August 25, 2009
Good news on house prices
I was happy and surprised to see that the nominal S&P/Case-Shiller seasonally adjusted Home Price Index rose by 0.75% in June for a composite of 20 U.S. metropolitan areas.
Let me explain first why I was surprised. I am expecting the unemployment rate to rise further, and feared that this plus the existing inventory of unsold homes would continue to put downward pressure on home prices.
Let me explain second why I see the increase in house prices as a favorable development. The key problem facing the financial sector has been the loss in the market value of securities constructed from U.S. home mortgages that may not be paid back. Falling home prices are a critical determinant of default rates, which in turn will ultimately determine how much those securities are really worth. If home prices have stopped their decline, a huge burden has been lifted from many financial institutions.
This isn't like 2005 when it was almost certain that prices would fall, and fall sharply. Now we are much closer to the bottom than to the top in prices (for some metrics, see House Prices: Real Prices, Price-to-Rent, and Price-to-Income). In some areas prices have probably already hit bottom-- like some non-bubble areas, and some bubble areas with significant foreclosure activity.
But I think many areas, especially the mid-to-high priced bubble areas, there will be further price declines. I'm not as certain as I was in 2005, but I think these price declines will drag down the Case-Shiller indexes-- and I don't think the price bottom is in.
I do not have a crystal ball, but ...
It seems there are many more foreclosures coming. Some of this depends on the success of the modification programs, but the Q2 MBA delinquency report shows a growing number of homeowners in the problem pipeline. And the Fitch report yesterday suggests few of these delinquent homeowners will cure.
That seems to mean rising foreclosures, and more distressed inventory. The MBA Chief Economist Jay Brinkmann thinks foreclosures will peak at the end of 2010. Historically prices bottom about the same time as foreclosure activity peaks....
I could be wrong-- this isn't as certain as in 2005-- but I don't think house prices have bottomed. If I'm proven wrong, I'll be the first to admit it.
My experience has been that when CR and the conventional wisdom see things differently, he's right and the rest of us are wrong. But I think we agree on this much: the uptick in the Cash-Shiller indices was a surprise, and, if it holds, very good news.
Posted by James Hamilton at August 25, 2009 08:52 PMdigg this | reddit
On the other hand, prices are still too high, or vacancies would be much, much lower. So I have mixed feelings.
Posted by: wcw at August 25, 2009 10:10 PM
Could the $8,000 rebate for first-time buyers have to do anything with it? In the part that you skipped, CR goes into a brief discussion that the rebate could have had the same effect on the demand for houses as the cash for clunkers had on the demand for cars.
Second, I would not worry about financial institutions, I worry about the labor/consumer, the 90% of us who, according to Merrill, account for 58% percent of consumption. Where to from here? Will our quality of life and, importantly, work remain comparable or its downhill from here?
My biggest disappointment so far is the total neglect of innovation and industry, and I mean not financial "innovation" or financial "industry", but the real thing. Once Brad Setser asked on his blog what comment posters thought should have been done to alleviate the crisis. I wrote that investment in innovation would be the key - the greatest investment: breakup monopolies and award direct grants - not loans and not just give aways but awards through a competition process based on novelty and feasibility of ideas - to small businesses and start-ups. Of course, most other posters worried about the QE and what would that do to their bags with money. So, after those who have nothing to do in the shrinking economy are evicted from their houses and displaced into nowhere and after bad loans are swept onto the balance sheet of the FED, the financial sector would start lending again - for speculation and leverage, and another cycle would take its course, followed by another bust and another leg down - this being not just a business cycle, but a staircase to the bottom. Someone must recognize that this is not a good way to go forward..
Posted by: biofuel at August 26, 2009 12:39 AM
The chart shows that house prices have not reverted back to the mean if the long-run expectation for housing price increase is roughly inflation. So Bernancke's liquidity tsunami and the NAR-lobbied tax credit for home purchases may end up supporting house prices above historical norms.
That may be an unalloyed good for Banks, but its debatable that this development would be good for the economy as a whole. Like a patient that recently got over malaria detecting the onset of fever, seeing housing prices rebound before mean reversion seems a matter for concern.
I see the stock market as being 20% over-valued on a dividend yield basis and take this to be another sign of excess liquidity. If my perceptions are correct - and I'm an engineer and business person, not an economist, so I freely admit I could be wrong - these price imbalances will eventually correct and we'll feel the pain of a bursting bubble again. I'll feel better about the future if CR is correct.
Posted by: OregonGuy at August 26, 2009 05:17 AM
Why do so many subscribe to the view that higher house prices are better? It is absurd. We all want the prices of everything else we buy to go down but for some bizarre reason so many people want house prices to be higher.
A related absurdity is the notion that easy access to mortgages "makes homes affordable". What nonsense. It just pushes prices up and makes everyone a debt slave. Only the banks should love easy mortgages, not the folks who "benefit" from them.
Posted by: John Smith at August 26, 2009 05:43 AM
John-- higher home prices help those who already own homes and hurt those wanting to buy homes.
But their are a lot more people who already own than those wanting to buy.
Through the wealth effect higher home prices encourage confidence and spending by home owners.
That is why it is good news, because it helps more people than it hurts.
Posted by: spencer at August 26, 2009 06:29 AM
No surprises here. The fad of banking system collapse is going away as fast as it arrived.
Now the real acceleration begins.
Posted by: Ivars at August 26, 2009 07:38 AM
Except in the low end of the market, stimulated by the $8k credit and "investors" scooping up foreclosures, hardly anything is selling here in the Chicago suburbs. Above $500k, especially above $600k, we have multiple years of inventory on the MLS even though only what absolutely has to be sold is listed -- sales rates are down nearly 80% from bubble peak. Yet the asking prices have still fallen very little, almost certainly because they are set by the amounts of the underlying mortgages, and the only way they can go lower is if the mortgage holder agrees to a short sale or forecloses and takes a loss on the REO. So the prices up in middle and high ranges of the market are not market-clearing prices -- only very few sales are being made, presumably to people who either feel they must buy or who think the market is going to come back soon.
Eventually, those homes are going to be foreclosed upon, and sold at much, much lower prices.
Posted by: jm at August 26, 2009 07:44 AM
spencer - re: the housing wealth effect.
I don't buy this argument, unless the homeowner is withdrawing equity through additional loans, which, if common, indicates a bubble to me.
I experience a wealth effect from my bank, brokerage, 401(K) balances. A house is not liquid - I have to find a greater fool to buy it - and there is no meter on the wall telling me what it is worth day-to-day. And even if it is worth more, I have to trade down to realize a gain since all other homes I might buy if I sell went up in price too.
Besides, do we really need to encourage spending in the U.S. now that savings rates have just turned positive?
Posted by: OregonGuy at August 26, 2009 08:06 AM
The one true positive aspect of the HPI numbers this week is that we are starting to see the seasonality return to the market, which strongly indicates that the market is beginning to return towards normalcy. But it has a long ways to go!
Technical aspects of the way these RSI series are constructed make them very unreliable (noisy) for the recent past even in normal (smooth) markets; with markets exhibiting cusps or even just higher-order curvature, these indicies have large errors. (Witness the size of the revisions.) Cruze-Cutts at Freddie has written quite a bit about this.
Also, note that the recent imposition and then expiration of foreclosure moratoriums greatly distorted market behavior and thus pricing in many markets, and there is solid evidence that this is now showing up in the RSI series in a big way.
Lastly, from a fundamental POV, there still are a great number of pressures on housing prices:
- Unemployment, the classic driver of housing difficulty, is continuing to worsen
- Homeowners are being educated and strongly encouraged to engage in ruthless default, and the volume of ruthless default is climbing rapidly, yet it will be a while before the corresponding (future) short sales or foreclosures filter into the RSI series
- Bank lending standards remain extrodinarily tight, to the extent that the market in most areas is dominated by investors purchasing foreclosures and REO disposal properties with cash financing (often in multi-property transactions, which can distort housing data)
- Rental housing remains available and lower cost, continuing to provide a ready alternative to ownership in most markets
As far as HPI determining the value of MBS, well, first, the market value of the securities took a haircut far too large to be based on HPI - instead, liquidity and uncertainty were, and remain, prime drivers. And the RA's still have a long way to go with properly refining their models. It is still very challenging to fund positions in these securities!
Further, many mortgage models place as much, if not more, emphasis on the cure rate as they do on HPI; with cure rates falling off a cliff, the outlook remains dim. For all the hype and hoopla, loan mods aren't working, even where they are available. Lastly, I will note that as much as banks have written down structured finance assets, many/most banks are still carrying whole loan mortgages (both resi and commercial) on their books at 100: these are the real problem assets now, and it is a very challenging problem. Banks that sold off mortgages and bought back (retained) positions in the AAA of the structure are in way better shape, just to hammer a bit on the structured finance bit....
Posted by: Dr. D at August 26, 2009 08:18 AM
It is good news to the extent that it helps financial market participants restore confidence in the economy.
However, don't housing prices typically continue to slowly unwind in the early part of a recovery from a recession? Measured unemployment will likely continue to increase as discouraged workers return to actively seeking employment.
Posted by: GNP at August 26, 2009 08:33 AM
"But their are a lot more people who already own than those wanting to buy."
Presumably those who own homes also "wanted to buy" at some point in time? Your logic breaks down. The number of home owners and home buyers summed over time is exactly equal. We were all buyers once, and would we not have preferred to buy at a lower price back then?
In any case, a high home price does not help most owners - they can never realize any "gain" because they still have to live somewhere.
Posted by: John Smith at August 26, 2009 09:41 AM
I expect home prices to increase as inflation begins to be manifest. As the currency declines in value traders attempt to trade depreciating dollars for appreciating hard assets. Housing fits this better than most. A home is something most average families can "invest" in. In an inflationary environment it is natural for the demand for real property to be greater.
I have been expecting home prices to increase not as a sign of recovery but as a sign that inflation is beginning to become manifest.
It is pretty clear that our current credit crisis and real estate bubble was caused by artificial expansion of consumption and the resulting decline in savings. It is strange that economists would see a return to these condisions as healthy.
Posted by: DickF at August 26, 2009 10:21 AM
JDH: "My experience has been that when CR and the conventional wisdom see things differently, he's right and the rest of us are wrong."
One thing that is interesting about CR's analysis is that he will often describe things in terms of sequences of states - e.g. he has talked about patterns of volume versus price, commercial versus residential real estate etc and the sequence they tend to follow in the business cycle. Is there a canonical way to formalize that kind of thinking (e.g. Markov state models with only one off diagonal element per row)?
Posted by: Robert Bell at August 26, 2009 10:35 AM
biofuel:"Could the $8,000 rebate for first-time buyers have to do anything with it?"
Very much so. Heard a stat on the news that a very high percentage of re-sales is low end houses and first time buyers utilizing the $8K. Not sure I remember the actual percentage right, but it was something like 40% of sales.
Normally I get as miffed as anyone about my tax dollars going for free stuff for other people, but in the context of a $3.5 Trillion Fed budget, I can see significant indirect benefit from this and also the cash4clunkers program. I think these are the two best bang for the buck programs going.
Posted by: Cedric Regula at August 26, 2009 10:55 AM
My understanding for those rattling on about inflation is that this index already is in real terms, accounting for that.
What is more hopeful is the same index for the price-to-rent ratio, which is much more hopeful. For Case-Shiller, it is indeed back to about the long-term average, partly due to increases in rents in recent years, which is not such a good thing. However, the FHA series shows that one still a bit above the longer term averages (and still falling).
Somebody posted on this recently showing these graphs on angry bear.
Posted by: Barkley Rosser at August 26, 2009 12:06 PM
CR did an analysis a few weeks ago of the trend in house prices during and after the 1980-81 recession, when we last had a major housing crisis mixed in with an economic decline. In that instance, housing prices continued to decline for another 3 or 4 years (I've forgotten the exact number). Who knows this time, but we should not be surprised if housing prices decline for another 3 to 5 years. The $8,000 rebate would make one expect some small rebound - look at what Cash for Clunkers has done for cars. Lastly, Bernard Baruch said, "Markets will fluctuate." I'm not at all surprised.
Posted by: Mike Laird at August 26, 2009 02:21 PM
Well, I was around in the 80s, so I know that mortgages started the decade at a Volker induced 12%, then banks slowly got over their inflation fears and I was able to re-fi at 9% by the late 80s. Then mortgage rates steadily declined thru the 90s and this decade, but now we get in a tizzy if they break above 5%. Why? It makes housing prices go down. Conversly, 25 years of generally falling rates must of had a lot to do with price appreciation.
So any future forcast of housing prices needs to take into account the future direction of mortgage rates. Also, the Chinese stopped buying GSEs and MBS a year sgo. CDO/CDS deals ended as well. So I don't think we are headed down from 5%.
Posted by: Cedric Regula at August 26, 2009 05:43 PM
The main advantage in maintaining home prices, I think, is the salutory effect on bank balance sheets and the effect on consumer demand. (Despite the fact that we have to live somewhere, an increase in the perceived value of the housing stock has shown to increase consumption more effectively than the same increase in the value of equities. And you can cash in on your home value without moving - just take out a reverse mortgage in your old age.)
I agree with Cedric R. - keeping more people in their homes may reduce the need for bailouts to lenders and help the budget deficit indirectly by keeping up GDP. On the other hand, it is a short-run, kick-the-can-down-the-road type of solution. When the temporary effect on home prices recedes, we are left with a bigger price decline (or smaller increase) in future.
It looks very much as though we will be in a double-dip recession, bouncing-along-the-bottom environment for some time. If Asian currency interventions increase with a temporary U.S. recovery, the end game may be particularly bad.
I recall many days running to CR's website and being comforted after looking with dismay at the rising DOW (which I started shorting in early 2007 on grounds that the consumer debt and home prices were unstainable) and wondering whether it was my views or those of Mr. Market that were fundamentally at sea.
Posted by: don at August 26, 2009 06:38 PM
I think this is a temporary spike. This country is not at all in the clear when it comes to the housing market. I am trying to hang in there because in a couple of months if I don't come up with the money, I myself will be in foreclosure. The job market still sucks and I have not found a job as of yet. It's been a year now. It's really bad here in New York. In any event, I know this will all turn around but it won't be anytime soon and I know my situation will turn around too. I just don't know when. I have to keep it together for my family. Well, back to job hunting tomorrow.
Posted by: William at August 26, 2009 09:20 PM
James, there is no such thing as a national housing market, consequently no index derived from such a market has meaning. When you look at the indices for the individual markets that comprise the national index a somewhat different picture emerges.
Housing prices in a number of troubled markets continue to fall, e.g. Las Vegas, Detroit. Quite a number of markets moved a little up, stayed the same, or a little down. Nothing particularly noteworthy.
To my eyes the market that showed the biggest turnaround was Minneapolis, exceptional among Midwest markets in that it was showing a sharp decline. The latest numbers have reversed that somewhat.
The commenter above who pointed to the first-time buyer incentive as a contributing factor is probably right. However, I doubt that we'll see the most troubled markets right themselves until their actual problems are confronted, which a one-size-fits-all policy neglects to do.
Posted by: Dave Schuler at August 27, 2009 07:23 AM
Based on current factors, I would guess like most that we're somewhere near a floor. However, if inflation risk materializes and interest rates rise off their historically low levels, then housing will get hammered again. I wish that wasn't my expected case, but somehow that's where I come out.
Posted by: Steve Kopits at August 27, 2009 08:01 AM
Anyone consider the implications of housing prices falling the same time interst rates were rising this winter? Did the stimulus talk drive up interest rates?
Posted by: aaron at August 27, 2009 09:18 AM
The Fed's purchases of mortgages are a big factor ($1.25 trillion planned this year, of which about half has been spent). That, the first-time-buyer subsidy and the federal guarantees on most mortgages could well create an early and artificially high bottom despite the high vacancy rates and continuing foreclosures.
There is likely to be a double dip as Fed and government intervention is withdrawn. And all interventions must be paid for, with interest.
If we learn anything from this recession, it should be that artificially inflating housing prices is not good for the economy.
Posted by: Tom at August 27, 2009 03:16 PM