Today seems to be all about Real Estate.
For those of you that follow this space, you definitely want to go read the latest work via Yale professor Robert J. Shiller on
"Long-Term Perspectives on the Current Boom in Home Prices" in The Economists’ Voice. Shiller wrote Irrational Exuberance warning of a peak in equity prices, it was published coincidentally with the peak in the market in 2000.
Shiller admonishes:
"The news is not good for homeowners. According to our data, homeowners
face substantial risk of much lower prices that could stay low for a
long time after. Luckily, though, derivatives products, notably a
futures market, are being developed that they will soon be able to use
to insure against this risk."
The good doctor doesn’t mince many words in the following pages. His warnings are stark:
• The data show no long-term up trend in Real Home prices
• The only other time the United States has experienced a large home price boom was around the end of World War II.
• Hedging instruments are soon to be available to Home owners to protect against severe downturns in Housing values (minor sales pitch)
Some of Shiller’s charts:
Real Home Prices versus Rent
It is striking that, while there does not seem to be a genuine long-term uptrend in real house prices, there does seem to be a genuine long-term downtrend in real rents. And yet, Shiller notes, In practice, however, the situation is very different: Not only do real home and rent prices fail to track each other, but the rent-price ratio has shown a remarkable downtrend since 1913.
Residential Investment as a Share of GDP
US versus Norway versus Amsterdam prices
Very thought provoking stuff; The entire piece (don’t worry, its short) is worth a read.
>
Source:
Long-Term Perspectives on the Current Boom in Home Prices
Robert J. Shiller
The Economists’ Voice, Vol. 3 (April 2006)
http://www.bepress.com/ev/vol3/iss4/art4/
All about real estate…I’ll say.
From a casual look at the first chart, I see a market that had pent up growth/demand (went nowhere for 50 years), that should now correct back toward 2. This might be right back to a smoothed straight line on a logarithmic scale.
Secondly, the “spike” move in the 40’s (somewhat comparable % move) did NOT end in a collapse.
Residential Investment / GDP is a very telling stat which takes into account dual-income families, etc.
If/when home prices drop, a lot of wealth will go to money heaven. Even a slight regression toward the home price mean would lead to a significant ripple in the economy.
Great story and link, BR.
There is no reason there should be any change in the real prices over the years. Houses may have more conveniences today and be more energy efficient, but production processes have become more efficient, too. There were houses built 100 years ago that were every bit as large and elaborate as those of today – and often with far more detail and hand labor.
Regulatory standards, especially for land development, may possibly have driven development costs up recently.
Dr. Shiller warns:
“Luckily, though, derivatives products, notably a futures market, are being developed that they will soon be able to use to insure against this risk.
Indeed, what luck! Dr. Shiller prescribes the “Case-Shiller” patent medicine to cure what ails ya. Guaranteed to cure homeowner blues, acne, cancer, and flatulence, all in a single 8 ounce bottle. Step right up, ladies and gentlemen! Supplies are limited! Call now!
And I am sure it is just a very strange coincidence that Dr. Shiller gets a big fat royalty check from companies that use his name in conjunction with that real estate futures trading that those frightened homeowners can use to save themselves from the price-drop boogeyman. No financial motive there at all. None. Not one penny to be made. Impossible.
I warned ya: “minor sales pitch”
This is a video showing Shillers housing price numbers tied to a roller coster. It’s very visually compelling, especially the last 10 years. Hold on it’s a long way down!
http://video.google.com/videoplay?docid=-2757699799528285056
~~~
BR: Uh, try this one:
http://bigpicture.typepad.com/comments/2007/04/real_estate_rol.html
sensationalism, nothing more. sure prices will pullback after the big move up, like everything else that regresses to the mean, bu the day that shiller sells his house and moves into an apartment then i will take his pablum a little more seriously. Let the pullback occur and start looking to buy again in three or four years when the last of the foreclosures are hitting the market. What no more immigration, no more families with more than 2 offspring, no more desire to have a house at the beach, country ect…. Dont worry about real estate, god stopped making land a long time ago. and to top it all off, global warming will take much of it away sooner rather than later.
Earnings Growth Falls Below 10%
http://tickersense.typepad.com/ticker_sense/
The economists expect a rebound in the fourth quarter of 2007.
Based on what? Wishful thinking? The Fed cut? Housing prices rebound?
I am perplexed as to why the economy should rebound in the end of 4th quarter?!?!?
Nicely put Nova Law.
So reality would probably be somewhere between Shiller’s gloom-and-doom and Lereah’s turnaround that supposedly was taking place throughout 2006.
Do Shiller’s calculations take into account the change in the CPI calculations 20/30-odd years ago to remove house prices from the CPI and only use rent-equivalent?
With the older CPI math, inflation would have been higher the last few years, which would decrease the size of the recent spike in the index (which is adjusted for “inflation”, which I assume is the BLS’s CPI).
It would still be a big spike, but it would be a bit smaller.
Interesting realtor’s B.S. (very similar to Wall Street buy stocks B.S.)
http://video.google.com/videoplay?docid=-2791652814139673140
There ain’t no housing bubble.
When folks buy a house their prime consideration is their mortgage payment. Since 1976 a 30 year mortgage payment on a median U.S. house is 4.5% per year. And: the median house, +5.4%; CPI +4.2%; Nominal GDP, 6.8%.
We’ve either been in a bubble for 30 years or there isn’t one.
Hmm, appears that I either need to be a faculty member “guest” and list my “institution” or else be an individual subscriber ($20) to read the entire article at bepress. (?)
Fred,
I think that pent up demand is always around to some extent – it must be replenished generationally. There are always a certain number of people from each generation who want a house but are unable to afford one. (maybe also some numbers from a continual flow of new immigrants living in inner city tenements).
In 1944, that generation got generous GI Loans. In our generation, we got 0% real interest rates from the Fed.
The difference about the 1940’s boom is that the GI Loans were assumable mortgages & could transfer with the house – which makes default less likely.
We don’t have that kind of support this time…
InquiringMind
“There ain’t no housing bubble.
When folks buy a house their prime consideration is their mortgage payment. Since 1976 a 30 year mortgage payment on a median U.S. house is 4.5% per year. And: the median house, +5.4%; CPI +4.2%; Nominal GDP, 6.8%.
We’ve either been in a bubble for 30 years or there isn’t one.”
For the last 60 years the median home price was 4X median income. It is now about 10X. Looks like a bubble to me.
“sure prices will pullback after the big move up, like everything else that regresses to the mean”
A reverse to the mean from current prices would be a roll back of prices from 40% – 60%.
You don’t have to call it a bubble or a crash. But it’s a very big drop.
“For the last 60 years the median home price was 4X median income. It is now about 10X. Looks like a bubble to me.” edhopper
Can you give me a source on the data you are using.
I have median US home prices at around 250k and median household income at around 45k. The current ratio would be around 5.5.
“There ain’t no housing bubble.”
Dang, Norman, thanks for clearing that up.
P.S. I admire the economy of your style. Others are so verbose, what with citing data sources and such, but you just cut straight to the Zarathustra pronouncements. Hat tip, sir.
Thus Spake Norman
InquiringMind…good point on the GI loans.
I would only comment as a chart technition that the “trading range” from the 1940’s to 2000 is one heck of a base. I’m sure you’ve heard the old saying, “The longer the base, the higher the chase.” That looks like the case on this chart. It is extended, but shows no sign (technically) of an impending “crash”. A pullback to the high 130’s looks reasonable to me. This might be pretty good news to some young people who have been recently shut out of home ownership, no?
Shiller: As you can see from the data, which I painstakingly constructed from the following sources . . .
Norman: There ain’t no housing bubble.
Shiller: I’m sorry, what did you say?
Norman: No bubble.
Shiller: But if we examine the data . . .
Norman: Since 1976 a 30 year mortgage payment on a median U.S. house is 4.5% per year.
Shiller: From where did you derive that factoid?
Norman’s Wife: Don’t question Norman. He knows.
Shiller: With all due respect to your husband, ma’am . . .
Norman’s Wife: Ah! Sush! If you’re such a learned doctor and all, what’s wrong with my pancreas?
Shiller: Ahh . . .
Norman’s Wife: A ha!
Norman: Charlatan!
The housing phenomenon began with a “close out price” sale on interest rates – when the Fed lowered rates to 1%. One would have had to have been a complete moron not to take advantage of the “bargain basement” financing available. Anyone who dreamed of home ownership jumped in; all those who thought they could never afford a bigger house jumped in; consumption (demand) was a function of money supply purely. Increased money supply did what it always does – raised prices due to artificial demand.
This all worked fine and dandy for 3 or 4 years until most of the eligible buyers had satiated their appetites for new and/or bigger homes. But business couldn’t face the prospects of a slowdown, having grown gluttoness on easy profits, so new methods were devised to keep the party rolling – and subprime was born along with liar loans and all manner of easy credit, buy now, pay later deals.
It is the last 2-3 years when a bubble formed at the top – and it is this “froth at the top” that is now coming undone.
From Roubini’s blog: “Subprime lending could decline by as much as 50% this year from last year’s total of about $600 billion, says David Liu, a mortgage analyst at UBS AG in New York. Alt-A lending also is expected to fall sharply.
Together, subprime and Alt-A accounted for nearly 40% of the U.S. home-mortgage loans originated last year, according to Moody’s Economy.com, a research firm based in West Chester, Pa. [emphasis added]”
Housing prices simply have to fall – demand has been satiated. Tightening lending over the next 2-3 years will cause more grief, along with the addition to the already glutted inventory supply caused by more and more foreclosures.
Whether or not this constitutes a “bubble” is fairly irrelevant – what it became was an overbought market and it is due for a correction.
Secondly, the “spike” move in the 40’s (somewhat comparable % move) did NOT end in a collapse.
Ah, yes, but how much of that was the formation of Fannie Mae combined with the Mortgage Interest Deduction?
And… they’ve been there ever since, haven’t they?
Here’s a good NY Times article about the big, bad interest deduction.
http://tinyurl.com/2whs8d
It’s a good read about why we don’t need it unless you believe in making the rich richer, and the poor, poorer through tax policy.
Chuck Ponzi
http://www.socalbubble.com
Nova Law beat me to the punch. Schiller’s been trying his damnedest to drum up support for “his” futures for over a year now.
I am sure homeowners can feel fortunate that there is a hedging mechanism just like Metallgesellschaft was fortunate that there were energy futures for hedging in 1993.
What Mr. Schiller doesn’t explain is what to do if you hedge using his futures and house prices actually go up. Your losses are marked to market and margin callable; your gains will not be. In extremis, one could be left in a situation of being forced to sell the very house one is attempting to hedge because of losses accrued on this hedge!
The median house price/median income is roughly 5.2. The distribution is quite broad, however; the median market has a median house price/income ratio of 3.7. Incidentally, the US does not look particularly expensive by international standards.
That last graph is very poorly made. There is no good reason to plot the indices on different scales. All it does is make the US look like its had a bigger runup than it really has. And why scale the international indices to 800 when they never get above 400?
In order to see that we are currently in a housing bubble, you have to remember that a housing contraction will cause a recession all by itself, even if everything else remains the same. If you take out the spending from MEW and the income from financing, selling, and building houses, which will all drop substantially if house prices drop at all, we have a major recession. And that’s before you account for the spillover effects of reducing spending that much. Has anyone else noticed how common it’s becoming to see news reports say things about how economic indicators are reaching levels not seen since just before the great depression? Do you understand what that means for the economy?
The only way out is to have real inflation be around 6-10% for about a decade while managing to keep inflation expectations low. Real inflation has to include wages. Continuous devaluing of the dollar might be the highest probability method of making that work.
I have been hearing Real Estate crash for the pass 5 years. Where is it? Everyone in CA that bought their house for $200k in the 70’s, $400k in 1996, $800k in 1998, $1 million in 2000 now worth almost 1.5 to $3 million??? Can you imagine buying a house in CA for $400k in 1996 and it be worth $3 million 11 years later? Can you say WOW!!!!
Mike: Can you imagine buying a house in CA for $400k in 1996 and it be worth $3 million 11 years later? Can you say WOW!!!!
Now, can you imagine a home owner whose income has not had a 3 fold increase in that same period? Not even a income double? WOW! It’s as if a helicopter dropped money
directly into the house. Wait a sec….a helicopter DID drop
a bunch of money into the house. WOW!
Hey, what are homeowners doing with all that free helicopter money? Did they go off and extract that free money with a MEW? WOW! DId they increase the leverage on the home to historically large multiple of income, without concern for an ability to carry the debt & maintenance & prop taxes & insurance through even a normal business cycle downturn, let alone the worst of past downturns. WOW!
In next week’s episode, our brave homeowners get direct experience with the concept of margin call. WOW!
Debt is like holding a satellite in the palm of your hand, while in orbit. It’s perfectly fine, but don’t be holding it on re-entry.
That last chart is statporn, garbage masquerading as data. The increase from 160 to 180 is the same as from 20 to 40. Shiller should be very embarassed since he works at the same place as Tufte.
http://www.edwardtufte.com/tufte/books_vdqi
Anyone who reads charts should immediately purchase and read the above, assuming you haven’t already.
Pardon, miami, it’s an index.
There is no reason there should be any change in the real prices over the years.
If prices were the cost of construction that would be true, but they are primarily the cost of land, and ‘they aren’t making any more of that’. As consumers have spent less on most other things for the last century, it is only common sense some other things will command a higher price. Housing has been the leading component. Some 20th century developments such as the automobile actually lowered land costs by encouraging commuting. Congestion and energy prices are reversing the trend, leading to higher urban land values.
In a place like the USA, or any moderate size country, the land cost has no reason to rise. There are huge empty lands evrywhere to build houses, cities can always grow when needed. The fact that ‘they aren’t making any more of that’ doesn’t matter at all when you have hundreds of thousands square miles still empty. US are no Luxembourg…