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November 20, 2008
Location and myopia
Russell Roberts
In two recent posts, I talked about the enormous variation across locations in the proportion of houses in a location with negative equity along with how myopic many of us were about the fragility of the housing market and the potential for meltdown. Here's an interesting analysis from the FDIC in February 2004 on both of these questions. Don't miss the justification for why home prices will stay high:
The most recent OFHEO data (see see Table 2) show that markets registering the weakest home price growth are, for the most part, cities that have seen significant recent economic deterioration as a result of the loss of dot-com or telecom jobs or, in the case of Salt Lake City and Provo, Utah, a post-Olympics slump. The markets with the strongest home price growth are mostly cities in California and the Northeast that typically have shown a tendency toward wide price swings because of supply constraints. These markets generally did not experience a disproportionate level of economic distress during and after the 2001 recession.
Table 2
Variations in Home Price Appreciation
(annual percentage change in home prices, third quarter 2003)10 Fastest Markets 10 Slowest Markets Fresno, CA 16.05% Austin, TX -0.31% Fort Pierce, FL 14.70% San Jose, CA 0.43% Redding, CA 14.44% Boulder, CO 1.07% Chico, CA 13.79% Denver, CO 1.35% Riverside, CA 13.34% Springfield, IL 1.57% Providence, RI 12.03% Provo, UT 1.62% Bakersfield, CA 12.01% Lafayette, IN 1.69% San Diego, CA 11.90% Salt Lake City, UT 1.73% Ventura, CA 11.81% Fort Collins, CO 1.73% Santa Barbara, CA 11.62% Greensboro, NC 1.89% The history of U.S. home prices suggests a clear potential for home prices to decline in individual markets, particularly in cities that have shown wide price swings in the past and where prices recently have risen dramatically. However, this same history also strongly suggests that it is highly unlikely that home prices will fall precipitously across the entire country—even if rising interest rates raise the cost of mortgage borrowing and reduce housing affordability. Further, a significant price decline does not inevitably follow a sharp rise in local home prices. In many cases, the aftermath of a housing boom has been characterized by slower sales and price stabilization until the underlying fundamentals have a chance to catch up with market prices.
Understanding the behavior of both buyers and sellers is key to understanding home price dynamics. Were prices to fall in certain markets, history and academic research suggest that potential sellers would tend to withdraw from the marketplace rather than proceed with panic sales. In fact, studies show that "household mobility [selling] is significantly influenced by nominal loss aversion," or a willingness to continue to hold the asset and take further losses in the hope that the price will go up one day.5 Because of homeowners' loss aversion, homes tend to stay on the market longer with asking prices set well above selling prices, and many sellers withdraw their homes without sale.6 This behavior is typical in all but the most economically distressed markets. Unless the number of homeowners who must sell because of job or income loss is a significant portion of sellers in a market, weakness in a local real estate market is more likely to result in a slowdown in transactions than a plunge in home prices. Although owners may be more inclined to sell in a down market if the property is not their primary residence, high transaction costs weigh against quick "trades" by investors.
Posted by Russell Roberts in Housing | Permalink
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Comments
Economists have to give up the idea that the current crisis is merely a housing bubble, one that is isolated to 3-4 housing markets. We just had the biggest stock market crash since the great depression. Fed and Treasury have taken unprecedented actions to pump money, yet, they are unable to stem the tide of liquidation. Borrow and spend economy is coming down. We will go back to a save and invest economy in the not so distant future.
No, those trade deficits are not capital surplus. If there was so much capital investment here, coming from overseas, it would have caused so much production that some of those imports would have been replaced by local production, or more would have been exported to offset the imbalance.
The so called capital surplus is nothing but the ability of the Federal government to borrow from international pool of savings, therefore finance the welfare/warfare state. Just like the market's trust in subprime paper vapoorized almost overnight, the trust of the overseas lenders to the U.S government could disappear just as quickly, especially given the federal borrowing plans for the near future.
Housing market was just one of the symptoms.
Posted by: Oil Shock | Nov 20, 2008 8:07:36 PM
Interesting quote. We may have these exceptional circumstances: a malfunctioning credit system, lots of uncertainty about future policies, a policy vacuum caused by government change, unwinding of heavily leveraged speculative positions and last but not least, an epidemical dimension to these problems.
Posted by: Rien Huizer | Nov 20, 2008 8:40:30 PM
How about this?
Posted by: Sam Grove | Nov 21, 2008 1:08:46 AM
We have had housing bubbles before. What made this one so disastrous?
What about the Federal deficits? I try to ask that question more fully here.
I sincerely don't understand why the enourmous amount of deficit spending is missing from the commentary.
Posted by: Henri Hein | Nov 21, 2008 1:23:12 AM
Without going into it any deeper one can understand why the federal deficits aren't talked about much by congress or the media.
A financial meltdown of housing and lending can be convincingly blamed by congress on "them evil capitalist free marketeers"; whereas, a federal deficit can only be blamed on congress.
Nothing strange or unusual about that, congress has been lying to people since 1787.
Posted by: vidyohs | Nov 21, 2008 7:11:30 AM
The Wall Street Journal has been fretting over exactly this for at least five years now. Their main concern was the behavior of Fan and Fred. Of course, it was Congress that was there behind the curtain pulling the levers.
Posted by: Gerald Hanner | Nov 21, 2008 9:03:36 AM
That's what always gets me about ambiguous calls for "more regulation" - who decides on which regulations are necessary?
"What's the problem, exactly?"
"When 90% of people are making stupid decisions, it can collapse the whole free market!"
"That's a good point. So what's the solution?"
"We get 51% of people to make a collective decision! Surely they'll be smarter when their Tuesday afternoon is on the line, not just their life savings!"
Posted by: roystgnr | Nov 21, 2008 9:10:28 AM
So, it seems that they (and I, I'll admit) miscalculated at this point:
This behavior is typical in all but the most economically distressed markets. Unless the number of homeowners who must sell because of job or income loss is a significant portion of sellers in a market, weakness in a local real estate market is more likely to result in a slowdown in transactions than a plunge in home prices.
In this case to a large extent, the homeowners' cashflow problem wasn't income loss it was increase in expense. So, in the future, we could be on the lookout for:
Job loss OR
Financing terms which change (ARM adjustment from negative amortization to full amortization, balloon payment, Index change [LIBOR, MTA, etc])
Loans made with no intention to ever pay (collect rent and don’t make payments, mortgage fraud = take cash out and run, etc.)
Outrageous increase in Property tax or property insurance or HOA fees
Severe property damage that causes many to walk away (environmental, fire)
Decreased Tax advantages from mortgage interest or sale of property, or depreciation for investment property
Government mandate (rent control, added taxes, . . . )
I would also include that today's higher Loan to Value requirements and other more stringent lending requirements are something of a barrier to buyers entering the market.
Posted by: Charlie Perkins | Nov 21, 2008 10:10:36 AM
Vidyohs,
I agree. That explains Government commentary and MSM. It doesn't explain blogs. I don't see this part of the issue being covered even by economics oriented blogs.
Either I'm missing something, or historically large deficits is a big part of the problem and we need to call them on it.
Posted by: Henri Hein | Nov 21, 2008 11:24:04 AM
These, individually, have not been insurmountable problems:
1. the dot-com bubble/burst
2. the housing bubble/burst
3. the oil bubble/burst
But taken together, there have been some interesting impacts on personal and corporate fortunes. The one factor not discussed is the Federal Reserve's role in all of this... the interest rate bubble/burst.
The dot-com phenomenon was painful, but not crippling for most investors.
The housing bubble was a marvelous job of marketing home ownership on a par with marketing gold. Mortgage companies and large investment houses came on like carnival barkers in plaid coats, bow ties, and bowlers. The Federal Reserve was only partly to blame for the abuse when it lowered the funds rate to 1%... but it certainly opened up the store for abuse. The bust was triggered by the rapid rise in the funds rate beginning in 2004. The absolute rate wasn't the problem; it was the differential between the earlier rate and the rate in 2006 that triggered the landslide of borrower defaults. The Feds micromanaging of the economy on both sides of the bubble/burst was the primary enabler.
Then the speculative energy bubble drove the proverbial nail in the economic coffin. In 2007, when economists and shills for investment houses were announcing the imminent arrival of $200/barrel oil, I projected $51 per barrel in the near future. Ahem.
It doesn't take a rocket scientist or a doctorate in economics to understand the impact of market anomalies in key areas. It just takes deja vu.
Posted by: Bruce Hall | Nov 21, 2008 11:30:54 AM
Net Export (NX) is equal to Net Capital Outflow (NCO). Therefore, when NX is negative -- a so-called trade deficit -- NCO is actually an inflow of capital...it is an accounting indentity in the national accounts.
You can read about why this is true here (via the Coyote Blog).
Posted by: LowcountryJoe | Nov 21, 2008 1:22:42 PM
"Unless the number of homeowners who must sell because of job or income loss is a significant portion of sellers in a market, weakness in a local real estate market is more likely to result in a slowdown in transactions than a plunge in home prices."
There's an underlying smooth curve calculus view in this statement. The housing market is a collection of individual quantum asking/offering, buy/sold events. When things are running smoothly, the collective curve might be smooth and even fairly predictable. When things are running smooth, the collective curve might take quantum jumps itself.
I'll offer a case in point. In the condo complex where I live in OC, CA, one family sold a unit last week that had been on and off the market for a year, priced in the 430K range. They found a buyer with cash and a very short escrow and left for about $375K. Moved out yesterday. We've found a clearing price more than 10% below the asking prices. Does the damn burst on remaining inventory in our neighborhood, resulting in an instantaneous 10% drop? Or is this just one outlier family that needed to move to cheaper digs ASAP?
Posted by: BoscoH | Nov 21, 2008 1:59:23 PM
Henri,
I see. This is pure speculation on my part as I have neither the data at my fingertips nor do I have the ambition to go find the data, but perhaps, adjusted for inflation, the amount of the deficits now are no larger than they were 50 years ago? So, there is no excitement about deficit spending.
Again I speculate, but I see no sincere intention on the part of the U.S. Government to ever repay the "debt" to the federal reserve, so it seems it is a matter of "who cares how high the deficits go", at least in officialdom.
The owners of the Fed are content to just get the "so-called" interest payments on the "so-called" debt, which ensures that they are and will remain extremely mind blowingly wealthy.
As long as you and I get up in the morning, put on our pants, go out the door, and create wealth that they can access through taxes, then debt doesn't matter to the government or the creditors, you and I are the collateral and we are doing what collateral should do......creating wealth.
Sucks for sure, but the alternative is a VBR and try selling that to the watchers of American idol.
Posted by: vidyohs | Nov 21, 2008 6:31:29 PM
What popped the bubble?
Well, it had to pop sometime if it kept growing, but this article rings my bell in that I recall newspaper articles about commuter developments and the ire of early bird buyers when developers began offering discounts on these new homes located a couple of hours away from Silicon Valley.
It seems that soaring gas prices made these home much less attractive at the original prices.
Posted by: Sam Grove | Nov 22, 2008 11:59:12 AM
I was not myopic. I knew, and everyone I talked to, knew it was a bubble, that the crash was near, and called the top of the crash pretty accurately.
Everyone who heard about no money down, negative amortization, no doc loans, everyone who observed the overwhelming proportion of improvident and insolvent members of protected racial minorities purchasing houses, knew that this could not continue. I called the top spot on, and lots of people called the top pretty accurately.
Posted by: James A. Donald | Nov 22, 2008 3:05:49 PM
Note well that the worst of the housing boom / bubble came post Feb. 2004, as did the worst of the Fannie Mae / subprime doomsday lending.
Posted by: Greg Ransom | Nov 22, 2008 10:49:12 PM
Housing bubbles are not new. Bubble popping is normal. Something else, a catalyst or an exacerbating factor, made a meltdown out of a regular downturn.
Posted by: Henri Hein | Nov 24, 2008 2:02:46 AM
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