Posted on 05/03/2008 10:25:47 AM PDT by SeekAndFind
IF YOU WANT TO know how smart I am, read my columns. If you want to know how stupid I am, read the comments section of my columns, where readers get to rip what I say to shreds.
Used to be that when supposed "experts" like me talked, all people could do was listen. Now they can talk back, and their ideas can compete with mine head-to-head on the web.
The most frequent criticism I get in the comments section is that, in my generally bullish view on the economy and the stock market, I'm overlooking the lethal effect of the housing collapse. No matter what argument I make about why folks should be buying stocks or why the economy isn't really in a recession, there's always that one-word answer: housing. It's like a magical incantation. All one has to do is say it, and bulls fall over dead.
So let's talk about housing. I look forward to seeing what kind of response I get. Because, yes, I'm going to find something bullish to say about it.
First, let me say that I'm not denying that the housing sector of the economy is in a downright depression. Has been for a while now. But for me, that's just a starting point for analysis. It tells you nothing in and of itself.
How bad is it? It's bad, alright. According to the latest GDP data released on Wednesday, the housing sector of the economy contracted at a 27.1% annual rate in the first quarter, making it the 10th worst quarter since records have been kept.
This is the ninth quarter in a row of a decline in the housing sector, with eight of the quarters showing double-digit drops. As a nine-quarter run, it's the second worst in history — actually, it's almost a tie for the very worst.
How about home prices? According to the Case-Shiller Index — the housing index most often cited by the bears — home prices are 15% off their highs of about two years ago. It's hard to rank that historically, because the Case-Shiller Index doesn't go back very far. But I'm confident that this is among the largest declines ever.
So am I ever going to get to the bullish part? Yeah, here it comes.
I'm not going to get up on the table and dance here. But let's take a deep breath and remember one very important thing about all markets, including the housing market: They simply cannot go down forever.
They cannot go up forever, either. The bears who were predicting a housing collapse two years ago were right. But the bears are making the same arrogant mistake now that the bulls made then. At some point, enough is enough — and a smart investor knows when to call it quits.
Markets reach extremes, whether highs or lows, and then correct in the other direction, for one axiomatic reason: value. At the very highs, things just aren't worth any more. At the lows, they just aren't worth any less.
I'm not here to tell you that home prices are at absolute bottom this very moment. But I can argue pretty persuasively that they might be. Or that they are close.
What establishes value in a home price? Like anything else, it's a question of historical norms. So how do we determine the norms? Try this way on for size.
Let's think of value in terms of affordability — the ability of people to buy the home they want. That has three elements. First, home prices — the lower, the more affordable. Second, mortgage rates — again, the lower, the more affordable. Third, personal income — the more of it, the more affordable.
Put it all together by calculating the annual mortgage payment you'd have to make to buy a house at the average home price, and then take that as a percentage of income. The smaller a percentage, the more affordable the home.
Let's look at the history. For home prices, we'll use the National Association of Realtors' index. It's showing about the same price decline as Case-Shiller, but I like it for this exercise because the data goes all the way back to 1972 (Case-Shiller only goes back to 1987). For mortgage rates, we'll use the Freddie Mac's 30-year fixed rate index. And for income, we'll use the Commerce Department's estimate of per capita disposable personal income.
And guess what? Today home prices have fallen so much, mortgage rates are so low, and personal income is so high — that homes are more affordable today than at any other time, ever — with mortgage payments on the average home eating up about 40% of income. (Keep in mind, disposable personal income is after-tax income; also, this is calculated on an individual basis, not a household basis.)
With houses more affordable than ever before, why should we expect prices to fall much further from here? Yet the bears insist that they will. Kind of like insisting that the Nasdaq will go to 6000 just because it's at 5000, no?
We can use the same kind of logic — the idea that markets at extremes can't keep getting more extreme forever — to analyze the effect of housing on the economy.
Precisely because residential investment has been cratering for nine quarters, it's become a very small fraction of total GDP — only about 3.4%. At this point, further steep declines (if any) just can't have that much of an effect on the general economy.
Let's put it in concrete terms — jobs. Since the housing market started coming apart two years ago, jobs in the housing sector — broadly construed, to include everything from bricklayers to mortgage brokers — have already declined by over 1.5 million. That's about 1% of the whole national labor force, and it takes housing employment back to where it was in 2000 before the so-called "housing bubble" even got started. Which begs the question: How many more jobs are there to lose in this sector?
So let's head to the comments section. Go ahead, bears, take your best shot. Tell me how bad it is. And the more you do that, the more I'll say that you've had your day.
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Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.
Bump.
What a maroon ... he titles his piece “Housing Prices Near or at Bottom? ( Why the housing bears are wrong )” and then boldly states “IF YOU WANT TO KNOW HOW SMART I AM...” and then the best he can say is “prices can’t go down forever”.
Used to be that when supposed “experts” like me talked, all people could do was listen. Now they can talk back, and their ideas can compete with mine head-to-head on the web.
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While I do not know enough about this person to say whether he is right or wrong, I do know this statement sounds arrogant and elitist. These people can’t know anything! They don’t have a column like me, how dare they question my knowledge!!!
No, they will not go down "forever".
They will go down until the average buyer for the average house in an average neighborhood that has an average job for that neighborhood can actually afford to pay a down payment AND principal AND interest at a fixed rate each month without going bankrupt.
Until hoses prices go down to that level, the houses prices may bounce up and down all they want above that level but those houses will remain unsold.
We all have columns.
Ours are just scattered around Free Republic. :-)
If the ninja and liar loans are unavailable, then house prices will have to fall back on the old dependable 3 x income formula.
No, but there are plenty of examples where markets go down for 30 or 40 years.
Two years is not "forever".
True.
And guess what? Today home prices have fallen so much, mortgage rates are so low, and personal income is so high — that homes are more affordable today than at any other time, ever
Flat out lie.
You forgot taxes. ;-)
You forgot taxes. ;-)
ARRRGGGHHH!!!
"Hey, honey! You remember how I told you we would never lose this house because we could afford the price? Well, some guy on the Internet just pointed out to me that I forgot one tiny little detail and ....."
Mrs. steveo is in the mortgage biz... She had her best month (April) in a long time. The vast majority were sales... People still want homes and if the price is right, and the loan makes sense it’s a done deal.
The houses are built by illegal aliens so the residential housing sector does zero zilch notta for the economy. In fact it just adds more burden by creating a boom in the illegal alien population and anchor babies.
House prices are so high that even if a household earns $100,000 a year and they have 20% down they cannot afford to get in, An $80,000 down on a $400,000+ house which is the absolute bottom on the edge of the ghetto surrounded by nasty dirty mexicans would cause payments of over $3000 ( over the 30% net income margin) If they do buy they will be hanging by a thread in jeapordy of going into forclosure if gas prices go up again or one of thier bosses sneezes and decides to replace them with a mexican because the entire population demographic is turning mexican fast .
I know because I have been searching for two years, 90% of california metro area neiborhoods are infested with packrats from south of the border. That drives the livable white neighborhood housing prices through the roof, into outer space.
the only way a good buyer can get in is to have a gigantic down payment
Slash prices on houses and they will sell, simple economics.
I’ll agree with your take on this - and add this:
Housing prices were pushed up by an artificial demand. By “artificial” I mean that people who didn’t have sustainable means to buy homes were given outlandish leverage by a very easy Fed policy and banking industry greed following 2002’s agenda of interest rate reductions, plus the Yen carry trade, a confluence of events on Wall Street (securitization of junk paper as AAA paper, which kept rates artificially low and liquidity overly abundant).
That leverage is GONE. Period. See ya. We can see new regulation coming down the tunnel every week now that is going to prevent the sort of lending stupidity of 2003 to 2006 from happening again.
Without that fantastic level of leverage, the demand won’t be coming back. People will have to actually justify to bankers why they should be able to get a mortgage. Bankers won’t be writing mortgages to people seeking to buy houses at 6X their household income. The wave of “ruthless defaults” has already created a response from banks to increase lending requirements, to decrease LTV’s on loans, to freeze HELOC’s, etc. Banks will require at least 10% down, and more conservative banks will likely require more.
Luskin is still playing the typical dumb economist. He keeps looking at the macro economic numbers. This economy and the bond and equity markets have not been driven by macro-econ numbers since last August. Everything since then has been driven by bond market events. And the one picture we can paint from the bond market is that a) too many people confounded “credit” for “cash” and b) they’ll learn (the hard way) that these are two very different things as credit is withdrawn from the US economy in nearly instant regulatory and bank policy changes. The effects of the lack of credit won’t be seen all at once in the macro-econ numbers; it is going to set in over a longer period of time.
The Fed just injected another round of liquidity through auction mechanisms this week, and they’re accepting ever more dubious “collateral” for the treasuries they’re “loaning.” This does not look like “the bottom.”
One more thing: Luskin obviously has never been a trader. One of the truism I’ve learned in trading the stock market is this: When talking heads keep saying “This is the bottom” — you’re nowhere close to the bottom. People have to throw their hands up, express nothing but disgust and despair, the conventional wisdom has to become “No one who wants to make any money would put their money there” before there is a “bottom.”
We’re not at a bottom. Just as bull markets don’t go straight up without corrections, bear markets don’t go straight down. Look at a chart of the NASDAQ stocks in 2001 to 2002 - there were counter-trend rallies that kept people saying “This was the bottom!” time and time again. It wasn’t until we got to October 2002 and March 2003 that we finally hit a “bottom.” By then, people were just chucking in the towel and selling stocks at fantastic discounts.
That is a great line.
I don’t think he sounds arrogant or elitist at all. He says specifically that he is a “supposed” expert, that people can talk back to him and have their ideas compete, and “If you want to know how stupid I am, read the comments section of my columns, where readers get to rip what I say to shreds.” That sounds pretty humble, even charming.
I question one of his axioms:
“What establishes value in a home price? Like anything else, it’s a question of historical norms.”
Actually, no. It’s a more fundamental question. The ratio of value to price, like anything else on the market.
I don’t mean value in a particular market, I mean absolute value. For example, you can buy a $20 pair of sunglasses for $200 in the upscale market across town. But their absolute value is still $20.
So what is the value of a $200,000 home that is being sold for $500,000?
Now people can still spend $500,000 for a $200,000 home, but most often only if they can get a lot of credit. And this same principle applies to businesses and our nation itself. We can only have a ridiculously high national debt, because someone is willing to lend us the money to buy things we can’t afford.
And what happens when nobody wants to lend money, so that people can no longer buy a $200k house for $500k?
Reality happens. The price of that house needs to drop to a little above $200k before it *should* be sold. If people can only pay cash, they will want value for that cash. Absolute value. They question the whole premise of why they should pay $500k for a $200k house.
But what about people who have $500k they want to spend on a house? Easy. They buy a house for a little more than $500k that is actually *worth* $500k. If nobody is selling a house that is actually worth $500k, then the buyer finds somebody who will build them a *new* $500k house.
And no, Mr Contractor, you have no reasonable expectation of being paid $700,000 net profit for building a $500,000 house.
Again, reality happens.
Now there is still credit available out there, even if it is tight right now. And the powers that be LIKE to spend more than they make, and want everyone else to overspend as well. But how long do you think that will last?
Time will tell. Eventually it has to end, however.
He does sound like he has a sense of humor, maybe sarcasm doesn’t come across well in print. Lord knows I’ve been accused of that numerous times.
It just sounds very ‘pajama blogger’ to me.
That leverage is GONE. Period. See ya. We can see new regulation coming down the tunnel every week now that is going to prevent the sort of lending stupidity of 2003 to 2006 from happening again.
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My aunt is moving to the Atlanta suburbs ,, she contracted on a nice small house at a price equal to what it sold for in 2000, the bank/mortgage lender refused to finance until the price came down an additional 10%, the seller agreed to the price reduction... my aunt has so-so credit but no debt and SS income and a gov’t pension , basically a no-risk customer for the bank... The banks ARE tightening substantially.
In my neighborhood I know of more than a few bank REO properties that are not on the market and probably won’t be for several years.. These properties will cap any price strength for quite a while, several owner occupies for-sales have been taken off the market also... I see at least 2-3 years before we get firming bids.
If this chart is correct just about every single bank will go under. The average house value was around $220,000. So in the next year and definitely by 2012 most homeowners will be upside down in either their mortgage or home equity line. There will be no reason to keep the house so they will be abandoned or the banks will have to renegotiate mortgages and write off the losses.
Eventually when all these homes are abandoned there will be a shortage of property owners. Rent will skyrocket which will raise home prices again.
I'm quite certain that "most" does not apply here unless, six years ago, America had already become a nation populated mostly by children with absolutely no impulse control.
I have two houses paid off and my debt load has been zero since 1997. That is not something that I consider extraordinary. That is something "most" Americans used to strive for.
For "most" Americans to be upside down, they would have had to borrow more money on home equity lines than all the equity they had ever accumulated before this Bubble stupidity began.
There will be no reason to keep the house so they will be abandoned or the banks will have to renegotiate mortgages and write off the losses. Eventually when all these homes are abandoned there will be a shortage of property owners. Rent will skyrocket which will raise home prices again.
In such a scenario, houses will not be "abandoned" like Thursday's leftovers.
The houses will belong to the mortgage holders, Property Management companies will step in to fix up the houses for cost plus a nice profit margin and then rent the houses out for 10% to 15% of the monthly rent as commissions.
The housing needs will be fully met by rental properties and nobody in their right mind will buy a house until the houses are priced where payments on down payment PLUS principal PLUS interest PLUS taxes do not devastate the household income.
Houses will then be like Delta Airlines jet aircraft. You rent a temporary seat for a certain period of time on a Delta Airlines jet but no average citizen ever considers actually buying such a jet at the prices they sell for.
5 Bed, 3.5 Bath; 4,080 Sq. Ft.; 0.38 Acres; $264,900 (probably overpriced by about $30k)
Okay, name a few.
“Today home prices have fallen so much, mortgage rates are so low, and personal income is so high — that homes are more affordable today than at any other time, ever — with mortgage payments on the average home eating up about 40% of income.”
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
Yep, the man is an idiot all right! Back in the sixties any banker worth his salt would have refused to lend fifty cents to someone who proposed to spend forty percent of income on a mortgage payment. Best I remember they used to tell people not to spend more than twenty five percent of TAKEHOME pay max.
if you dropped that house into my town, redondo beach california it would be going for OVER 2 million easy and would probably sell in 6 months or less to a rich foriegner or movie star
Okay, name a few. " Japan.....lol ! !
japan recovered from the bubble burst of 1945 but never did recover from the bubble burst in 1972
Mr. Luskin is right so far as he goes. But there's one very important element he completely leaves out.
Movement in the housing market is determined by affordability---as Luskin points out, a dynamic of home prices, the cost of money and personal income. But it's equally determined by emotion (for lack of a better word). IOW, it's not enough for housing to be affordable. Buying or selling a home, or investing in real estate, also has to be desirable---i.e., something the individual wants to do for reasons above and beyond the fact that he can now "afford" a different house.
What I see in this market that is new is a complete change in the mentality that underlies the housing market. I've explained it before with reference to years ago when the mentality (emotion) about cars was that it was desirable--almost necessary---to trade in one's car every few years, if not every year, and that one of one's goals in life was to get an ever nicer ride.
Somewhere along the way this mentality changed. More and more people began hanging on to their cars longer and longer, even until they were junkers and driving them into the ground. It no longer was the socially required/expected thing to do to always be getting a new car and always be trying to upgrade one's auto. People on a large scale decided that a certain level of car worked for them and that was that. We never went back to the scene where cars were traded like marbles and they were the ultimate status symbol (except for a much smaller social segment who continues to care about such things).
This downturn has been so shocking to middle America and hit so deep into the populace that it seems many have re-evaluated why they wanted to keep moving from home to home every few years anyway. The new mentality is "eh, this place is good enough; let's just get on with our life."
Since the market has always had only a relatively few buyers and sellers who HAD to move (for a job, a family reason, etc.), and was mostly made up of people who WANTED to move ("I really need a mudroom;" "I'd like to be closer to work or have a bigger yard"), a wholesale change in how people formulate their housing desires will be a big determinant of how low prices have to go before even people who are satisfied with staying put go, "That deal is too good to pass by."
I do agree that the potential impact of the housing sector's collapse on the general economy may be overblown. However, within the sector it's the Great Depression and most of us knew people whose financial mindsets were set by the Great Depression for the rest of their lives. That, too, may be true in the housing sector's "Great Depression."
There is a mass awareness of a fact that people previously failed to appreciate: that real estate can, in fact, lose value for a very long time. Once that is internalized by many, many people, there will be many who won't be looking to dabble in the market unless they absolutely have to.
The deeper this new mindset is ingrained, the deeper prices have to be cut to overcome it. IOW, if indeed the whole mentality about whether one even "needs" (i.e., WANTS) a new house has changed, the amount of resistance to returning to the market has changed---it has increased and exponentially. Therefore, the "cure"--lowering of prices---has to be even stronger to overcome that greater resistance.
I agree.
No, many Americans who made conservative financial choices, but who happened to buy within the last 4-5 years, are still upside down in their houses. I know some neighborhoods where the homes lost over $200K in value in two years, for no reason except that a couple of miles down the road a zillion developments opened at once, right as demand was already slackening. With literally hundreds of vacant never-lived in homes sitting on the market, the “newer” resale market was the first to tank.
Today home prices have fallen so much, mortgage rates are so low, and personal income is so high — that homes are more affordable today than at any other time, ever — with mortgage payments on the average home eating up about 40% of income.
For the bubble states, however, this is still just beginning. Although the bubble burst well over a year ago in central California, it is only now starting to get to the premier markets like San Fransisco and Silicon Valley. Prices will eventually have to get cut by about 50% more, but there are still a lot of factors delaying that, from the psychology of the defaulted home renters to the banks struggling to avoid taking possession of an enormous number of properties and taking the loss.
In order to call the bottom in northern California, The foreclosed properties will be bought from the banks at the same rate they are being added, and they will no longer be driving the prices down. None of this is close to happening yet. I don't see it happening this year.
I checked on the square footage, though, and the county auditor says it's only 2684.
http://auditor.cuyahogacounty.us/REPI/res_bldg.asp?txtParcel=21530109
So I guess it would only be a million in CA.
Here's the listing. http://auditor.cuyahogacounty.us/REPI/res_bldg.asp?txtParcel=21530109
Interested in a riverfront house with 60’ dock? (The Rocky River’s mouth is about a half mile north. Then it’s 60 miles across Lake Erie to Canada.) Only a million. Check it out. Of course out boating season is only about 6 months long.
It used to have a marina for sale with dockage for 43 boats. It was there this morning, now it’s gone. I think that went for 2.5 million.
http://realtyone.realliving.com/Property/Details.aspx?PropID=3978156
Americans who bought in the last 4-5 years did NOT make a "conservative financial choice".
They made a foolish choice by buying at a price that was wildly inflated because every burger flipper at MacDonalds had a $200,000 mortgage offered to him and everybody on a teacher's salary had an $800,000 mortgage offered to them.
They were even more foolish than the burger flippers because they were matching, with real money they intended to repay, the bids offered by the burger flippers with smoke & mirrors money they could not possibly repay.
My two houses were paid off more than 10 years ago. The stock market after the High Tech Bubble crash was doing so so and I had a lot of cash available to invest in anything I wanted to.
Be that as it may, I was not going to touch that Bubble Real Estate market with a ten foot pole because it was built on smoke and mirrors. Buyers were taking on debt that they could only barely afford "Interest Only" monthly payments on and was guaranteed to bankrupt them once the grace period on the gimmick loans expired. Yet, those buyers bought anyway because everybody knew that real estate trees grow to the sky and the worst that could happen was that, three years down the road, they could sell the house at a profit.
The houses prices were totally out of synch with what people could actually pay without gimmicks and the current disaster was totally predictable.
What should the buyers of the past 4-5 years have done?
Wear one of these T-Shirts during the years of the Real Estate Bubble market:
That is what "making conservative financial choices" was all about during those years.
Spending 40% of income feeding a mortgage is way out line with historical percentages.
Traditionally, before the current insanity, 28% of your pre-tax income had been the maximum amount that mortgage lenders would even allow.
Don is frequently on CNBC. Always interesting to hear or read.
It may as well be the Anbar province.
The chart ignores the 500k exclusion of income. This raises the baseline.
-—”5 Bed, 3.5 Bath; 4,080 Sq. Ft.; 0.38 Acres; $264,900 (probably overpriced by about $30k)”
Yeah, but who would want to live in OHIO?
I’d much rather pay $750K for a 3 bdrm California coastal condo.
“They will go down until the average buyer for the average house in an average neighborhood that has an average job for that neighborhood can actually afford to pay a down payment AND principal AND interest at a fixed rate each month without going bankrupt.
Until hoses prices go down to that level, the houses prices may bounce up and down all they want above that level but those houses will remain unsold.”
Unquestionably correct! The average family fella can’t handle a $2K a month mortgage and car and gas and health insurance and college for the 2.25 kids...its just all still just too expensive.
...And spiraling property taxes rigged to the cost of inflation as they are in Ohio.
These clowns are dreaming if they think otherwise.
I love the huge swings in the weather in Northern Ohio. I love the winter and the snow. I love Lake Erie. I've been to California and other places where the weather is always 'nice' but that's not for me. A year without a house-shaking blizzard wouldn't be as fun. I love watching the plants make a comeback in spring as they are doing now. I love having my own yard and a workshop to play in. I think a condo would drive me nuts. But hey, folks are all different. I'm very happy here.
I don’t understand this housing price graph. My parents bought a home in 1959 and sold it in 2001 for about 13 times the price they paid. As the difference in no way is reflected in this graph, does that mean that the difference was really mostly illusionary due to inflation and the loss of value of the dollar?
Interesting post.
Where would you recommend people invest their money for the next few years to get a modicum of return?
The graph plots prices in "constant dollars" that are adjusted for inflation. The benchmark chosen was average house prices in 1890 paid for in 1890 dollar which is set at an arbitrary "value" of 100.
The 1890 Dollar was chosen because 1890 is the year at which the chart starts plotting.
A house price value of 120 on the graph means that house prices, adjusted for inflation, are 20% increased from 1890 and a house price value of 80 on the graph means that house prices, adjusted for inflation, are 20% decreased from 1890.
To "adjust for inflation" you use an Inflation Calculator.
Any price difference brought about just because of inflation is factored out.
Let's look at your parent's house in 1959 and pick a price for 1959 of, say, $10,000 to keep the math simple.
Plugging the numbers into the Inflation Calculator to compare the years 1959 and 2001, you get the answer:
"What cost $10000 in 1959 would cost $60423.82 in 2001. Also, if you were to buy exactly the same products in 2001 and 1959, they would cost you $10000 and $1681.46 respectively."
So, with inflation alone, the price difference between 1959 and 2001 should have been only six times more.
Since the house sold for 13 times more in their area, the actual inflation adjusted cost of your parent's house as compared to an 1890 house doubled (and a little bit more) between 1959 and 2001 and so the value on the graph would be a little over 200.
The graph shows that, in America as a whole, the 200 value was reached in the year 2006. So, your parent's area was five years ahead of the rest of America in house price increase.
I’m sorry, I don’t like to give out that kind of recommendation. I don’t know your risk for tolerance, your age, your responsibilities, assets, liabilities, etc.
A financial adviser needs to know a whole lot of personal information about you to make a competent recommendation. I’m not a financial adviser and I don’t like to make off-the-cuff recommendations.
BUMP TOO!
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