Wednesday, May 19, 2004

The Price of a Home: An arm and a leg?

Brad Delong presents an interesting urban-development hypothesis for rising prices in California.

I think that two things are going on here. First, that America as a country is not yet productive enough to support everybody at the upper middle class standard of living we as a country believe that everybody deserves. (And, perhaps, when we are rich enough our idea of what an upper middle class standard of living is will have changed as well.) Second, there is the California homeownership fact. I'm beginning to think that it is yet another disastrous fallout from Proposition 13, another present to me and my children from those who voted with Howard Jarvis. With property taxes capped, it makes very little sense financially for a local government to approve nearly any increase in housing density: the property tax revenues don't cover the services that increased population density requires. Developers pay initial ransom in order to get sprawl subdivisions started, but once there are voters who don't really want an increase in density, there's no way to assemble a political coalition to make it happen.

And with no way to build up, you build out. And building out means you have to commute by car. And commuting time costs means that housing prices near the center go up and up and up. Thus Angelenos (and Bayareans) pay more and get less housing than people in other parts of the country. (Except for those of us with Berkeley-subsidized mortgages.)

Well there are two sides of the coin. First it's apparent that prices are rising perhaps unsustainably in many urban centers, especially California, but on the other hand the handy arguments found in articles like this on on a housing bubble haven't resulted in a bubble popping yet. Note that this "storm watch" is dated late 2002.

The combination of credit-related asset deflation in the stock and real estate markets, combined with rising interest rates, will have a lethal effect on debt-strapped households. The housing bubble will deflate gradually. It will take time, maybe years, for it to unwind. Fortunately for homeowners, the price of their homes doesn’t appear as a ticker tape across a computer screen nor is it listed in the newspapers each day. The only visible sign of distress will be the increase in for sale signs in the neighborhood. Judging by what happened in the last recession, housing prices peaked several years after the recession and would take close to a decade to recover and rebuild pricing momentum. Right now homeowners, like stock investors, are in a state of denial preferring to act like ostriches rather than face reality. What could trigger the unwinding of the housing bubble? Several events could burst the bubble - a dollar crisis, the unwinding of the bond market bubble, and the second capitulation phase of a bear market in stocks. The stock market bubble, which is still with us, is the subject of Part III and the final chapter of Bubble Troubles coming soon.

To be fair, a housing bubble if it exists (as I think it does) can't begin to unwind until interest rates begin rising. Which is just around the corner - mortgage rates have already been sneaking up of course.

This Slate article claims that the housing building companies are well-positioned. This means that they're not overstocked on inventory and are often building now only on order-and-deposit, meaning that the customer has to walk away from a chunk-o-change to bail out on the house purchase.

When the housing bubble pops, who will burst with it? The last time housing prices fell sharply—in the late 1980s and early 1990s—the slump laid low real estate brokers, mortgage bankers, and, especially, developers.

But this time around, strangely, large, publicly held home-builders may escape the worst damage. They're a case study in how an industry can become more stable when it gains geographic scale and public ownership. During the tech bubble, executives and the stock market acted crazy while customers buying tech products behaved rationally. In the housing bubble, by contrast, the customers are acting crazy, while executives and the stock market are behaving rationally.

What a comforting thought - the developers and financiers will be okay while families get locked into houses that they can't get rid of for anything approaching their purchase value and the carpenters and laborers get their jobs cut in a downturn. Very very comforting there Daniel Gross!

Nathan Newman Blog probably has been the most consistent blogger arguing for a Housing bubble.

The Federal Reserve Bank of Dallas has an analysis as of 2004 on the Web that analyzes the vulnerability of the housing market to bubble-itis.

Issue 2, March/April 2004
Federal Reserve Bank of Dallas

How Vulnerable Are Housing Prices?

In recent years, overall home prices have risen dramatically, by 37 percent since 1997 (26 percent when adjusted for inflation). Such increases have raised concerns that low interest rates have spawned a housing-price bubble. In such a case, previous increases in housing prices would leave them so far out of line with fundamentals that they would be vulnerable to falling.

If a national housing-price bubble has emerged, the pace of the current economic recovery could be affected in two ways. First, fears that housing prices could fall may deter families from buying new homes, which could slow home construction. Second, actual declines in housing prices could slow consumer spending by reducing housing wealth. This is important because, as emphasized by Federal Reserve Chairman Alan Greenspan, people have increasingly tapped housing wealth to fuel consumer spending in recent years, helping offset the drag from past stock market losses.[1]

This article reviews evidence on the possibility that housing prices could fall, first discussing key considerations about housing prices and then turning to the vulnerability of national, regional and metro housing prices. Throughout, housing prices are measured by indexes that control for quality changes by tracking prices from repeat home sales in different broad areas. Consequently, the article does not comment on home prices in particular neighborhoods, nor does it shed light on differences in home prices within various parts of the country (for example, upper-end versus middle-range or low-end priced homes).

Still, we can glean some information about how vulnerable housing prices are to declines nationally and in particular regions and cities. One key finding is that although there is little risk of a national bubble, prices in some areas are vulnerable if local economic conditions deteriorate. [emphasis added]

It seems to me that this (national) median income family ($45k py) in LA that was featured by the article discussed by Brad is going to get slammed by the correction. When will it come?

Well according to this site on Housing Starts and Permits and using data from the US Census Bureau as of May 19, 2004 the Housing Starts seem to have begun peaking already.

The April number for new housing starts was 0.7% less than the the number from March, 2004 for single family homes.

Of course this isn't definitive proof, but it seems like the beginning of a trend. The good news is that the price of new housing will probably gradually go down. The bad news is that in areas that have little construction and where people are tied into low-interest but high principal mortgages from the height of the boom there is going to be limited mobility.


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