Housing Basics

Huosing prices take a LOOOONG time to fall

It can take twice as many years to go down, as it took to go up.

Edward Leamer, economist at the UCLA Anderson School of Management, was presenting a paper at Jackson Hole, in which he gives the Federal Reserve an ‘F’ for failing to target the housing market.

In a Bloomberg interview, he explained why it takes so long for real estate markets to adjust.  Whereas he thinks the builders will stabilize by the end of the year, owner occupied homes takes forever to adjust because sellers have the option to not sell. 

Note – Bloomberg does not archive interviews, so this will only be available for a day or two, on Bloomberg’s homepage.

Leamer explains why prices on owner occupied homes fall so slowly.  Sellers dig in their heels, year after year after year. 

“If I don’t get my price, I’m not gonna sell”…next year they say, “If I don’t get my price I’m not gonna sell.”

So it takes forever to normalize, because the prices don’t fall as fast as they need to. 

Prices in some Calfiornia markets need to fall 30-40%.  The downturn is inevitable.

…but the sellers of owner occupied homes just don’t let that happen, because they say “I’m not selling unless I get my price”, so what happens is that transaction prices move down ever so slowly and you don’t get a normalized market price… [cut off, end of interview…he probably meant to finish by saying “for a long time]

Hat tip to Tanta at Calculated Risk for finding this total gem of a quote in economist Edward Leamer’s paper , which he presented at the Jackson Hole, Wyoming conference.  Dr. Leamer totally nailed the emotional component of sellers.  This is one of the best quotes I have ever seen!  In bold, I put the parts relating to prices, sales, or volume.

We love our homes. We don’t love our investments in General Motors or IBM, and when the stock market sends us the daily message that share prices have plummeted, we reluctantly accept that unwelcome reality. Homes are different. We have a close personal relationship with our homes. When the market is hot, buyers stream by our front doors proclaiming that they love our homes even more than we do by offering prices beyond our wildest dreams. Charmed by that flattery, many of us sell our loved ones, confidant that we have turned our homes over to people who will treat them well. Thus rising prices and high sales volumes. When the market cools, however, only a few prospective buyers come to our front doors, and those prospective buyers bring a most unsettling message: “We know you love your home, but it isn’t worth nearly as much as you think.” That can be a deal-breaker for female owners, but the clincher for males is the fact that their idiot neighbor sold his home for $1 million just last year, and the male owner is not going to take a penny less than that. It doesn’t matter what the market thinks. This house is worth $1million. Period.

Housing hormones, both estrogen and testosterone, make owners very unwilling to sell into a weak market and that unwillingness tends to keep the prices of homes actually sold high while greatly reducing the volumes of homes sold. What we observe are not market prices but sellers’ prices.

If you don’t like this love story, another good one is that sellers look backward, remembering what they or their neighbors paid, but buyers look forward, wondering what the house might be worth in a couple of years. Positioned in time looking in different directions, when the market is rising, owners estimate the value less than prospective buyers, and a sale occurs, but when the market is falling, the owners remember the good old days of high prices, and the buyers are thinking about a better deal in a couple of months. Then there is no transaction, unless it is at the high sellers prices. A third story comes from the behavioral economics: It’s loss aversion.7 As long as I don’t sell my home, I can comfortably maintain that it is worth what I paid for it.

Lawler on OFHEO versus Case Shiller Index

Patrick Lawler, OFHEO’s chief economist, noted that “the market turned very sharply” last year, with house price appreciation down from the previous year in every state except Texas.

The same data show that house appreciation for the year as a whole was down to 4.1%, Patrick Lawler said.

He joined in a discussion of the differences between the OFHEO index and the S&P Index. The OFHEO index is based only on single-family homes with loans purchased by Fannie Mae and Freddie Mac and it underrepresents properties financed with subprime loans, but it has broader geographic coverage.

Because the OFHEO index does not include loans over the conforming loan limit, it undersamples housing in expensive markets such as San Francisco, he said.

The standard House Price Index also includes refinancings, which recently have tended to overstate home price gains. Accordingly, Lawler indicated that his agency has been focusing more attention on its purchase transactions only index, which excludes refinancings.

The Data Lies

Almost every statistic reported about the housing market is misleading in some way.  While the housing market is getting worse by the day, you wouldn’t know it from information reported by the government, Wall Street, banks, realtors, media, and industry associations.  Worse, none of them have tried to educate the public about the problems with their data. 

Here you will find the most complete description of what is wrong with the housing market data.  Most of it is my own work.  Some is copied from other sources as noted.   If you have some “data lies” reports to add, please contact me at [email protected].

Case-Shiller index is fatally flawed 

Instead of measuring housing values, as we are led to believe, the index measures the change in price from the last time that group of home sold.  As long as many homeowners are selling for more than they paid for their homes, the index will be upward biased.  It ignores incentives, new home sales, effect of all those expensive remodels, and all those homes that are languishing and not selling. In short, it is not a home price index at all.  Rather, it’s a “sold price index”. 

Quirky MBA categories understates subprime delinquencies 

5/20/07:  The Mortgage Bankers Association counts a subprime loan as delinquent only if it was made by a subprime lender.  In their category, Countrywide is a prime lender, so none of Countrywide’s delinquent subprime loans are counted. 

Construction job losses not counted in unemployment data

Job losses due to the busting housing market are much higher than shown in the unemployment reports, because construction workers, realtors, and mortgage brokers are usually independent contractors and don’t get unemployment pay.  In the past year, 600K illegal construction workers lost their jobs – none are in the data. 

 $/sq ft does not measure price changes of homes, but price changes of the mix of homes sold

Small homes cost $400/sq ft, while larger homes cost $300/sq ft.  When fewer small homes sell, the $/sq ft goes down.   Thus, $/sq ft is a distribution number.  There is not a number that measures the change in home prices! 

Median price, average price, and $/sq ft are not price indicators

These are distribution numbers, meaning they measure the change in the mix of homes sold.  In a cooling housing market, the first time buyer is squeezed out first, so the smaller homes make up a smaller percentage of sold homes every month.  This trend toward more large homes selling makes the median and average price go up, and the price/sq ft go down (since larger homes cost less per square foot). 

5/11/07, per a comment by Patrick B. on patrick.net, I want to reiterate that the reduction in subprime lending causes even fewer low end homes to be sold, so we should expect the median to rise sharply in the next few months.  Subprime lending was really hit in February, so closing from April 1 onward should show the effect of more large homes sold, skewing up the median and average, and lowering the $/sq ft.  I anticipate that next week’s release of the April data will show a bigger shift than we have seen to date.

From the Credit Suisse Report:  The Data Lies

The data lies on housing starts, the OFHEO index, NAR home prices,  new and existing home sales.  Analyst Ivy Zelman looks behind the headlines, and explains why these indicators are plain wrong.

MBA Purchase Index rises, but lending is down

The MBA Purchase Index, which measures applications, rises as borrowers make multiple applications, and bankrupt lenders increase volume to those left in business.   People have misinterpreted the recent rise in the Index to signal more purchases of homes.

The MBA Refinance Index should be subject to that same error.