One Guy Typing

All Real Estate is Local

Given my profession I welcome articles like this, the national numbers on housing may not apply to all locations...

National housing price declines and foreclosures have not been as severe as some analyses have indicated, and they are not as important as financial manipulations in bringing on the global recession, according to a new analysis of foreclosures in 50 states, 35 metropolitan areas and 236 counties by University of Virginia professor William Lucy and graduate student Jeff Herlitz.

Their analysis shows that most foreclosures have been concentrated in California, Florida, Nevada, Arizona and a modest number of metropolitan counties in other states. In fact, they claim that "66 percent of potential housing value losses in 2008 and subsequent years may be in California, with another 21 percent in Florida, Nevada and Arizona, for a total of 87 percent of national declines."

"California had only 10 percent of the nation's housing units, but it had 34 percent of foreclosures in 2008," Lucy and Herlitz reported.

California was vulnerable to foreclosures because the median value of owner-occupied housing in 2007 was 8.3 times the median family income, while the 2007 national average was only 3.2 times higher than median family income (and in 2000, it was lower still at 2.4).

Interestingly, the researchers blame the financial system for the mess far more than the housing bubble per se:

"Damage to the balance sheets of large banks and AIG occurred not mainly from losses on foreclosed residential mortgages, but because of borrowing short-range to buy long-range derivatives and from selling credit default swaps insuring derivatives backed by mortgage payments," Lucy and Herlitz said.

"These financial manipulations had high-speed forward gears, but when the housing bubble burst, the banks and AIG discovered they had neglected to create a reverse gear with which they could separate foreclosed properties from some forms of mortgage-backed securities."

Liquidate Arizona

From the Economist Blog:

The damage in these markets is remarkable. Read the Wall Street Journal's story on Maricopa, a Phoenix suburb, for a taste. It includes a lot of stories like this:

Mr. Price, a financial adviser with an office in Phoenix, and his wife, Cindy, a photographer, liked the small-town feel. They paid about $180,000 for a four-bedroom home in early 2005. By late 2006, Mr. Price figures, the value had rocketed to about $270,000 amid a "frenzy" of speculation. Now, with foreclosure sales dragging down values, he thinks the home would sell for only around $50,000.

Some 75% of households in Maricopa are underwater. That points to an interesting problem with the Obama administration's housing plan—it won't help those in the worst trouble (the aforementioned Mr Price, who likely owes something like 200% of the value of his home, couldn't refinance under the new plan). And those in the worst trouble are often geographically concentrated. The Obama plan is a sling. Phoenix needs a full-body cast.

The former residents could soak up the excess housing in the other 49 states.

Market Timing, Stocks and Publishing

I am in the middle of reading Niall Ferguson's "The Ascent of Money."  The book is well written and interesting, but it also shows the temporal limitations of the publishing industry.  "Ascent" is organized in Chapters around the invention and evolution different financial instruments.  Obviously, the history of the joint stock company, invented in Amsterdam, by the way, didn't change since the book's completion in April of 2008.  But the evolution part at the end of that chapter, as well as a number of other is already a bit out of date.

Ferguson calculates how much money he would have had his parents bought him 10 grand in either stocks or bonds when he was born.  He uses this to demonstrate the well known investment standard that stocks are the best investment over time. In April 2008 stocks would have come out about double bonds Ferguson calculated, of course stocks are off more than 40% since then.  Meaning in February 2009, stocks and bonds would have been nearly equal for little Niall and it's worth questioning the 'standards' at least a little bit.

Confidence

Here's one way:

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Zombie Party

One of the more enjoyable phrases to come out the financial meltdown is Zombie Banks.  Zombie Banks are insolvent banks whose corpses are kept animated by the government.  Zombie banks are a bad thing because they lack actual money or independence to make loans or investments.

In the NYT, Frank Rich makes a good case that in the wake of the stimulus debate the Republican Party is a Zombie Party:

This G.O.P., a largely white Southern male party with talking points instead of ideas and talking heads instead of leaders, is not unlike those “zombie banks” that we’re being asked to bail out. It is in too much denial to acknowledge its own insolvency and toxic assets. Given the mess the country is in, it would be helpful to have an adult opposition that could pull its weight, but that’s not the hand America has been dealt.

Why Deflation is a Problem

As someone who's only ever had to contend with inflation, the idea of prices coming down doesn't seem so bad, at least not at first blush.  But, of course, firms can't continue to pay people the same amount if revenue falls, so wages, eventually will come down.  In the end, overall, we'd be likely to end up where we were, though some people would be better off and others worse (especially if wage cuts are unevenly spread via layoffs).

Economists in the last thirty years have written quite a bit about "sticky wages," the fact that wages are often slower to respond to price changes than say bread and milk.  Sticky prices of anything are a problem in the face price changes because it creates temporary distortions that may not reflect the underlying relative market values of goods.

But the ultimate sticky price item is debt.  In the past fifty years homeowners have taken advantage of this fact to achieve good profits on a not very exciting investment, housing, which, on average, rises in value just above the inflation rate.  Since the mortgage debt does not rise, the homeowner achieves an increased profit.

Deflation reverses this process, and not only for homeowners, but anyone from firms to governments with debt.

As John Kemp explains, via reuters, the only thing worse than Stagflation is Debt-Deflation:

From the late 1960s through until the current decade, relatively high rates of inflation ensured that GDP continued to grow in nominal terms even when it fell in real ones during cyclical recessions. Even during the deep recessions of the 1970s and 1980s, nominal GDP was generally growing because the decline in real output was more than offset by relatively high rates of price and wage inflation.

Payment ability for households which experienced unemployment and firms that experienced a sharp drop in demand for their products was often severely impaired. For these few, homes were often repossessed and individuals and companies could be made bankrupt.

But for the majority of households that remained employed, and for companies that experienced only a moderate decline in demand, wage and price inflation continued largely unabated, continued to raise their nominal cash flows, and make it easier to pay off debts incurred during the previous boom.

The combination of falling output with rising prices (labeled “stagflation” ) is usually seen as the worst possible outcome for the economy. Well, the worst except one: debt-deflation.

Because stagflation in the 1970s and 1980s ensured that, for most people, the real burden of debt remained manageable, or even improved, despite the recessions. The misery was borne by the minority of workers who became unemployed and the minority of firms that became insolvent. For the rest, inflation continued to boost nominal cash flows and increase debt-service capacity.

In the most indebted nation in history (in nominal terms, of course) deflation is probably the last thing we need.

Wishful Blogging

There's a bit of a lovefest going on in the liberal leaning blogs with conservative leaning Harvard economist Ed Glaeser.  And given my inveterate contrarian nature, it rubs me the wrong way.

The genesis of el lovefesto is that Glaeser's a guy with libertarianish leanings who doesn't like most land use regulations, single family homes or the suburbs. (Though he lives in the wealthy suburban enclave, but he's a Hahvahd Professor).  There's a great deal of true and interesting stuff in what Glaeser writes.  But, the sealer on the lovefest is that Glaeser's writing tends toward patness and over simplification.

Most famously, to me, Glaeser had a big econometric paper complete with formulas (Ones that assumed land value is always 20% of housing costs, a lazy and absurd assumption as any $300 appraiser could tell you) that predicted that real estate bubbles couldn't happen in metro areas with elastic supply.  Tell that to home buyers in Arizona, Vegas or Tampa who've suffered the largest losses despite having very elastic markets.

It was a weird claim to make.  Real Estate bubbles predate zoning by a couple of thousand years.  The tech bubble was certainly not caused by a lack of shoddy IPO's to bid up.  Bubbles are born of momentum, what economists refer to as 'information cascades,' and easy credit.

To his credit Glaeser recalculated his models based on the new information.

But, he's still peddling the land use regulation line, and it's still being eaten up by liberal bloggers because they want it to be true.  They rightfully recognize the environmental cost of sprawling development and they want there to be an economic argument too.  Unfortunately, Glaeser's argument isn't very good.  Calculated Risk the real estate uber blogger and a retired finance economist, has been tracking the rise and fall of the real estate bubble on a daily basis for years.  Projecting the time it will take for a recovery in real estate values CR's biggest data point is the estimated oversupply of housing units in the country, which he puts currently at about 1.9 million units.

If we add this up, 820 thousand excess rental units, 900 thousand excess vacant homes, and 150 thousand excess new home inventory, this gives about 1.87 million excess housing units in the U.S. that need to be absorbed over the next few years. (Note: this data is noisy, so it's hard to compare numbers quarter to quarter, but this is probably a reasonable approximation).

These excess units will keep pressure on housing starts and prices for some time.

 

Bubble prices induced too much housing construction, not too little.  There are inherent inefficiencies in the real estate market that have little to do with land use regulation, which I'd argue is probably a small net negative in efficiency terms though far less so than the cool kids think, it takes time to build supply, projecting future total supply is difficult (when demand is up there are usually four developers ready to step in for every two needed developments), it is highly correlated to the credit markets, building houses is pro-cyclical (All of those construction and RE jobs creates demand for housing).

I also think there's an underrepresented view point that it should be hard to build housing and commercial building, or at least there should be some thought put into it given the duration of the investment. But that will wait for another post.