrich is that due to Associations dragging their feet, due to political gridlock in Washington DC, due to the anemic economy, nothing much will change in the overall environment. The scenario specifically contemplates the idea of “Crash and Rebirth”, but only in the context of Association membership: frustrated members leave, but innovate into a new organized form, which leads to good things in the end.

The issue is that that “Crash and Rebirth” should start with the largest organization affecting all of us: the United States of America. If there is a Crash, it won’t be just Association membership numbers; it will be the overall economy and polity of the United States. Those of my readers not yet familiar with the work of Mark Steyn are encouraged to become familiar as soon as possible.

A Detour into Facts

The dominant fact — which simply wasn’t mentioned in any of the Scenarios — that has to be the touchstone for anything related to the real estate industry is the $16 trillion in federal government debt. The second dominant fact is the roughly $1.2 trillion in annual deficit spending. The third dominant fact is unfunded liabilities from entitlements (Social Security, Medicare, and Medicaid) to the tune of $120 trillion by some measures. The final dominant fact is the finances of local and state governments, driven largely by unfunded pensions.

We pause here to note that California has had three cities file for bankruptcy since June. The latest, San Bernardino, did so due to unfunded pension and benefits liabilities. And you can Google “California budget crisis”, “California unfunded liabilities”, and so on yourself to see the bad news at the state level.

Why do we care about these boring and depressing we’ve-heard-this-all-before doomsday projections?

Because the housing market is intimately tied to all of the above. There is no mortgage market today without Federal support, whether FHA loans or Fannie/Freddie. All of those require that the Federal government actually have money, whether through taxes or through borrowing. State governments and even more so the local governments rely heavily on property taxes to finance their operations; San Bernardino’s bankruptcy is directly tied to the collapse in the housing market.

Political gridlock, institutional malaise, and so on cannot keep things in the status quo because the status quo has at the very least significant numbers of municipalities and counties going belly-up. The status quo has California and Illinois running out of money — an unprecedented event in American history. And politicians and the local residents will be asked to make a choice between keeping property taxes as is, or having schoolteachers, firemen, and cops — or as happened in Scott Walker’s Wisconsin, Andrew Cuomo’s New York, and Rahm Emmanuel’s Chicago, break the public unions in some real ways.

There is no status-quo scenario under which one of the above will not happen. And none of those things point to gridlock or status quo — ask the partisans on either side in Wisconsin.

There is no chance at all that gridlock would increase after November 2012. Why? Because we have a binary choice: either Obama wins or Romney wins. On the current polling, the Republicans will remain in control of the House, and there’s a 50/50 chance of Republicans taking the Senate as well. So the options are:

• Status Quo: Obama President, Democrat Senate, Republican House –> same gridlock we have today
• GOP White House: Romney President, Democrat Senate, Republican House –> decreased gridlock as Romney will copy Obama’s precedent in making policy via Executive Order
• GOP Sweep: Romney President, Republican Senate, Republican House –> decreased gridlock

I rule out the GOP Congress: Obama President, Republican Senate, Republican House possibility because I can’t imagine a voter going into the booth, pulling the lever for Obama, but then voting for a Republican for Senate. Same goes for other non-real scenarios, like Romney President, Republican Senate, but Democrat House.

And whoever ends up in office, no matter the level of “gridlock”, the issue they would have to confront is something pretty much all economists agree upon and fear, but pretty much everyone does not take into account: failure of a Treasury auction. (Oh, and it almost happened.) At that moment, the US Government starts to run out of money to the tune of $1.2 trillion per year.

Even a President Romney, with a GOP House and Senate, could not immediately lay off the entire Federal government. Even in fiscal emergency situations, they’ll have to find a way to muddle through, paying higher interest rates, cutting programs left and right, and hope that the economy picks back up.

In the meantime, while the United States is looking to restructure itself financially, anything that wouldn’t have people rioting in the streets immediately would need to be cut. Stop giving out FHA loans? You don’t have burning and looting. Stop sending Social Security checks, you do. So the policymakers will be forced by events to make changes, no matter what, no matter who is in office, no matter what the outcome of the elections.

Back to Ostrich

Set against that background of facts, I think Ostrich takes on different tones. For the sake of stimulating thought and conversation, let me ask a few leading questions.

• No matter who wins how in 2012, does the Federal budget problem have to be addressed or not in the next five years?
• Will addressing the deficit problem result in somebody’s ox being gored?
• Whose ox will be gored? Investors? Public unions? Taxpayers?
• The Mortgage Interest Deduction costs the Treasury $131 billion per year.

In this environment, “Value of the Association” discussions inevitably transform into “Value of the MLS” debates. And the Ostrich scenario talks about Zillow. Really?

And we have this profoundly amazing sentence in the Report:

Yet another trigger for this was a lobbying scandal, a backlash against the Super-PAC era, which ignited public outrage for a full year and implicated large advocacy groups. Guilty by association, the sterling reputations of trade organizations like the NAR were tarnished overnight, catching many leaders by surprise because this kind of criticism didn’t happen after the subprime crisis.

Might I suggest that many leaders aren’t looking in the right places if they’re surprised by guilt by association. For that matter, sterling reputation of trade organizations like NAR? In whose eyes? Spend some time in the comments section of major media portals (CNN, CNBC, etc.) and see for yourself about that ‘sterling reputation’ bit.

Long and short of it… the Ostrich scenario cannot be a story about “Crash and Rebirth”. Rather, if it assumes the status quo, head-in-the-sand mentality of Association leadership, institutional gridlock and so on… it’s a “Crash and Burn” story in which America begins not a slow decline but a rapid collapse. At best, it’s a “Twilight of the Gods” story, in which the once-mighty American empire goes through a long period of decline, as the British Empire did before it, as the Roman Empire did before that, and high schoolers everywhere would suddenly realize that the poem Ozymandias has real connection to their lives.

The idea that the real estate industry would somehow experience a rebirth when the country as a whole is either in decline or burning is preposterous. As America goes, so goes the American real estate industry — the reverse, sadly, is not true as we all so painfully learned in 2007-2008.

The thought-provoking exercise for those at REThink Future and for future decisionmakers is, “What should I do in the event of a Crash and Burn?” The features of that story, logically deduced from current dominant facts, are:

• Far higher interest rates, due to US Treasury having to pay higher rates to lenders
• End to or significant limits to the Mortgage Interest Deduction, as well as large scaling back of Federal support for housing finance, starting with the FHA
• Local and State governments getting squeezed between pension obligations and property owners

And so on. Longtime readers of Notorious realize that these themes are not new here.

The Silver Lining

Because stories are powerful things, let me add something about the possible silver lining. The Chinese saying that there is always opportunity in a crisis proves apt. There will be massive opportunities in any sort of Crash and XYZ story. Maybe NAR goes to 150K members. Maybe the industry is totally screwed for five years while the entire country deleverages. But fact remains that people have to live somewhere, and as long as we don’t become a fullblown Communist country (like China where private ownership of land is prohibited), there will be buyers, sellers, renters, and landlords.

So if you’re doing a private scenario planning exercise at home, while reading this post, I would urge you to look at the things you can actually affect. As an individual agent or broker, chances are that you’re not going to get the Senate to approve funding Fannie Mae/Freddie Mac after the Crash. You can’t personally move the economy yourself.  Your answers will be different from mine, which will be different from the next guy over.

But I’ll give you my $0.02 since nobody asked for it. The hallmark of any Crash-type scenario is that people get very focused on the essentials. Anything that isn’t necessary is probably gonna have to go. So look at what is actually essential.

1. Associations: A Crash would actually revitalize the Association, as only the hardest of the hardcore members would stick around afterwards. The MLS may go the way of the dodo bird thanks to advances in technology and shifts in consumer behavior, but there will still be those few who want to come together to do stuff. It will be smaller, more focused, and more valuable to those who remain. So if I’m an Association leader, I start drawing up plans for what my Association looks like post Crash, with 10-15% of the current membership. I start looking at which functions, positions, etc. I cut, and which I keep.

2. Brokerages: A Crash doesn’t have to affect brokerages, since current brokerage model has very little fixed costs. If sales volume drops by 50%, the variable costs (i.e., the agent split) also drop 50%. But a lot of non-necessities will need to go, whether those are nice offices, technology tools for agents, or what-have-you. The obvious thing, however, is that if the Scenario assumes/presumes a Crash, it means home sales will dry up quick… except from investors. And investors invest in real estate because they expect rental income growth. Conclusion: Renter Nation, and the brokerages that figures out how to make money specializing in rentals are the ones who stand to benefit in this scenario.

3. Agents: See Brokerages above. If you’re not tooling up to work with investors and renters, expect pain.

The silver lining in all of this is that after the Crash, the survivors will be stronger, faster, smarter across the board. Because they were forced to become those things to survive. So after we all emerge out the other end of the fiscal storm, even if we’re an empire in decline, those brokers, agents, and Association type folks who are left will be the best and most nimble of them all. There is a good possibility that the industry as a whole would be more efficient, more consumer-centric, and more productive with the few who remain making a very good living indeed.

Of course, it needs to be said once again, that these are the strategic responses to the Crash and Burn or Twilight of Gods scenarios, based on the actual facts facing all of us today. If you don’t buy the Crash or Twilight scenarios, then you’ve got nothing to worry about! Go ahead and sign that lease for 20,000 sq. ft. of office space — it’ll all work out fine.

But… This Is Too Probable

One thing I need to address is the very reasonable and very professional objection to this deconstruction of the Ostrich. It’s stated right at the beginning of the post:

Possibilities not probabilities.

The scenarios are not designed to predict the future but rather to open our thinking to new strategic possibilities at multiple levels—for the industry, for the NAR, and for individual leaders. Resist thinking about the most probable scenario, since most game-changers start out as improbable or hard to imagine (e.g. the Arab Spring, the Internet, etc.). Instead, ask: what strategic questions does this scenario raise? What can we learn from it?

It does appear that my critique is mostly based on grounds of realism — “dominant facts” and so on. A good rejoinder is that I’ve entirely missed the point, which is not to discuss the probable scenario, but the game-changing one that is unexpected and improbable.

For me, the problem with that is, as a former Dungeon Master in a complex AD&D campaign, and an avid reader of both science fiction and high fantasy, I can easily imagine improbable and hard-to-imagine game-changing scenarios. All of them would force NAR and its members to confront major strategic issues.

A few examples of such “Black Swan” type of events:

• Europe absolutely implodes, causing hundreds of billions in losses around the world, as major money center banks are all exposed one way or another to the collapse of the Eurozone. That results in mortgage rates spiking overnight to 18% since even the mighty American Treasury can’t borrow anymore money, because all of the sovereigns around the world impose instant capital controls prohibiting the movement of money and assets across their borders. That means no more Chinese buyers for American T-Bills, or Canadian investors in Phoenix apartments.
• Israel bombs Iran with nuclear weapons that they are coy about having, but everyone knows they have, to prevent the mullahs from getting one of their own. The Middle East blows up, and the United States gets dragged into another war. Taking advantage of the situation, China simply annexes Taiwan, knowing the U.S. is stretched too thin to do anything about it. Global economy goes into a tailspin, and (horror of horrors!) iPhone 5 is shelved since most of the parts come from Taiwan.
• Scientists at the Nanotechnology Lab at Univ. of Illinois make a breakthrough, creating tiny robots that can assemble any physical product molecule-by-molecule. Manufacturing in America becomes 10,000 times cheaper as a result, since these nanobots can assemble everything from a car to a hamburger at the molecular level, and do it on-site. Star Trek technology basically becomes reality, and a brand new BMW can be replicated for about $250 in materials… in your garage. The economy is back with a roar, even though most people are no longer working, since they don’t need to, because these nanobots can create anything out of household garbage and industrial waste.
• Cold fusion is finally perfected by a team of anti-capitalist scientists in Canada, who release the technology to the world as open source so that anyone can make a perfectly safe and efficient fusion reactor at home for about $2,000 and off-the-shelf parts from Home Depot. Every single energy company, oil & gas company, and energy company goes bankrupt, but the economy is no longer dependent on cost of energy. The economy booms like we have never seen in history.

And I can go on and on and on, inventing scenarios that are plausible, not entirely nuts, and pose truly profound strategic questions. It is certainly fun and interesting, but I believe the exercise is ultimately less than perfectly useful.

The point, I think, is to alert various parts of the industry — and specifically the leaders and members of NAR — to what could happen, and what they need to be thinking about as leaders. That can be done most profitably, I believe, with scenarios that are grounded solidly in dominant facts.

Up Next…

In part 3, we will delve into the Beauty and the Beast scenario, which has its own very interesting insights and challenges. Feel free to comment here, or wait until the series is finished (whenever that is).

-rsh