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CR,
I downloaded a working paper version of the forthcoming paper from the NYFed website (one of the coauthors is from the NYFed).
If you consider interest rates and rents, 1982 was the worst overvaluation in housing ever! Not coincidentally, the economy was in the the depths the worst recession in the postwar era with 10.8% unemployment. Interest rates were north of 16%. So, you had extrenely high cost of carrying and extremely low benefit (high unemplpyment and therefore low rental demand). If that kind of period is the benchmark, then housing today is undervalued indeed. Of course, I have not heard of anybody say that housing was a bubble in 1982.
The major problem that I have is that comparable rental for single-family homes are typically impossible to find, which makes the whole exercise pretty futile. The only place where you can get good quality rental data is for condos. Surprise, surprise--the paper excludes precisely those.
The rent-versus-buy decision is asymmetric. It is relatively costless to move from rent to buy than the other way around, becasue of people's psychology with respect to sunk costs. That is the major reason why prices are sticky downward. As such, prices did not collapse in 1982. Only transactions collapsed. Prices are also slightly sticky upwards, becasue people will generally not tend to bid up home prices to the full extent of interest rate drops. However, prolonged interest rates declines, such as we have had in the last several years, will tend to create price momentum and expectations that feed on each other and lead to overshooting.
If houses were so greatly valued, what explains the difficult so many people have in afforiding to buy them and the move toward risky financing? Clearly, the risk of price decline for a leveraged asset like housing, ought to figure somewhere in the calculus.
One fact that gets repeated ad nauseum is that nationally home prices have never had decline in the postwar era (they did decline during the Depression). True enough. The reason is that with 20% downpayment, people usually had equity and a reason to stay. And because people dont like to sell at a loss (even though that is a sunk cost), transactions fell off instead of prices. That is not the case now. There are many who dont have much equity. More importantly, many dont have the financial wherwithal to go through a moderately rough period, let alone a horrendous downturn like 1982.
Lastly, some of the facts in the paper are plain wrong. They note that the number of buyers with more than 90% LTV has actually declined in the last few years. This is nominally true for "conventional" mortgages isofar as they take into account only the first mortgage. Two objections. One, a large percentage of primary mortgages today have a piggyback homeequity loan (second mortgage) of anywhere between 10-20% of the value. Two, conventional mortgages are a lower and lower fraction of total orginations. Most of the crazy fina
The housing bubble may be more impacted by press coverage than the Stock Market Bubble was. For most Americans, housing is far more important than their stock portfolios. And houses can't be disposed of as easily as stocks can (well liquid stocks). If enough people believe there's a bubble, then prices will fall.
Some anecdotal evidence. I am clearly seeing more property come on the market in the past few weeks in my neighborhood. What is interesting is that those priced in $2 million for 5000 sq.ft are sitting around. For context, this is the San Francisco Bay area. I have seen the first "price reduced" sign. I see properties that where hanging around get re-listed at lower prices. Realtors here are talking about buyers hesitating and being more cautious and adding the contingency of sale of their house. So this could get interesting as deals could fall out of escrow if the buyers find they cant sell their house for what they expected. I think the state of the market this coming spring the supposedly best time for real estate transactions would provide a very good indication of where housing prices are headed.
I caught the "Bubble Trouble? Not Likely" opinion piece in today's WSJ. The argument,in my mind, seemed to be pretty weak and based on one statistic only. However, I did find it interesting that the two gentlemen who wrote the piece are both professors of real estate. I am sure they have side consulting gigs, speaking engagements, etc., within the real estate industry and this may help them form their arguments.
I am sure they have side consulting gigs, speaking engagements, etc., within the real estate industry and this may help them form their arguments.
Actually I don't think that probably effects their view point all that much... My guess is they REALLY believe the 'New RE Economy' hype... Oh I am sure some don't believe it yet still hype it... like some of the dotbomb analysts who pumped-n-dumped... But just like 2000 most of them believed the hype then and I am sure most of the RE folks believe their own hype now.
Tea,
1982 does make an interesting comparison. Do you have a link for the paper at NYFed? Consider for instance, that from 1970 to 1982 median US house prices increased 194% (using NAR data), while CPI went from (using 1982-1984=100 as per CPI BLS) 37.8 to 94.3, which yields a change of 149%. If you consider 2nd quarter 2005 prices, since 1993 you get an increase of 95% for US median home prices. CPI for 1993 to 2005 is 38%. 45% versus 57% over a twelve year period is not such a terrible difference. However, in 1983 BLS implemented the rental equivalence housing component of the CPI. A BLS study comparing both older and newer versions of the CPI for the period 1978-1998 found that the rental equivalence downwardly biased CPI in their study for the years 1978-1982 by 1 percentage point per year. Strangely enough, if you account for and generalize that bias, you get identical real home price appreciation percentages (either were understating current inflation, or overstating older inflation.) Also note: 1) the very mediocre nominal house price increases from 1981 to 1985 2) the real home price loss running from 1980 until 1985 3) the very high mortgage rates of the time (rough avg. 12 16% from 1980-1985) allowed for easing of rates to cushion the blow to weakening real estate. While there is still some downward potential in mortgage rates (4%, 3%, ??), there is not really the kind of room for accommodation that existed in the 1980s (by 1987 rates were 9%, and by 1993 7%) without risking very undesirable scenarios. From that perspective, the comparison is rather gloomy for the present time.
http://www.bls.gov/opub/mlr/1999/06/art4full.pdf#search='BLS%20rental%20equivalence%2019781982'
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
Historical Data
JS,
I will get you the link tomorrow.
My point in bringing up 1982 was to highlight the contrast. In 82, the economy was in the depths of a terrible recession, interest rates were sky high, and credit conditions were tough. Yet apprently housing was terribly overvalued. Today we have a growing economy, much lower unemployment, and easy credit conditions. Still, apparently housing is grossly undervalued relative to 1982. I wonder what it will take to get housing to be overvalued. Also, imagine how undervalued housing would be if we were to get into a recession. That would be the greatest buying opportunity ever. (sarcasm)
I read the WSJ article. I somewhat agree that correct statistic to observe is the monthly cost of owning versus the monthly cost of renting, because this is how people think economically about a house. This statistic really makes sense when most people have fixed rate mortgages, but now most people in the "bubble" coastal markets have adjustables. As short term rates move up (25 bps Fed increase tomorrow), the cost of owning a home on an adjustable mortgage will rise and the studies key statistic will change.
tea, Here is the paper: Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions
I didn't read it all. I will be polite and just say I disagree.
Best Regards.
Hey, CR. I think you misquoted me. My specious analogies all involve booze, not drugs.
You're so polite about that NY Fed piece. I seem to remember The Fleck having a good rant about it; I'll see if I can find that.
FYI about Ohio: it isn't a price bubble market, as you note. It is, however, a mortgage fraud hotspot (at least in some of the cities). I will go on record any day in agreement that the lenders ought to be held responsible for making fraudulent loans, or buying them from fraudulent brokers. And furthermore, (this is the "controversial" claim) lenders are responsible for writing lending guidelines designed to make a killing in the bubbly markets that incidentally make it easier for fraudulent loans to get into the system. The dynamic here is that all the "stated income" and "reduced appraisal" stuff that (perhaps) makes sense in California, where markets are strong and employment is generally more stable, is creating opportunities downmarket (in the more troubled economies of the midwest and south) for the predators to feed.
Apres le bubble, the fraud problem will come out of the woodwork and it will be unspeakable. That ought to worry investors a whole lot. (You think you have the ability to put back a defective loan? You wait til the courts find out how bad your due diligence was--you're lucky not to end up being considered a party to it.)
CR,
Thanks for the paper link. The paper contains very poor argumentation and Im surprised and dismayed to see it at the Fed. The caveats alone bring it into question: exclusion of condominiums (as Tea mentioned), use of OFHEO data which excludes all non fnma and fmac transactions, expectations of capital gains are used to justify the current value of housing (begging the question), whatever their model does not reveal cannot be a factor (increased use of ARMs cannot be a factor since it does not show up in their model), etc. In addition, their numeric calculations are incorrect. Using their own data, the real price appreciation in 1995-2004 is 3.9%, not 3.6% (this kind of inaccuracy really disturbs me in financial documents.) If you use broader measures of the real estate market like NAR data, real median house price appreciation is far more egregious: using NAR and BLS shows a real price increase of 41.7% from 1975 to 1995, not their mere 10% over two decades. I dont know what these guys are smoking or what their vested interest is, but the numbers really speak for themselves: NAR US home median home price 1970 $23,000, NAR US median home price 2005 $208,500, BLS CPI 1970 37.8, BLS CPI 2005 193.2. That yields a 906.52% nominal increase with a 411.11% inflation adjustment. With 73% of firsts showing an LTV of 71% or higher (2004 data from Mortgage Bankers Association), this is really a story of absolutely massive credit expansion. Who needs jobs, income, productivity or infrastructure when you can borrow ad infinitum.
JS
JS, good analysis. I agree that the paper is surprisingly poor.
Tanta, please excuse my confusing drunks and bartenders with dealers and crackheads! I agree with your comments on fraudulent loans, but I expect most "bad" loans to be made in reasonably good faith. I would expect most mortgage brokers follow the rules and try to maximize their income - so I think the major problem is systemic.
Best to all!
Copying to here what I just wrote on Thoma's blog ...
The Fed version of the paper ends with "Our evidence does not suggest that house prices cannot fall in the future if fundamental factors change. An unexpected rise in real interest rates that raises housing costs, or a negative shock to a local economy, would lower housing demand, slowing the growth of house prices, and possibly even leading to a house price decline. However, this fact does not mean that today houses are systematically mispriced."
I don't know whether to laugh or cry when I read, "An unexpected rise in real interest rates [may cause housing prices to decline]. However, this fact does not mean that today houses are systematically mispriced."
It seems to me that purchasing in a time of historically and anomalously low long-term interest rates, with 4:1, 9:1 or even higher leverage, an asset whose price is so interest-rate sensitive, and which cannot yield cash flow sufficient to cover loan and tax payments, is simple insanity.
What an exquisite manifestation of the concepts of Austrian School theory of the business cycle! Could there be any better example of how too-low interest rates cause people to make bad business decisions?