Bubble, Bubble, Toil and Trouble…

From MacroMarkets: The top two charts illustrate the gap between the S&P/Case Shiller Home Price Index and its baseline trend level. The baseline trend extrapolates the average rate of Index growth before 2000, the year when prices took off in many real estate markets. The current gap for U.S. National is -3.9%, and for Boston it’s +15.3%. By this measure, U.S. National has overshot downwards slightly, and Boston prices still have a way to fall. The S&P/Case Shiller Home Price Index is not adjusted for inflation.

From The Big Picture: The bottom chart shows existing-home prices over time, adjusted for inflation, with a forward projection. (Courtesy of the The New YorkTimes, as modified by Steve Barry for The Big Picture.)

Legend - Red: Boston proper Blue: Metropolitan...

Metropolitan Boston (Image via Wikipedia)

Some experts now suggest the bubble is over. Is it finally a good time to buy a home? The perennial question has gained salience in this troubled economy. The answer depends, of course, on one’s view of home prices. Have they bottomed, or will they fall further? Recently, David Leonhardt wrote a provocative article in The New York Times, in which he tried to sort out this tangled question.

Housing economists are sharply divided on the issue, he explained, and fall into two distinct camps. One group cites historical evidence that home prices track inflation. This camp won’t deny that home prices rose roughly with incomes between 1970 and 2000, but that was an exception, they claim, caused by falling interest rates and government programs to encourage home ownership. They argue that prices still have some 30% or more to fall, nationally, before returning to their pre-bubble inflationary growth. Houses will then be a lot more affordable for a lot more people. This group I’ve dubbed the Populists.

The other camp I will call the Optimists. They argue that home prices track, not inflation, but income growth, which since 1970 has risen a good deal faster than inflation. These economists rely on more recent data, dismissing the older data used by the opposing camp as unreliable. In this view, as we grow richer, we spend more on housing — so our housing expense does not decline as a percentage of income as does our outlay for staples. The chart to the left from The Times illustrates this point.

The top two charts, above, reflect the Optimists’ assumptions. Even so, you can see that Boston area prices still have a way to fall. The bottom chart shows the Populists’ view, with prices poised for a much bigger drop.

In the long term, I lean to the Optimists’ view, for two reasons that could be captured by the terms, scarcity and vanity — not necessarily in that order of importance. Both drive up home prices. Scarcity of land is particularly acute in Greater Boston, an older, built-up city. Vanity has always moved folks to keep up with the Joneses, or if wealthy, build or buy a trophy house to advertise their success.

In much of the country, at present, inventory is being added at a faster rate than it can be absorbed, while many home buyers continue to sit on the sidelines. This has led to dire predictions of further steep declines in home prices. Like politics, however, all real estate is local. Is this a good time to buy? In the Boston area, sales were up 10% from last year through August. Let’s see how well prices hold up here as the year progresses.

We’re recovering from an unprecedented bubble. Whatever the prognosticators say, we should be wary of inferring too much from the past. The past may not be prologue.

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Home Prices Rose Modestly in Second Quarter 2010

Left: Four S&P/Case-Shiller Home Price Indices – Percent Change From a Year Ago
Right: Two S&P/Case-Shiller Home Price Indices – Index Monthly Levels

Broadly, across the country, home prices improved modestly in the Second Quarter of 2010. They gained relative to the previous quarter, and also against the same quarter a year ago. So stated the S&P/Case Shiller Home Price Index, in its latest, June report.

Its U.S. National Home Price Index rose 4.4% in the second quarter of 2010, after having fallen 2.8% in the first quarter, and was 3.6% above year-earlier levels.

Recent monthly gains have been slowing, however, both nationally and in the Boston area. This is doubtless due to the expiration of the homebuyers’ tax credit, and to continuing high levels of foreclosures and inventory.

But the news is not all bad. This is from their latest, June report:

“While the numbers are upbeat, other more recent data on home sales and mortgages point to fewer gains ahead,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “Even with concerns about near term developments, we recognize that the housing market is in better shape than this time last year.”

For the Boston area, June Index levels were up 1.2% over May, 3.4% over a year earlier, and are back to their level of October 2003.

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Were the Critics Right?

July’s abrupt drop in existing-home sales produced a wave of concern in the media and in Washington. Talk was rife of a double-dip, housing recession.

In truth, the news was neither bad nor unexpected. Hopes had simply been unrealistic. Proponents had promoted the tax credit on the grounds it would kick-start the housing market.

Critics said it would simply steal future demand, at taxpayer expense.

True, existing home sales in the Boston area have been running almost 10% higher than last year, but that may be due to improved affordability.

I say the critics were right!

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Boston-Area Home Sales, in July, Fell Faster Than Nation’s


In July, existing-home sales fell nationally to their lowest level in more than a decade. Sales were down 27.2 percent from June to July, as reported on August 24 by the National Association of Realtors. It was the lowest rate for existing homes–which include houses, condos and townhouses–since 1999. For single-family homes, it was the lowest sales rate since 1995.

Over the same two-month period, existing-home sales in the Boston Metropolitan Statistical Area (MSA) plunged a whopping 39.2%, far exceeding the 27.2% reported nationally by the Realtors. The cause of the disparity was not readily apparent (although a small part–only–may be due to the Realtors’ use of seasonally adjusted numbers).

For the year, July sales were down 29.0% in the Boston area, but that was consistent with sales in the Northeast as a whole (see below).

Some fall-off in sales was expected after the initial expiration of the tax credit on June 30, but such a big, one-month drop took analysts by surprise. The U.S. drop of 27.2% was twice what many were expecting. It even led some to suggest that the tax credit may have created temporary demand of its own, rather than drawing down presumed (but non-existent) future demand. It also amplified fears about the health of the larger economy.

Such concerns may be exaggerated. As the graph, above, reveals, existing-home sales for June and July, combined, in the Boston area, remained almost unchanged from 2009 to 2010; for the latter year, they were simply skewed by the tax credit. From January through August, in fact, Boston-area home sales were running 9.4% higher this year over last — although perhaps due as much to low interest rates as to the tax credit.

In their press release, the Realtors made a similar point, predicting that, for the country as a whole, 2010 home sales will just edge out the average for the last 20 years “because of healthy activity in the first half of the year.”

The Realtors also cited modest, annual increases in home prices, despite declining sales. However, these gains may have simply reflected a boost in consumers’ buying power due to lower interest rates. In fact, many commentators say home values have been stagnant over the past year, and predict further price declines after July’s disappointing news.

The Realtors also reported that the seasonally adjusted annual sales rate of 3.83 million for the country as a whole was 25.5 percent below the level of July a year ago.

Regionally, they said existing-home sales in the Northeast dropped 29.5 percent to an annual pace of 620,000 in July, and are 30.3 percent lower than a year ago. The median price in the Northeast was $263,800, up 4.8 percent from July 2009.

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Fed Acts to Keep Interest Rates Low

Concerned about the slowing pace of recovery, the Federal Reserve on August 10 announced renewed efforts to keep interest rates low.

As reported by The New York Times, the Fed will reinvest proceeds from its mortgage-bond portfolio in long-term government securities.

According to The Times, “From January 2009 to March 2010, the Fed bought $1.25 trillion in mortgage-backed securities and about $175 billion in debt owed by government agencies, primarily the housing finance entities Fannie Mae and Freddie Mac. The Fed had planned to allow the size of that portfolio to shrink gradually as the securities matured or the debts were prepaid.”

“Instead, the Fed will now reinvest those principal payments in longer-term Treasury securities.” The goal is to “help keep money readily available in the financial markets.”

This is viewed as a modest first step by the Fed to keep downward pressure on long-term interest rates, and so stimulate borrowing.

For home buyers, it means mortgage rates should remain historically low for some time.

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Did the Tax Credit Push Home Prices Down?

Left:  Four S&P/Case-Shiller Home Price Indices — Percent Change From a Year Ago
Right:  Two S&P/Case-Shiller Home Price Indices — Index History, Reported Monthly

The tax credit certainly worked as intended to bolster home sales. Existing and new home sales, inventories and housing starts all showed big improvements in March and April — all the categories, that is, except home prices, which continued their month-to-month decline in most of the country. Two metro markets reported seven consecutive months of price decline. The Boston metro area was one of four to show six consecutive months of decline.

Nevertheless, on a year-to-year basis, price data was up in many areas, suggesting not that the housing market is improving, but rather that the rate of decline may be slowing.

Foreclosures and unemployment are the two reasons most frequently cited by economists for the continuing monthly decline, coming after four months of upbeat news.

But there may be another contributing factor. Home sellers found themselves in a race to the bottom. Fearing they would be left out of the buying frenzy in the months leading up to the April 30 tax credit deadline, they cut their prices, and cut them again.

If, in fact, this was the case, we could see a little “bounce” in home prices in the months ahead, as sellers find themselves freed of the deadline pressure. Continuing low interest rates could help as well, a gift from investors fleeing the troubled euro for the relative safety of U.S. Government securities.

The home price trends cited here are from the latest, February report of the closely watched S&P Case-Shiller Home Price Index.

Among the witches brew of home sales statistics and prognostications to which we are treated every month, no indicator provides a better signal as to the health of the housing market, I believe, than this redoubtable index.

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New Home Sales Surge, with Boost from Tax Credit

Sales of New Homes Soar With Help of Tax Credit -- Courtesy of The New York TimesA newsletter arrived in my in-box, today, with these manic pronouncements:

The week ended on the most dramatically impressive new home sales numbers in 47 years. March’s 26.9% increase was the biggest monthly sales gain since 1963, taking us to a 411,000 annual rate! Supply dropped to 6.7 months, inventories fell to 228,000 and the median price went to $214,000, up 4.3% versus last year. Some put the sales surge to the soon-to-expire tax credit, but the facts remain that the economy IS recovering and homes ARE substantially more affordable!

The day before, March existing home sales came in UP 6.8% at a 5.35 million annual rate, UP 16.1% from a year ago, with all regions showing gains! The existing home median price went to $170,700, UP 0.4% from a year ago. These good numbers reversed a three-month slide and sent the supply of existing homes down to 8.0 months.
The new home sales thus reported were from the Commerce Department, and the existing sales from the National Association of Realtors (NAR).

It’s true, the impressive returns were due in no small part to an improving economy. But more sober heads were quick to remind us that these numbers masked ongoing weakness in the housing market. In fact, they owed much to the $8000 tax credit, expiring in a few days, and mortgage rates held artificially low for five quarters — near 5.0% — by the Fed.

New homes are selling too slowly, facing as they do bargain prices for existing homes, while existing homes must compete with a huge overhang of foreclosures. In the Boston metro area, at least, pickings are slim for buyers, as prospective sellers bide their time. The housing market is not out of the woods yet, by any means, the grayheads warn.

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