Friday, October 24, 2008

Home sales activity picking up

As noted before, home sales are picking up, and look to have bottomed out. This has got to be very good news, since it means housing prices have fallen to levels that are now allowing the market to clear. If prices find a bottom soon, this will remove a huge source of uncertainty from the market. I keep thinking that with the Fed ensuring that money is available to those who want it, the market can sort out the subprime losses and life can go on, and this financial nightmare will soon fade into the past.

One hurdle that has popped up of late is government waffling on whether the debt of Freddie and Fannie is actually backed by the US government or not. If the government were to walk away from the mountain of debt these agencies have issued, it would be a true nightmare of unthinkable proportions. Clarification of this matter is needed urgently.


Howard said...

Steve, I just found your blog from Larry Kudlow. Keep up the good work as I love your info and hope you are right. HJ

Scott Grannis said...

Thanks, I hope so too

Spiral said...


Did you hear anything today about Great Britain's economy? I thought I heard that it contracted more the previous quarter than in 16 years.

Do you know of any good web sites that would report this kind of economic news?

Spiral said...


Sorry. I found the answer to my own question. It's a piece from bloomberg.

London Olympics May Need 500 Million Pounds; Fundraising Fails

The U.K. economy shrank more than forecast in the third quarter, evidence that Britain is in the grips of its first recession since 1991. Gross domestic product dropped 0.5 percent from the second quarter, the first contraction in 16 years, the Office for National Statistics said today.

Mark Gerber said...

Hi again Scott,
Thanks again for your thought provoking blog.

I suspect you already know the Case-Shiller index is derrived from weighted buy/sale price pairs for the same house. Price changes for homes that turnover more frequently (ie. less time between transactions) receive a higher weight. I believe this makes Case-Shiller more of a marginal price indicator as opposed to an average price indicator such as OFHEO (and Realtors, which generally tracks OFHEO). Of course, other apples-to-oranges differences may exist as well, such as Case-Shillers tendency to normalize Americas trend towards larger average house size while OFHEO is subject to this bias.

The marginal price should set the market equilibrium price, but in real markets this takes time. I believe this explains why Case-Shiller rose about 80% from 2000 to 2007 while OFHEO only rose about 40% (based on your inflation adjusted charts). At this time, using your extrapolation of the current Cash-Shiller level, it looks like Case-Shiller is still about 25% above its 2000 while OFHEO is about 35% aover its 2000 level. Based on these observations alone, and assuming these two indicees are otherwise apples-to-apples (which they are not, as you point out, at the very leatt because of the different geographical coverage) it looks like average housing prices have at least 10% more to fall to just catch up with Case-Shiller.

Case-Shiller probably also over-represents employee owned houses versus employer owned houses. I hypothesize that employers move less often because they are anchored by the businesses they own. Thus, I would guess that Case-Shiller is more correlated with median prices than average prices, and this is why I think Case-Shiller might normalize somewhat for house size.

Finally, I am wondering about the price deflator you use for your inflation adjustment. I recognize this is a bigger topic, but I would sure like to understand inflation metrics better. Ever since the Boskin commission reformulated the CPI, it does appear to track the personal consumption deflator closer, but it seems to me that the true cost of living for most Americans has actually been going up at a rate closer to the pre-Boksin CPI. Gold also appears to have been confirming this higher inflation rate post-Boskin. If this higher inflation is the better measure, then housing prices may truly be nearing a bottom.

As always, I look forward to your thoughts.

Best regards,

Scott Grannis said...

Spiral: when it comes to measuring GDP, remember that 0.5% is very much within the zone of standard error. GDP growth is often revised up or down by that much after all the numbers are finally in. Also note that GDP numbers in the US are traditionally annualized, whereas in most other countries they are not. So the 0.5% drop in one quarter in the UK would be a 2% drop in the US.

Scott Grannis said...

Mark: excellent observations which make sense to me. The price deflator I used for this was the personal consumption deflator. In my experience I have come to believe that it fairly represents actual inflation, whereas the CPI tends to overstate inflation. I know that many people think the CPI understates it, but I have spent many years looking at the numbers and they always seem to add up correctly. No measure of inflation is perfect, and sometimes they seem to lag reality, but over a period of years I think they do a pretty good job.

Of course, there are leading indicators of inflation such as the value of the dollar and the gold price. But as we have seen recently, they can be very volatile. A persistently weak dollar and a rising gold price would be signs of rising inflation in the years to come.

Most measures of inflation are going to be very low or negative for awhile, due to the big drop in energy prices. They key thing to watch will be the "core" measures which exclude energy.

Spiral said...


Can you elaborate on the nightmare of the government defaulting on Fannie and Freddie debt? I am sure you are correct. But can you describe how this impact would be felt if the government did try to wiggle out of their prior committment to those debt holders?

Scott Grannis said...

There is about $1 trillion of debt that has been issued by government sponsored enterprises (GSEs), most of it by Freddie and Fannie. This debt was always considered to be the next best thing to Treasuries--extremely safe. As such, it was purchased widely by large institutions around the world.

Freddie and Fannie are essentially bankrupt right now, and only continue to exist because they have been taken over by the government. The shareholders of both were wiped out in the takeover, but so far the holders of the $1 trillion in bonds are up in the air. Will they be wiped out or not?

The other day a government spokesman backed away from saying that Freddie and Fannie's debt was fully backed by the government. He wanted to make a technical qualification. But to some it sounded like maybe they might be abandoned.

Because of these ongoing concerns, the spreads on agency debt have soared over the past 10 days to record levels of rough 150-175 bps. This is I think what is keeping other spreads from coming down.

The default on $1 trillion in debt that was thought to be as good as Treasuries would send shock waves throughout the global financial system, and would seriously undermine the credibility of our government. It is virtually unthinkable.

Someone in the government needs to make sure the message is clear.