Two Views on Housing

As the housing market continues to flounder despite historical stimulus and artificially low interest rates, we thought it might be a good idea to share a couple of different views on the situation going forward. Our view more closely resembles that of Mr. Schiff's, however the extent of the decline in prices is very hard to even ballpark. What we do feel confident about is that home prices will fall further.

Question #1 for 2011: House Prices

www.calculatedriskblog.com

Two weeks ago I posted some questions for next year: Ten Economic Questions for 2011. I'm working through the questions and trying to add some predictions, or at least some thoughts for each question before the end of year.

1) House Prices: How much further will house prices fall on the national repeat sales indexes (Case-Shiller, CoreLogic)? Will house prices bottom in 2011?

Real House Prices

The following graph shows the Case-Shiller Composite 20 index, and the CoreLogic House Price Index in real terms (adjusted for inflation using CPI less shelter).

In real terms, both indexes are back to early 2001 prices. Also both indexes are at post-bubble lows.

As I've noted before, I don't expect real prices to fall to '98 levels. In many areas - if the population is increasing - house prices increase slightly faster than inflation over time, so there is an upward slope in real prices.

If real prices fall to 100 on this index (seems possible) that implies about a 10% decline in real prices. However what everyone wants to know is the change in nominal prices (not inflation adjusted). If real prices eventually fall 10%, that doesn't mean nominal prices will fall that far. House prices tend to be sticky downwards, except in areas with a large number of foreclosures. That is key a reason why prices have been falling for years, instead of adjusting immediately.

There is no perfect gauge of "normal" house prices. Changes in house prices depend on local supply and demand. Heck, there is no perfect measure of house prices!

That said, probably the three most useful measures of house prices are 1) real house prices, 2) the house price-to-rent ratio, and 3) the house price-to-median household income ratio. These are just general guides.

continue reading......

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Home Prices Are Still Too High

They would have to decline another 20% just to get back to the historical trend line.

By PETER D. SCHIFF / Appeared Wall Street Journal

Most economists concede that a lasting general recovery is unlikely without a recovery in the housing market. A marked increase in defaults and foreclosures from today's already elevated levels could produce losses that overwhelm banks and trigger another, deeper financial crisis. Study after study has shown that defaults go up when falling prices put mortgage holders "underwater." As a result, the trajectory of home prices has tremendous economic significance.

Earlier this year market observers breathed easier when national prices stabilized. But the "robo-signing"-induced slowdown in the foreclosure market, the recent upward spike in home mortgage rates, and third quarter 2010 declines in the Standard & Poor's Case–Shiller home-price index—including very bad October numbers reported this week—have sparked concerns that a "double dip" in home prices is probable. A longer-term view of home price trends should sharply magnify this fear.

Even those economists worried about renewed price dips would be unlikely to believe that the vicious contractions of 2007 and 2008 (where prices fell about 30% nationally in just two years) could return. But they underestimate how distorted the market had become and how little it has since normalized.

By all accounts, the home price boom that began in January 1998, when the previous 1989 peak was finally surpassed, and topped out in June 2006 was extraordinary. The 173% gain in the Case-Shiller 10-City Index (the only monthly data metric that predates the year 2000) in those nine years averaged an eye-popping 19.2% per year. As we know now, those gains had very little to do with market fundamentals, and everything to do with distortionary government policies that set off a national mania for real-estate wealth and a torrent of temporarily easy credit.

If we assume the bubble was artificial, we can instead imagine that home prices should have followed a more traditional path during that time. In stock-market terms, prices should have followed a trend line. When you do these extrapolations (see lower line in the nearby chart), a sobering picture emerges. In his book "Irrational Exuberance," Yale economist Robert Shiller (co-creator of the Case-Shiller indices along with economists Karl Case and Allan Weiss), determined that in the 100 years between 1900 and 2000, home prices in the U.S. increased an average 3.35% per year, just a tad above the average rate of inflation. This period includes the Great Depression when home prices sank significantly, but it also includes the frothy postwar years of the 1950s and '60s, as well as the strong market of the early-to-mid 1980s, and the surge in the late '90s.

In January 1998 the 10-City Index was at 82.7. If home prices had followed the 3.35% annual 100 year trend line, then the index would have arrived at 126.7 in October 2010. This week, Case-Shiller announced that figure to be 159.0. This would suggest that the index would need to decline an additional 20.3% from current levels just to get back to the trend line.

How has the market found the strength to stop its descent? No one is making the case that fundamentals have improved. Instead, there is widespread agreement that government intervention stopped the free fall. The home buyer's tax credit, record low interest rates, government mortgage-assistance programs, and the increased presence of Fannie Mae, Freddie Mac and the Federal Housing Administration in the mortgage-buying business have, for now, put something of a floor under house prices. Without these artificial props, prices would have likely continued to fall.

Where would prices go if these props were removed? Given the current conditions in the real-estate market, with bloated inventories, 9.8% unemployment, a dysfunctional mortgage industry and shattered illusions of real-estate riches, does it makes sense that prices should simply fall back to the trend line? I would argue that they should overshoot on the downside.

With a bleak economic prospect stretching far out into the future, I feel that a 10% dip below the 100-year trend line is a reasonable expectation within the next five years, particularly if mortgage rates rise to more typical levels of 6%. That would put the index at 114.02, or prices 28.3% below where we are now. Even a 5% dip would put us at 120.36, or 24.32% below current prices. If rates stay low, price dips may be less severe, but inflation will be higher.

From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices.

In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognize this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with.

Mr. Schiff is president of Euro Pacific Capital and author of "How an Economy Grows and Why it Crashes" (Wiley, 2010).

Mom & Dad - Send More Money!

Ever wonder how all that money you are sending "Jr." is actually being spent down at the University? Turns out, it's probably not being spent as you might have hoped. Does any of this actually surprise anyone? We sure hope not, but it is a cool graphic from that guys over at Daily Infographic.

They have it broken out into "Back to School", "Non-Essential Items", and "Entertainment". Seems to us that most of this stuff could be considered non-essential. We are not suggesting you ask to see all Jr.'s receipts next year, although, we bet some of you just had that thought cross your mind!

Source: Daily Infographic

Free Ride is Over

There are clearly those in the mainstream media that want us to ignore these types of proclaimations, such as the one from Sen Colburn recently. Our view is that all opinions need to be heard, regardless of how overly dramatic they may seem. Our readers will undoubtedly hear the mainstream view from other sources with far greater reach than our blog, so we will share the alternative view....

Sen. Tom Coburn repeated his warning Sunday that the United States will experience "apocalyptic pain" if the country fails to immediately address its economic problems, and he called upon President Obama to lead the way.

"If we don't experience some pain now, we're going to experience some apocalyptic pain," Mr. Coburn, Oklahoma Republican, said on "Fox News Sunday."

He said the upcoming debates — including ones on federal spending cuts and the U.S. debt level — should not be a "standoff" between Democrats and the incoming wave of GOP conservatives in Congress.

Mr. Coburn said he hopes the president "gets out and hold hands with us."

He said that not resolving U.S. economic issues could result in 15 percent to 18 percent unemployment, the "middle class destroyed" and the poor hurt most by inflation.

Mr. Coburn also said the country could have potentially ruinous economic problems like those in Greece and Spain.

© Copyright 2010 The Washington Times, LLC. Click here for reprint permission.

Another View on Inflation

Hey, look, regardless of where you fall on a given issue, it is very important to listen to the opposing argument and keep an open mind. In the spirit of the holidays, we took some time to read Scott Sumner's post on disinflation over at his blog The Money Illusion.

One of the issues he did not touch on was precious metals. I would sincerely like to get his take on why we are seeing a ten year "blow your face off" bull market in gold. One of the aspects of his blog overall that we love is his point that at the end of the day, monetary policy is complicated. If you cannot agree with that premise, we think you might want to step back and reevaluate your position.

"During the past several years I’ve repeatedly insisted that the huge increase in the monetary base of 2008 would not produce high inflation. I suppose I was naive in thinking that when it became clear that excessively low inflation was the real problem, the inflation hawks would admit they were wrong and re-evaluate their models. I don’t see much evidence of that happening.

One recent theme has been the supposedly unreliability of the core inflation rate, which is now below 1%. Critics (and cartoon bunnies) point to the fact that food and energy are an important part of the average American’s budget. When it’s noted that even headline inflation is barely over 1%, the attention turns to other prices. For instance, Congressman Ryan has recently argued that the Fed should focus on commodity prices. My initial reaction is to say “Yes! Let’s focus on commodity prices! Commodity prices are the best way to tell if money is too easy or too tight.” Think I’m being sarcastic? Then you are in for a surprise.

Before continuing, I’d like to remind readers that in late 2008 you could count on one hand the number of economists (in the entire world) claiming monetary policy was very tight. So let’s take a look at the change in commodity prices in late 2008:

That’s right, commodity price indices fell by more than 50%. That’s Great Depression-style deflation. And where was Congressman Ryan when the Fed was engineering one of the greatest deflations in world history? I don’t recall him or any of the other inflation hawks calling for easier money. But maybe I missed something. If so, I hope my readers will dig up all the stories of conservatives demanding easier money in the fall of 2008. In any case, it’s good to know that whereas back in late 2008 I was almost all alone in viewing money as being extremely tight, I now have the vast right wing conspiracy on my side. Money really was tight in late 2008. And if commodity prices are now the preferred metric of the right, then I’m half way to convincing the economics establishment that I was right all along. Now I just have to convince the left that money was way too tight in 2008. About those near-zero interest rates . . .

BTW, I don’t mean to bash Congressman Ryan, who is from my home state and is one of the best of a bad lot. If all 435 Congressmen and women were like him we’d probably end up with a much more economically sensible tax and spending regime. But I have to say that the conservative movement has recently been grasping for straws on monetary policy. All their predictions are coming in false, and they aren’t drawing the appropriate conclusions.

Update 12/19/10: This post wasn’t well written. I have always felt that commodity prices were one of many useful indicators of whether money is too tight or too easy. But I left the impression that I completely supported a monetary policy that single-mindedly focused on commodity prices. In fact, I’d prefer the Fed look at a wide range of indicators when estimating market NGDP growth expectations, including stock prices, bond prices, TIPS spreads, forex rates, commodity prices, real estate prices, etc. Many commenters correctly pointed out that commodity prices can be an unreliable indicator, and I entirely agree. I got overly enthused trying to show that if it was the right indicator, then money was ultra-tight in late 2008."

Interesting Take on Lumber

Our friends over at the Global Macro Monitor posted some interesting information on lumber prices. As the chart shows, prices have been moving up recently and have broken out to new highs. The post mentions that the catalyst for rising prices is likely an improving outlook for the economy and for the housing sector.

We would caution that this may be a different animal this time around. Many assets are moving up in value recently, especially commodities. We would not be willing to suggest that this rise in prices is anything more than some inflationary pressures which are now being seen in many sectors.

A Legand is Gone....

We rarely discuss issues outside of the world of business, however, there are some stories that transcend all aspect of culture and society. Many of you may not be familiar with Bob Feller, who passed away yesterday at the age of 92. He was, quite simply, a baseball player the likes of which the world had never seen and most likely will never see again. We are all taken back when we see another human being with skills or abilities that are beyond our wildest imaginations. Then, there are people like Bob Feller, who make us marvel at the limits of humanity. The great athletes of our current generation, such as LeBron and Tiger, are nothing more than afterthoughts when put up against the accomplishments and abilities of Bob Feller. Yes, the world was a different place back then, but not as different as you might like to think or hope. Take a look.....

Also, here is a great article by Frank Deford in the SI Vault.

Total U.S. Credit Market Borrowing

Our friends over at The Big Picture brought to our attention these charts from the Global Macro Monitor Blog that illustrate just now dramatic the drop off in private credit market borrowing was back at the start of the credit crunch. Beautiful charts, but this is the part we have some issues with....

"If, as the President says, ‘the flow of credit is the lifeblood of our economy”, the country would have died in 2009 had not the policymakers taken the extraordinary measures they did. These charts illustrate how close we were to the abyss and should give a clearer perspective on what Bernanke & Co. were/are up against. They are heroes, in our book, for stabilizing the situation and pulling us back from the abyss. The jury is still out, however, on long-term structural adjustment and preventing a global sovereign debt crisis."

Heroes? We think not, when you consider that they only acted in a manner that was perfectly predictable. There was no way they were going to just "let the free market work" and stand on the sidelines. That's not what "politicians" do during times of turmoil, they act, even if those actions will have dire consequences down the road. We only have theories and hypothesis about what would have happened had the free market been allowed to work. However we will all get to document the final outcome of the path Mr. Bernake has lead us down. Stay tuned...

Jim Rogers: "All Of You Who Have MBAs Have Made Mistakes" And You Should Be Farmers Instead

Jim is at his best in this interview. We agree with his overall premise that food prices will be going much higher over the next decade.