Thursday, August 16, 2007

Food for Thought

This is NOT a prediction, it's just a projection, based on historic trends.

Housing prices over the past century+:

Click for larger image

This chart is based on the work of Dr. Robert Schiller, the bestselling author and Stanford economist, based on 116 years of U.S. housing market data.

One interesting feature is the huge dip in the middle of the chart. Although it's been labeled "Great Depression" by the graphic artist, it's clear that the inflation-adjusted price of existing homes was plunging fifteen years before the stock market crash, including all throughout the "Roaring Twenties". I've read an explanation that attributes this to advances in materials, construction technology, and construction techniques which greatly lowered the cost of new homes, similar to what happened with automobiles.

Note also that although inflation-adjusted prices have centered pretty consistently around $ 110K since WW II, in the past few decades we've been getting a lot more house for the money than they used to in the 60s and 70s, so the value received per dollar spent has been going up* - again, similarly to automobiles.

* At least, it was until the turn of the century.

22 Comments:

Blogger Bret said...

Anything's possible, I suppose. That'll be quite the economic disruption if it actually does come to pass (the 40+% drop in housing prices)!

However, I'm skeptical (as always) even if it is a "projection" as opposed to "prediction".

In modern times (post WWII), note that pull backs are about 15%. My understanding is there's natural resistance at that level - people can't afford to move with losses greater than that so they just stay put until the demand at that price returns. Since the latest runup is so huge, perhaps that number is bigger, but it's hard for me to believe that it's 40+%.

There are ever more restrictions on who can build where and what they have to pay for before they can build. The local and state governments who do this think they're sticking it to the developers. Of course they're not. They're sticking it to all new and potential homeowners since they're the ones who ultimately pay for the lack of supply relative to demand. I don't see anything to mitigate that lack of supply (especially here in California), so I don't see prices dropping all that much.

Also, as we all get richer, eventually I would think that we will allocate more and more of our wealth to owning desirable property so I expect over the next centuries the housing prices to trend up.

On the other hand, for my daughters I wouldn't mind seeing a big correction so that one day they can afford a house too.

August 16, 2007 5:27 AM  
Blogger erp said...

bret: Have more confidence in your daughters. Assume they'll excel in life and be able to afford their dreams just as you did.

Our housing experiences mirrors this graph. We about broke even on houses from our first one in 1956 to about 1980 when we sold a house for $500,000 we had purchased a few years earlier for $75.000. After a couple more very profitable real estate transactions, we retired and moved to a small town that time forgot on the Florida coast.

Unfortunately, developers remembered us, but that's a story for another day.

August 16, 2007 6:25 AM  
Blogger Oroborous said...

Sure, many people will simply stay put, but some people have to sell, and others will walk away, leaving the mortgage companies to take whatever they can get.

Since prices are set at the margins, even if 90% stand pat, the market values of all of their homes are going to drop to something close to what the desperate are willing to take.

Further, even if prices simply stagnated for a decade, (and they're actually falling at the moment), if we had 3% inflation for that decade, then in the end those nominally-stable prices would reflect a real loss of 25% of value.

In modern times (post WWII), note that pull backs are about 15%.

This has been the largest national housing boom of the past 116 years. My guess is that we're not going to have an average retreat from the high.

It seems very reasonable to me to think that we could eventually see an inflation-adjusted pullback of 33%.

August 16, 2007 7:04 AM  
Blogger Bret said...

oroborous,
I don't disagree with an inflation adjusted pull back of 30+%. But that will take far longer than the graph shows. If we're all the way back down by 2011, I'll really be surprised.

August 16, 2007 10:21 AM  
Blogger Harry Eagar said...

The joker in the deck is the approaching deaths of the generation that accumulated the greatest wealth in history. As their children, who are also accumulating wealth at a great rate, inherit, they will be able to pour money into real estate if they want to.

This applies to that fraction that gains wealth. The other fraction, which doesn't, has been priced out of housing for a long time, and their situation is going to get worse, not better, I think. (It's true, as Oro says, that you get more house for the dollar now. Where I come from, almost everybody has moved up from a single-wide to a double-wide.)

Anyhow, while I don't question that graph, I cannot believe FHA didn't affect the housing market, although I don't see it.

Somethin' funny goin' on.

August 16, 2007 10:43 AM  
Blogger erp said...

Harry, then you question the timing?

Just kidding.

Hey the president's daughter, Jenna, got engaged and Padilla was found guilty on all counts.

Good news does happen. Rejoice.

August 16, 2007 12:20 PM  
Blogger Harry Eagar said...

The runup in housing prices has not b been excessive in terms of year-over-year advances.

But I question a curve that is smooth when such events happen as a massive shift from renting to owning.

Also, until the Levitts and similar builders started including appliances in the sale price, houses were sold 'bareboat.'

I did a story about housing (my first, as a matter of fact) in 1973. The cheapest house for sale in my city was priced at $36,000, but the builder told me $6K of that was for appliances, primarily built-in A/C.

The house would have been unsalable without it.

Factoring that in would flatten Oro's graph even more.

I don't believe the value of my house really went up 50% in the last two years, but that's what the tax assessor says.

Also, national figures mask what's going on. Skipper and I had lunch in Honolulu last Friday and we discussed housing.

No doubt about it, there should be at least 2 curves -- one for places where, as bret says, the government interferes, and one where it doesn't.

So, as usual, I find myself disaggregating the aggregates.

August 16, 2007 3:16 PM  
Blogger Oroborous said...

Also, national figures mask what's going on...

Sure. But in this case, they're very relevant, and not just a point of academic interest, because the consequences of the unwinding will be felt nationally, in terms of lower consumer demand and fewer jobs.

Some places will be much harder hit than others, of course. Contra Bret, I expect to see home prices in Central and Southern California at 40% below their peak by 2010.

The SoCal housing bust of the 90s was nearly that bad, and the preceeding boom hadn't been nearly as strong as this one has been.

Over the past two years, over half of all mortgages made in SoCal were stated-income, adjustable-rate mortgages.

What that means is that there are tens of thousands of nominally-homeowners in SoCal who lied about their incomes to secure mortgages that they can't make the payments on when the teaser rates reset. They're essentially just leasing their homes.

Everyone on all sides of the real estate transactions were well aware of what was going on, but it was in everyone's interest, IN A RISING MARKET, to facilitate what is officially fraud in order to keep the boom rolling along.

The problem that arises is that the market is now falling. The boom there has well and truly ended, and those stated-income borrowers have NO HOPE WHATSOEVER of securing refinancing on favorable terms, which was their only option to keep their payments low enough to carry.

I'm not overstating the case when I write that they absolutely WILL NOT find anyone to refi them, unless they can come up with some serious money to put down. The credit markets came perilously close to grinding to a complete halt this week, and we're still in the opening stages of the blow-ups over bad mortgages.

2008 is going to be a "Year from Hell" for people in the finance world, and pension-fund managers, and indeed the next few years are going to be a crucible for less-experienced people in the finance and construction industries, and all of sectors which support them - the kind of event that leaves a career-long mark on those who survive, like those who experienced the oil-patch meltdown in the 80s.

For instance:

"Moody's Investors Service said on Thursday that it downgraded 691 mortgage-backed securities because of 'dramatically poor overall performance.' These residential mortgage securities were originated in 2006 and backed by closed-end, second-lien home loans, Moody's said. ... 'These loans are defaulting at a rate materially higher than original expectations'"

Some useful sites for anyone interested in picking up some more info about the subject:

www.globaleconomicanalysis.blogspot.com/ - a little bit on the sensational, "sky will fall" side, but well-written and very informative.
www.calculatedrisk.blogspot.com/ - concentrates almost exclusively on the housing bust, very reasonable tone.

August 16, 2007 6:33 PM  
Blogger Oroborous said...

Some southern California real estate info...

From Orange Co., CA - the ocregister site:

O.C. home-buying slump equals '89-'91 decline

"The streak goes on. DataQuick reports today that July marked the 22nd straight month that O.C. home shoppers bought fewer homes than the year-ago period. (O.C. buyers snapped up 2,391 local homes in July, or 43.5% below the 20-year average!) This selling slump ties a similar streak from June 1989 to March 1991 for the longest sales drought in the 20 years of DataQuick sales figures."
[Emph. add.]

Also, the median sales price for new single-family homes and condos dropped by 18% from July '06, and even with the much-reduced prices, (and the recorded drop in official sales prices doesn't include the added value of now-common incentives such as upgraded kitchens or free plasma TVs), sales figures are off by 26% from a year ago.

From another ocregister article:

Riverside County median prices are down 4% from a year ago, and sales are off by 42%.

San Bernardino Co. median prices are down 3%, and sales are down 43%.

San Diego Co. median prices are down by 2%, and sales declined by 13%.

Again, this is before the full effects of ARM resets and much tougher mortgage refi requirements, which we'll be seeing in '08 and '09.

August 16, 2007 9:44 PM  
Blogger Bret said...

oroborous wrote: "I expect to see home prices in Central and Southern California at 40% below their peak by 2010."

I'm sure some house somewhere will sell for more than 40% below its peak. As far as an aggregated market, say nominal median price in San Diego Metropolitan Area, I'll be very, very surprised. There's only 29 months before then. If we do get that rapid and deep a pullback, housing prices will be the least of our worries - it'll be a sign that something's happened to the real economy (as opposed to this non-real finance stuff).

o also wrote: "The SoCal housing bust of the 90s was nearly that bad..."

Here in Sunny San Diego, the nominal drop in the median price was about 17% and that took 6 years. I expect that or a bit more over the next 5 years this time around.

o also wrote: "The credit markets came perilously close to grinding to a complete halt this week..."

A complete halt? What, is the Fed on vacation? If not, then, by definition, the credit markets won't grind to a complete halt. Take a deep breath - everything's gonna be all right.

oroborous wrote: "I'm not overstating the case when I write that they absolutely WILL NOT find anyone to refi them, unless they can come up with some serious money to put down."

Relatively few people bought right at the peak (that's part of the reason it's the peak - demand was getting soft at those prices). Anybody who bought before 2003 has a lot of equity in their houses. Also, lenders are known to refinance somewhat more generously in conditions such as these (they can only handle so many foreclosures so if they think there's a reasonable chance the borrower can make it through they give it a shot with some sort of payment restructuring).

oroborous wrote: "2008 is going to be a "Year from Hell" for people in the finance world..."

You're really buying into this gloom and doom thing, aren't you? I suggest taking another deep breath. You might be right, but I'm not worried at all.

oroborous also wrote: "San Bernardino Co. median prices are down 3%, and sales are down 43%. "

That's what happened last time (and the time before) as well. Sales collapsed but sale price did not. People just put their houses on the market and waited, in some cases many years, until they got a price they were willing to take. ARMs are not a new thing, by the way.

August 16, 2007 10:36 PM  
Blogger Oroborous said...

If we do get that rapid and deep a pullback, housing prices will be the least of our worries - it'll be a sign that something's happened to the real economy (as opposed to this non-real finance stuff).

Financial stuff is non-real in the same way that gravity is - it can't be touched or seen, but it's quite capable of killing you.

It's very real to people over the past five years who paid an extra hundred grand or more for their home because they were competing to buy with hot-money speculators who were buying five houses at a time. They're out an extra eight grand a year, every year.

It's also quite real to the hundreds of thousands of people who have already been thrown out of work due to the housing bust, and the millions more who will follow.

Here in Sunny San Diego, the nominal drop in the median price was about 17% and that took 6 years. I expect that or a bit more over the next 5 years this time around.

Add in inflation, and the real median price in SSD was down by a full third last time.

As for expectations, look again at the headline chart and consider that it wasn't Salt Lake City, Dubuque, and Peoria driving housing prices to heretofore unseen heights. It was places like Southern Florida, Las Vegas, and Southern California, and those are also going to be ground zero for the meltdown.

You might want to look at what's happening in Vegas and Southern Florida, by the way. Florida's nominal prices are already down by 50% in places like Key West and Miami Beach.

Relatively few people bought right at the peak (that's part of the reason it's the peak - demand was getting soft at those prices). Anybody who bought before 2003 has a lot of equity in their houses. Also, lenders are known to refinance somewhat more generously in conditions such as these (they can only handle so many foreclosures so if they think there's a reasonable chance the borrower can make it through they give it a shot with some sort of payment restructuring).

True, people who bought before 2003 ought to have a lot of equity in their homes. However, this real estate boom has also seen a boom in home equity loans. Homeowners have been taking out an aggregate total of hundreds of billions of dollars worth of equity every year - $ 600 billion in 2005 alone. Therefore, many fewer households actually have significant home equity left than a quick look at purchase dates would suggest. They've already spent it.

As for payment restructuring, sure, that could work, as long as lenders are willing to extend that 2% teaser rate for thirty years.
For instance, only 16% of households in the LA metro area can afford to purchase the median-priced home, using "conforming" loan standards. So there are many tens of thousands of nominally-homeowners who have no hope of carrying a rationally structured mortgage. For them, it was always a bet that home prices would continue to increase, and that they'd be able to refi every year or two.

ARMs are not a new thing, by the way.

When was the last time that ARMs made up two-thirds of mortgages issued, as was the case last year in SoCal ?

Never, that's when.

Ordinary people are about to have the lesson driven home that leverage cuts both ways.

August 17, 2007 7:51 AM  
Blogger Harry Eagar said...

Well, not 'ordinary people' as such. If people move on average every five years, then 95% of Americans (ordinary by definition) have mortgages (if they are owners to begin with) older than 5 years, less whatever percentage refinanced.

If they've been making payments for 5 years, presumably they can keep doing so, unless they are in a bad ARM.

But, to get into a bad ARM, one of two things had to happen. 1. You were speculating. 2. You weren't really participating in the economy in the first place.

It's a big country.

If housing prices fall way off peaks in So. Cal., that enlarges the 16% who can afford to buy. It wipes out the nuts and the never-hads. So much to the good.

I am a business reporter, of a humble and unsophisticated kind. But sometimes I think I got a better handle on it than the competition.

For example, the other business publications around here made much of big percentage increases in bankruptcy filings after 2001.

Following my practice of disaggregating the aggregates, I looked at the captions of the filers.

Turns out the spread between claimed debts and claimed assets was, in over 90% of filings, less than the price of a second-hand pickup truck. Wiping these people out of the economy had no effect on business conditions.

If you want to see big percentage dips in the market price of real estate, check out Hawaii hotel sales since 1991.

August 17, 2007 10:05 AM  
Blogger Bret said...

oroborous wrote: "Financial stuff is non-real in the same way that gravity is - it can't be touched or seen, but it's quite capable of killing you."

Killing? Unless you're borrowing from the mob, I don't think there are too many deaths from financial hardships. If you count people that get so distraught they commit suicide, I suppose, but I personally attribute that sort of thing to emotional instability, not finance.

Look, I don't disagree that some small percentage of people in the U.S. are going to have some hardship. Big Deal. People took risks and got burned. I've taken risks and got burned - nobody shed any tears for me and I wouldn't've wanted them to.

What I'm saying is that it will make only a little tiny difference to the economy overall.

Secondly, financial assets are unreal in that the houses are still standing, someone will continue living in them, the economy will keep going, etc. All that's changed is who gets to control some of the money which is, for the most parts, just data in a computer.

oroborous also wrote: "Add in inflation, and the real median price in SSD was down by a full third last time."

Sure, but I don't think it makes sense to apply the national CPI when the region is clearly experiencing a deflation due to falling house prices. If that's what you wanna do, fine, but it paints a picture that's not felt on the ground by those of us here.

You keep using words like "killing" and "meltdown". I just don't see it as being anywhere near so dire. It'll correct itself, and quickly, and have minimal effect on the economy.

August 17, 2007 10:45 AM  
Blogger Oroborous said...

If housing prices fall way off peaks in So. Cal., that enlarges the 16% who can afford to buy. It wipes out the nuts and the never-hads. So much to the good.

It wipes out everyone whose home is their only substantial asset, which encompasses far more than speculators, nuts, and never-hads.

Hundreds of thousands of families are going to have their lives significantly altered for the worse.

While it was inevitable that the mania would end badly, not everyone who participated did so avariciously. A lot of people just wanted a house for their families, and lying about their income and accepting responsibility for paying back a loan that was ten or twelve times their gross income looked to be the only way to do it, after a few years.

I don't view what's going to happen with glee.

If you want to see big percentage dips in the market price of real estate, check out Hawaii hotel sales since 1991.

Is that due to fewer Japanese tourists, because of Japan's long-running economic problems ?

August 17, 2007 10:51 AM  
Blogger Oroborous said...

All that's changed is who gets to control some of the money which is, for the most parts, just data in a computer.

Here's an example of a guy who can't be so cavalier. For him, the fact that someone else is controlling the data in a computer that used to have his name on it will have extremely real consequences, despite the abstract nature of money:

"The Pittsburgh Post Gazette has the sad story of a man whose lifetime of saving evaporated with the collapse of Metropolitan Savings Bank.

"Raymond Przybilinski socked away $521,000 from a lifetime of driving trucks, working overtime when he could and playing the piano or accordion late into the evenings at weddings, hotel bars and social clubs.

"The money was destined for his five children. But that was before more than half of the family nest egg disappeared on Feb. 2 as state banking regulators seized Metropolitan Savings Bank in Lawrenceville, citing "unsafe and unsound" operations. When Mr. Przybilinski tried to take his money out, the man in charge of Metropolitan Savings' assets informed him that there was only $200,000 left to withdraw -- the amount protected by the federal government."

Was he taking a risk? Sure. Did he realize it? Doubtful.

Life ain't fair and all that, but it's only Monopoly money that's non-real, because winning or losing the game has no effect on the rest of your life.

I don't think it makes sense to apply the national CPI when the region is clearly experiencing a deflation due to falling house prices.

Yes, that's true, but only if you assume that people are going to buy another house in the same region with the money that they get from selling their current home.

If they're going elsewhere, or are paying medical bills, or buying a vehicle, etc., then the regional deflation in housing is simply irrelevant to their loss of purchasing power.

I just don't see it as being anywhere near so dire. It'll correct itself, and quickly, and have minimal effect on the economy.

I strongly disagree that it will be quick or have minimal effect, but from your lips to God's ear.

August 17, 2007 11:17 AM  
Blogger Harry Eagar said...

Yes, the imputed value of their homes will fall, but the only use of a house is to live in. They will still live in the houses. Where's the harm?

Back in the '80s, my brother did some consulting work for a manufacturer of gold jewelry. They were playing the futures market and had a big advantage because when they guessed wrong, they could always accept delivery.

Finally, they got to a point where they were $415 million ahead, and they woke up and said, 'Hey, this is nuts. What we know how to do is turn gold into jewelry. Let's go back to that.'

So they did.

++++

The Hawaii hotel prices (as of other trophy properties bought with fat yen, like Pebble Beach golf course) declined because they had been purchased (in some cases with loans that paid NEGATIVE interest or with 100-year yen mortgages) that were far beyond their ability to support with revenue.

Houses in So. Cal. don't produce 'revenue,' but they have an imputed revenue equal to their rental value. If they cannot support that, the price falls to the next seller.

The prices the Japanese paid were ridiculous -- tulip mania ridiculous -- and had to fall.

They fell faster because the yen dropped, because California demilitarized and because tourism dropped after Gulf War I.

Some properties sold for half what they had cost to build.

Anyhow, it's always a bad bet to lend money to people who have to borrow to pay the interest. That's who are mostly going to get shaken out in this contraction, and we're better off without them.

August 17, 2007 11:29 AM  
Blogger Oroborous said...

Yes, the imputed value of their homes will fall, but the only use of a house is to live in. They will still live in the houses. Where's the harm?

There is none, as long as they don't have to move for any reason, and they can continue to service the mortgage.

But if it takes a decade for people to be made whole, as happened in SoCal during the 90s, then a lot of people will have to move for various reasons during that timeframe.

And, we know beyond a shadow of a doubt that one unique feature of the SoCal real estate bubble is the extent to which ordinary people, who didn't intend to speculate and don't think of themselves as gamblers, were buying houses with mortgages that were essentially intended to be short-term loans, bridge financing.
A lot of them won't be able to make the payments on the kinds of refi loans that they now qualify for, since the hot money's gone, and they can't make the payments on their current loan either, once the long-term provisions kick in.

August 17, 2007 12:00 PM  
Blogger Bret said...

oroborous wrote: "...but from your lips to God's ear..."

Or was that Allah's ear? Yahweh's? Satan's? I can't keep track anymore.

August 17, 2007 6:12 PM  
Blogger Harry Eagar said...

So, how are they worse off than they would have been if the value of their purchases had just stayed flat.

They put nothing in, they lived in the house while making mortgage payments that turned out to be rent, and they walk away and start over.

They may carry a deficiency judgment against them that will make it hard to get credit in the future, but they shouldh't have had credit.

Don't miss my drift. US housing is seriously messed up. That free market you guys admire so much does not deliver modest 2-bedroom houses for people to buy, so if they do buy, they have to try to buy 5-bedroom, 2,000-square-foot mansions. At least in So. Cal.

If they don't buy, they rent crummy, badly-designed 'garden apartments' and kick themselves for not getting on the gravy train like their friends who did take ou t crazy mortgages.

Where I grew up, people lived in tarpaper shacks, which was a step up from log cabins (and the poorest were living in log cabins still when I was a boy). From tarpaper shacks they went to single-wide trailers, then double-wides, unless they were ambitious and lucky.

Go to Atlanta. For mile after mile, you will see hundreds of thousands of mansions that attempt to and nearly do emulate Tara. Goody for them.

Try to find the next step down in that market.

August 17, 2007 7:15 PM  
Blogger Hey Skipper said...

I was living near Oxford, England, from the late 80s through the early 90s.

During that time, the government added the M-40 (M-4?; heck, I can't remember) to the motorway network. Consequently, the drive time from Oxford to London dropped by at least half.

Hello, housing price boom. As my arrival there -- typically -- proved that in life, like comedy, the secret is in timing, I got there as the motorway was nearing completion.

What was clear to me then was that housing prices had reached a point where there was no longer a market of capable buyers (college tuition is hurtling in this direction).

Whereupon the market proceeded to tank. (Thankfully, I decided to rent).

Which is part, if not all, of what is happening in places like LA.

When I was selling my Rochester, MI, house, a couple from San Diego made an offer, contingent upon the sale of their home: a 750 square foot ranch on a postage stamp, asking $500,000ish.

They were prepared to pay 60% of that for a house just under four times the size (basement excluded), with a three car garage, on a one-hour yard*.

Having grown up in SoCal, I know San Diego has a wonderful climate, but at some point shoveling snow might seem a reasonable burden to bear.

I ended up taking another nearly identical offer, without the contingency.

And suffered the kind of baby seal beating you read about in the papers -- $289K, compared to the 2000 purchase price of $336. I prefer to ignore the cost of the driveway and deck I replaced in 2005.

Had I not put %25 down on the house, we would have been writing a significant check to get out from under the thing.

Of course, had I taken most of that 25% and put it in the market, I would have had a lot more money to write that check with.

Then, having bought high and sold low, I turned around and bought high.

Proof positive that I have a tin-brain for business, and should be thankful I can find employment as a glorified heavy equipment operator.

August 17, 2007 9:51 PM  
Blogger Bret said...

"I know San Diego has a wonderful climate, but at some point shoveling snow might seem a reasonable burden to bear."

Never!!!!!!!!!!!!

(Of course, since I can easily afford my mortgage, easy for me to say).

August 17, 2007 10:38 PM  
Blogger Oroborous said...

Fannie Mae Predicts Price Decline Will Accelerate in '08

By David S. Hilzenrath
Washington Post Staff Writer
Friday, August 17, 2007

"Fannie Mae, the mortgage finance giant, yesterday predicted that housing prices will decline by 2 percent on average this year and by 4 percent next year as mortgage delinquencies rise, lenders tighten borrowing standards and the volume of unsold homes approaches record levels.

""This is clearly a market poised for more severe overall credit losses," Enrico Dallavecchia, Fannie Mae's chief risk officer, said in a conference call with investment analysts.

"Adding to the trouble, Dallavecchia said, is that many borrowers with adjustable-rate mortgages are facing rising monthly payments, which could drive them into foreclosure. "This could have a cascading effect in the market," he said."

Courtesy of Calculated Risk.

August 18, 2007 12:06 AM  

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