Tuesday, November 30, 2010

Real home prices: 18 months of stability

This first chart shows the inflation-adjusted value of the increasingly-popular S&P/Case Shiller Home Price Index. Prices have been essentially flat for the past 18 months. It's tempting to see a bit of weakness in the most recent months, however. Many observers are calling for a renewed decline in prices due to a flood of foreclosed homes hitting the market once the "robo-signing" problem gets straightened out. My view for some time has been that prices have fallen by enough already to clear the market and establish a new equilibrium level. In real terms, the average house price has fallen 35% from the early 2006 peak, and is only 15% above the early 2000 levels.

Taking into consideration that 30-yr fixed rate mortgage rates have declined from 6% in early 2006 to 4.5% currently, that equates to an effective decline in the monthly cost of purchasing a home of about 50%, not to mention the fact that real personal incomes are up over 6% since 2005. Do prices really need to fall further?

The second chart shows the Case-Shiller index of housing prices in 10 major markets (the first chart includes 20), and it includes data back to 1987. Prices today are 44% above the level of 1987, which equates to an annualized rate of gain of 1.5%. But again, this is less than the rise in real personal incomes (which averages about 3% per year), and less still considering that mortgage rates were in the low double-digits in 1987. Houses are far more affordable today than they were in 1987.

This last chart is an updated version of the one in Robert Shiller's book, "Irrational Exuberance." This inflation-adjusted index extends all the way back to 1890. Here we see that current real housing prices are 32% above their 1890 levels, which equates to an annualized rate of gain of only 0.2%, far lower than the rise in real incomes. It's no wonder that the average person can buy bigger and better houses today than their ancestors did.

None of these charts rules out a further decline in prices, but they do lend support to the view that prices have declined meaningfully to date, and are no longer out of line with historical price trends. Considering the ongoing rise in real personal incomes and the historically low level of mortgage rates today, the average home price has never been more affordable. I can't rule out further home price declines, but I think they are very unlikely.


brodero said...

Since central air conditioning didn't come into prominence until the 1950's I always problems with housing
charts going way back. This chart looks like Shiller at work....the dude is way too academic in his observations...especially when you include data that has William Mckinley as President...

Benjamin Cole said...

Excellent post, but real estate remains in a deep recession.

I have mixed feeling about this; we overinvest in real estate, thanks to the tax code. Yet our economy is what it is. If real estate does not come back, I see long, very long term pain for many middle-class families (ie your biggest investment is a dud) and small businesses (try getting an SBA loan w/o postng collateral, ie real estate). Banks will suffer (try collecting on property loans when the value of the property is less than the loan).

These problems could cascade, as banks become even less willing to lend on property, leading to Japan-style perma-recession-deflation.

Can't happen here? Ddi anyone in Japan, 1990, expect it to happen to the-then world's most vibrant economy?

Who would expect that the yen would appreciate mightily, but Japan would become an economic backwater, and stock and property values would fall by 75 percent over 20 yers?

Benjamin Cole said...

OT, but I always like hearing about Milton Firedman, my favorite thinker, let alone economist.

Milton Friedman Supports Ben Bernanke on Quantitative Easing

David Beckworth relays a catch by Doug Irwin:

http://macromarketmusings.blogspot.com/2010/11/case-closed-milton-friedman-would-have.html Case Closed: Milton Friedman Would Have Supported QE2: The debate over what Milton Friedman would say about QE2 can now be closed. Below is a Q&A with Milton Friedman following a speech he delivered in 2000. In this excerpted exchange with David Laidler, we learn that Friedman's prescription for Japan at that time is almost identical to what the Fed is doing now with QE2:

David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?

Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”

It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.

So Milton Friedman said in 2000 that the Bank of Japan should do what the Federal Reserve would be doing 10 years later! In fact, if names, dates, and places were changed in the above excerpt one could get a 2010 Ben Bernanke Q&A. Friedman's belief that a zero policy interest rate could be contratctionary and thus required the central bank to buy long-term securities shows that he understood unconventional monetary policy long before it was vogue. He truly was a great economist.

Benjamin Cole said...
This comment has been removed by the author.
marmico said...

A couple of suggestions to improve your charts. Specify whether you are using SA or NSA index values and which (BEA?) deflator.

Another heads up. The Federal Reserve uses the CoreLogic HPI. The data is more granular and timely and now shows year over year nominal price declines.

The second leg down in residential real estate commenced the month after the tax credit expired.

Bill said...


Does it make sense for the EU to try another tack in fighting this contagion issue? Seems a shame that all of the positive US data news is going to waste on the Euro debt crisis which looks like it might lead to another world financial crisis.

Scott Grannis said...

Bill: the signs of contagion (e.g., swap spreads, equity prices, sovereign debt) are not strong enough to suggest we are on the verge of a world financial crisis. US swap spreads, for example, are still at levels that are perfectly consistent with normal conditions. Sovereign spreads suggest that the PIGS are about as risky as junk bonds. Euro swap spreads are still well below the levels of last May/June. Equity markets are still doing relatively well. Implied volatility of equity options is way below prior crisis levels. That's not to say things can't get worse, but the market has a hair trigger for these things by now, the news is all over the headlines, and yet there is still no sign of panic.

Steve Fulton said...

Probably the best (or at least the least wrong) way to look at housing costs is as a percentage of real income. On that measure, housing, as an expense item, is as cheap as it has been in 40 + years. Having said that, it is not homogeneous enough to classify as an investment asset as either rich or cheap. A condo in Vegas is worth pretty much nothing-clearing levels should be in the 50% of construction cost area, while multi family or single family in say Austin (where adults run the state and local governments) are probably pretty decent investments.

marmico said...
This comment has been removed by a blog administrator.
Bill said...


There is no question that Atlanta will be behind other cities regarding a commmercial real estate recovery. However, it's better than it was last year and will improve next year based on the deals we are seeing. And yes, the AIA billings index is down this month from last month's reading but there are still some signs of life out there, at least for the larger firms that do business over seas. Enjoy your circle jerk with Krugman and Roubini.

Frozen in the North said...

Talking your book doesn't equate to analysis. Very glad to hear that thinks are great in Atlanta (2% of America's population), but what's that got to do with America? America's reality is that for 10 year too many homes were built, people are upside down on their mortgage.

The primary implication, is labor mobility. If you cannot sell your house in Miami, you cannot take the job in Atlanta, or New York.

The economic drag of a stagnant housing market that cannot clear its excess supply is detrimental to economic growth, since labor mobility is a key component of GDP growth.

Brodero: As for Case Shiller, they have taken into account "home improvements" that's why there is a 3 month lag on their index. It takes into consideration these changes.