2006 December 09 Saturday
Official Figures Understate Housing Price Declines

David Leonhardt of the New York Times reports that official figures on housing prices understate the extent of the recent housing price drops. An auction of houses in Naples Florida showed a 25% decline in housing prices in the last year.

The highest bid on one three-bedroom ranch house with a pool was $671,000. In 2005, the same house sold for $809,000. Another house, just steps from Naples Bay, received a high bid of $880,000, compared with $1.35 million a year earlier. On average, the bids suggested that the houses at the auction had lost about 25 percent of their value since 2005, according to Thomas Lawler, a real estate consultant who analyzed the results.

After tripling since 2000 the 25% decline still leaves Naples with very expensive housing.

Many sellers hold off from selling when prices decline. Auctions show what prices are at when sellers are committed to selling. Though perhaps auctions draw lower prices because they only bring in buyers who are on the market looking on the day of the sale.

The US government thinks Boston area prices rose by 1% in the last year. But industry sources put the price drop at anywhere from 10% to 20%.

In reality, homes across much of Florida, California and the Northeast are worth a lot less than they were a year ago. The auction in Naples may have exaggerated the downturn in the market there, but not by much. Tom Doyle, a Naples real estate agent, estimated that a typical house there, sold in the normal way, would go for about 20 percent less than it did the previous fall.

In the Boston area, prices have fallen about 10 to 15 percent since the middle of 2005, estimated Chobee Hoy, who owns a real estate brokerage firm in Brookline. Jerome J. Manning, who runs the Massachusetts-based auction company that conducted the Naples sale, told me he thought that values had dropped about 20 percent around Boston. (The government, meanwhile, says the average price rose 1 percent from last summer to this summer. But here’s all you need to know about how well the government tracks the Boston market: the index excludes any mortgage larger than $417,000.)

People pulled so much money out of their homes with mortgage refinancings that the average home owner in the Boston area has no more paid equity in their home than they did in 2000. What else has changed since 2000? The nation as a whole has sold huge amounts of government debt to foreigners as we've run increasingly larger trade deficits.

Are we looking at a asset bubble burst recession in 2007? I can think of one way for the US government to economize as tax revenues decline: Pull out of Iraq.

Leonhardt sees three reasons why the real estate price index reported by the US government's Office of Federal Housing Enterprise Oversight is misleading:

But it has three big weaknesses that end up making it much less useful than it could be. First, it excludes any mortgage over $417,000, because Fannie Mae and Freddie Mac — the two big mortgage buyers — don't own loans so large. Obviously, many mortgages on the coasts are bigger than that.

Second, the data for individual metropolitan areas includes not just house sales but also appraisals done for a mortgage refinancing. Appraisal values, as many people know, tend to be inflated.

Finally — and by necessity — the index includes only houses that have actually sold lately. In a falling market, with an enormous number of properties for sale, the houses that are selling tend to be more appealing than the average house.

What I wonder: When the baby boomers start retiring will there be a big bust in housing prices?

Paul L. Kasriel, Senior VP and Director of Economic Research at the Northern Trust Company, has written a great article arguing that the real estate bust has quite a ways to go to hit bottom: The "Carry" Trade in U.S. Housing Looks to be Over.

Former Fed Chairman Greenspan has recently commented to the effect that the worst of the housing recession is behind us. History is not on the side of this view. Chart 3 shows the peak-to-trough percentage declines in the GDP line item, real residential investment. In the prior nine housing cycles, the average peak-to-trough decline is 24.6%; the median is 22.6%. The peak-to-trough decline to date in the current housing recession is 7.9%. Unless this turns out to be a more moderate than usual housing recession, unlikely given the amount of speculation and leverage involved in the boom, then we have "miles to go" before we can put this housing recession "to sleep." Thus, don't look for the carry trade in housing to turn profitable any time soon.

Prices are down. Prices will probably fall further. But will the affordability of housing return to what it was, say, 10 years ago?

Share |      By Randall Parker at 2006 December 09 08:12 PM  Economics Housing


Comments
Rich said at December 10, 2006 2:14 AM:

Nouriel Roubini is an economics professor at NYU who has done an analysis of the housing market. He believes that up to 40% of the growth in employment since 2001 is directly related to housing. This doesn't include employment in secondary areas like appliances or construction related transportation. He also believes we will be in a full-blown recession by Q2 next year. A recession would mean higher unemployment, more people selling houses, and fewer buying. The downward spiral would begin. There are absurd loans available. (Subprimes, Option ARMS, Interest-Only) And people have been buying real estate like it was a 90's tech stock. Altogether it looks like a very ugly housing market ahead.

And your point about baby boomers is also very relevant. Many of them will be looking to downsize on retirement, or else have been counting on house sales to help finance their retirement. That will be a continuing trend over the next 20 years. So we have a ridiculously overpriced real estate market driven by very low interest rates and a gold rush mentality on the part of lenders and builders. Real estate has become the equity investment of choice. Loans that should have never been issued are common. And you have an aging population with a large number of retirees coming up.

Sound like Japan anyone?

Randall Parker said at December 10, 2006 8:20 AM:

Rich,

Another important factor in housing prices is interest rates. What's the big wild card in interest rates? China. They buy US debt. That keeps down US interests rates. Will downward pressure on the dollar force the Chinese to give up their dollar peg? They are holding that peg by buying US debt. Will they stop buying US debt? That'll cause a big rise in US interest rates.

Actually, a Chinese abandonment of their currency peg to the dollar brings double whammy: No Chinese purchase of US Treasury bonds means a big drop in the dollar which means a big rise in the price of imported goods. The resulting inflation would force the US Federal Reserve to hike interest rates. On comes a recession plus the cost of mortgage payments goes way up. Then people suddenly won't spend as much to buy a house. Their chief cost is the monthly mortgage payment. Prices must come down to make the mortgage payment affordable.

Also, the retirement of the boomers will decrease the amount of capital available as the boomers switch from net savers to net spenders. That'll also put upward pressure on interest rates.

Plus, when the boomers retire the US government's finances will reach a crisis point and taxes will go up. That'll decrease the after tax income available to buy houses and hence lower demand.

But there's another twist that cuts in a different direction: A cheap dollar means that US building materials (e.g. lumber) become cheaper for the Chinese to buy. That'll drive up demand for US building materials and put upward pressure on prices. That'd tend to drive housing prices up rather than down.

crush41 said at December 10, 2006 12:23 PM:

Of course, that double-whammy wallops the Chinese twice as well: the debt they hold becomes worth less and their biggest export partner loses lots of its buying power. How long will this 'artificial' absurdity continue?

David Lajaunie said at December 11, 2006 10:07 AM:

The OFHEO Housing Price Index (HPI) is based on Fannie Mae and Freddie MAC data of repeat SFD home sales using conforming loans from those institutions. Consequently, it represents a rather small sample of the residential sales market and does not report private sales, new home sales, condos, attached or multi unit sales. As mentioned, it also underreports high-end sales due to the current conforming first mortgage limit of $417k. Furthermore, it is sampled and subject (as is the Census data) to a fairly large error. The MLS data set is many times larger, is not sampled, and provides info on other variables such as discounts, give backs, commissions etc. all of which affect cost. It should be said however that MLS data underreports new home sales and thus tends somewhat to understate housing cost appreciation.


We've already experienced a rather substantial demographic change with regards to housing relating to the WWII generation, most of whom it can be safely said have moved into their final housing arrangements. This may have affected US home sales in the ninety's but I haven't seen any data to verify that. It certainly does not seem to have adversely affected the market in toto. Baby Boomers on the other hand, are in the process of receiving the greatest trans-generational transfer in wealth in all of recorded history so somehow I don't think that will have a negative impact on housing prices. Given increasing immigration, decreasing land availability in major MSA's, imposed design improvements, restrictive and anti-market local covenants, married with the penchant of Boomers to spend money, I suspect home prices will recover within the next couple of years and begin their march upwards again.


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