Tuesday, April 14, 2009

Home price update (2)

This chart uses the data contained in Shiller's book "Irrational Exuberance." (HT: Mark Sadowski) It is an index of inflation-adjusted home prices using his methodology, and the last datapoint that is available is for Q4/08. Considering the lags in the way the index is measured and published, I've estimated, extrapolating from recent monthly housing price data and inflation data, what the value of the index is likely to be for Q2/09. This in turn is probably a decent guess as to where housing prices are currently. If we consider the period from 1950-1999, when the index averaged 112, to be relatively "normal," then current prices are only about 7% above normal. But considering that mortgage rates are now at all-time lows, and housing affordability by other measures is at or close to record highs, I think it's safe to say that the housing bubble has fully deflated. Housing prices are at or very close to levels that are reasonable—if not attractive—from an historical perspective and from an affordability perspective.

If it is indeed the case that we have seen all or almost all of the decline in housing prices, then this has very bullish implications for the economy and for financial markets. If home prices do not fall further (and indeed start to bounce, as suggested by my Inland Empire anecdote post) then we should begin to see that delinquency and foreclosure rates stop rising. This in turn will put an effective limit on the losses of banks, and it will greatly enhance the transparency and pricing of all the exotic mortgage-backed securities out there, potentially resulting in improved pricing for securities that are now distressed given fears of an ongoing decline in housing prices. The good news would quickly cascade upwards as confidence in banks returned. This crisis started with the collapse in housing prices, and putting finis to that tragic episode is an indispensable part of an eventual recovery.

9 comments:

Mark A. Sadowski said...

Scott,
I dropped by to see your latest posts and was surprised by what I saw here. I was happy to give you the heads up and honored that you followed through by posting this.

I'm not as sanguine about this data as you however and I guess I'm a pessimist by nature. Rents are plummeting across the country and I'm not sure that we should put too much stock in current mortgage rates as a factor. Furthermore in big housing bubble busts there tends to be an overshoot in prices.

My pessimism has served me well in the past (I call it "the power of negative thinking.") I've been busy dealing with a case in point and consequently you probably won't be hearing as much of my criticism in the coming weeks. My ex-significant other is in the hospital with permanent kidney failure most likely due to chronic high blood pressure. Furthermore she may have multiple mylenoma (it is an incurable disease), but we'll find out for sure soon. (She is only 44.) I warned her for years to watch her blood pressure and pay attention to doctor's recommendations. She had been ill for four months and was especially ill the week and a half before I got her to the hospital. I nagged her in vain trying to get her to go to a doctor sooner. One more day and she probably would have been dead.

I gave her my own amateur diagnosis of kidney failure a couple of weeks earlier and she dismissed it as my usual pessimism. But I'm proud of my accuracy (I have absolutely no formal medical training) and I'm rarely wrong about things in general (if I do say so myself).

Thinking about the worst prepares us for that possibility and sometimes helps us avert it. Some of what the economy is going through right now was due to prior excessive optimism. Many of my criticisms here have been in that spirit.

The economy will turn around someday but given today's retail sales figures and the PPI it still appears to me that it will be later rather than sooner. I know you think I'm a permabear but I just think that I'm a well informed realist.

Franco said...

interest rate are at record lows, so rising rates and rising unemployment should put an end to the housing problem! c'mon scott. it will overshoot down. probably for a year at least. the trillions will cause 8% mortgages by summer as pessimism falls in the stock market ( and everyone runs from bonds) . this will start the housing prices to accelerate downward.

Using that graph anyway you like won't work. think through what i propose and let me know what you think.

Scott Grannis said...

Mark: to date your pessimism has been largely rewarded, but recently you have missed out on some pretty good returns on equities TIPS, high yield and emerging market debt and equities. Just about everything has beaten cash by a mile in the past month. Going forward will tell the tale of course.

As I've argued before, it only takes a leveling off of economic activity to make risky investments pay off. You are getting paid handsomely to take risk these days, since the market is still priced to a depression and deflation.

Scott Grannis said...

Franco: I don't think interest rates will rise unless the economy first picks up. The world is so scared of a global depression that bond investors are quite willing to settle for 3% yields. Once even a small degree of optimism returns, then yields will begin to rise. But that won't shut down the economy; higher yields will be driven by a stronger economy and possibly by rising inflation expectations. Plus, to the extent inflation expectations rise, housing becomes more attractive.

I can't rule out an overshoot on the downside for housing prices, but I do think the balance of risks now favors housing investment. Prices are down significantly and financing costs are very low, and some people can even take advantage of a tax credit to buy a home. I'm hearing a lot of people around here say that buying a house is now cheaper than renting. You can buy a house and rent it out and make money. That hasn't been the case for a long time.

I'm an incurable contrarian as well. When everyone is telling me that prices are going down forever and the economy will never recover, and almost no one is willing to be optimistic despite over 3 years worth of a major housing correction, I have a strong urge to bet the other way.

Cabodog said...

Interesting RE stories out of Sacramento:

Median sales prices for area homes up in March:

http://www.sacbee.com/realestatenews/story/1777870.html

Homes for sale in region shrink to 2005 levels:

http://www.sacbee.com/realestatenews/story/1777800.html

Inventory is 8189 homes vs. 16,262 in August 2007.

Also, Sacramento distressed property inventory is down to less than one month.

Doesn't really suggest lower prices, unless the "shadow inventory" of REO homes mentioned in one of the articles gets dumped on the market. Even then, there seem to be a plethora of buyers ready to scoop up affordable homes.

Me thinks the tide is changing in SAC, ground-zero of the housing boom/bust.

Scott Grannis said...

Thanks for the green shoots from the grass roots. Sure seems like we're putting in a bottom here in more than a few places.

Bill said...

Scott: What do you make of the CPI falling again (by a small 0.1%) in March? Is deflation making a comeback or is this just a minor, temporary fluctuation?

Bernard said...

Affordability is a relative measure that not only relies on rates and prices but on the ability of an individual to 1) be in a position to take advantage of the "affordability" and 2) believe that in the future they will have the ability to maintain that "affordability". I do not think your charts capture any of that sentiment. It would be more interesting to see a poll by geographic region of people who plan to buy a home in the next 12-24 months and what the top 3 criteria are for them to pull the trigger.

This blogs needs some counter balance. Where are the next risks coming from? That is what I want to know. In ’97 we had the Asian crisis, ’98 the Russian default and LTCM, in ’00 it was the dot bomb followed by some corporate malfeasance, and by ’07 the whole system was kaput. With TRILLIONS of government money floating around the Global system, where is the next disaster coming from?

Scott you are as good if not better than the next Economist but I think this world needs some balance, is that to idealist in this day and age?

Bernard

Mark A. Sadowski said...

Scott,
My own version of gree shoots: Maureen tested negative for multiple mylenoma. Phew! I may be able to criticize you more frequently sooner than I thought.