Monday, July 26, 2004

Housing Bubble: Maybe or Just Braindead?

Sometimes the editorial practice of putting forth "both sides" of an issue isn't informative, it's just schizophrenic. The problem is that the argument of a dialectic presupposes both sides are informed about the facts, and can identify their external assumptions, and are making pro and con judgements about various choices of emphasis and interpretation. In a adversarial or advocational environment however shallow knowledge or differences in rhetorical presentation can shift the truth into either a muddled mess or tip the debate toward the wrong conclusions.

The NYT did that this past weekend by putting up two articles, one sensible and fact based and the other rather speculative but in presenting both without value judgements as to their content to the uninformed reader it might have seemed that they were equivalent if differing arguments.

Here the article presents the artificial dillemma:

Even as the housing market has set more warning bells a-clang, some bubble-skeptic economists dismiss the idea that housing prices are due for a pop. Sure, home prices are high, they say. They might decline somewhat to adjust to rising interest rates. But nothing justifies an uncontrolled plunge.

The argument is likely to continue - regardless of what actually happens to the price of homes - because the argument doesn't really have much to do with housing prices. It is about fundamentally different views of how markets operate.

Housing prices have indeed soared. Stoked by some of the lowest interest rates in history, home prices in Los Angeles rose 18 percent in the last year. In Miami, they jumped 14 percent. But do these amount to bubbles?

Then the article presents a very credible expert who has been vindicated by making correct predictions.
Robert Shiller, the famed Yale economist and bubble-ologist who predicted the end of the dot-com stock boom in his book "Irrational Exuberance," argues that they do. He explains that bubbles are created when the prices of assets are fueled by psychological rather than economic considerations.

From apartments in New York to tulips in 17th-century Holland, a bubble is born when people lose sight of the fundamental value of an asset and are willing to pay whatever it takes because they see that prices have risen like crazy and assume they will continue to do so.

"People get excited about price increases and start behaving differently," Mr. Shiller says.

After all, he says, bubbles always pop. Like a Ponzi scheme, a bubble will survive only as long as the herd believes in ever-rising prices. If something pricks this faith, if no next buyer is willing to pay more, the herd will run and the bubble will deflate catastrophically.

Take the stock market. From 1996 and to 1999 the price of tech stocks in the Standard & Poor's index rose nearly sevenfold, goaded by dot-com enthusiasts who claimed that a new economy with much improved qualities justified prices previously believed to be impossible.

Then the herd turned around. By mid-2001, tech stocks had fallen back by 70 percent. [emphasis added]

Okay on the side of bubbles, we have a prominent expert who correctly called the stock market movement. On the other side we have ...
But despite these dramatic upheavals, not everybody is convinced that bubbles even exist. Peter Garber, a global strategist at Deutsche Bank, believes that psychological explanations like herd behavior are a deus ex machina invoked by economists who do not properly understand the economic underpinnings of the market.

Mr. Garber argues that from the Dutch tulip craze to the stock market boom of a few years ago, soaring prices have been justified by economic fundamentals - be it the earning potential of rare tulips or stocks.

Some of the arguments backing the tech boom ultimately proved to be flawed, he acknowledges, but the analysis holding stock prices up - that productivity had reached a new level and companies would be able to capture this in higher profits - was reasonable. When stock prices fell, it was because of changes in this underlying business landscape.

In the other corner we have someone who admits that the basis of the arguments for the high prices were wrong, but he continues to argue that there was no bubble. Based on what evidence, that he was wrong but we should believe him anyway? Okay what is the other "bubble skeptic" they put forth?
Another bubble-skeptic is Kevin Hassett, director of economic policy studies at the American Enterprise Institute and co-author of the fabled "Dow 36,000,"* which was published in 1999 when the Dow Jones index was around 11,000. Mr. Hassett says there is an ideological component to the belief in bubbles. Liberals, who tend to believe that government must step in to protect people from market imperfections, will likely see more of them. Conservatives, who like their markets unfettered, will see less.

In any case, it's difficult to predict when bubbles may burst. The Fed chairman, Alan Greenspan, was three years early when he said stocks were irrationally exuberant in 1996. According to Laurence H. Meyer, a governor at the Fed during the rise and pop of the dot-com bubble, Mr. Greenspan gleaned from the experience an undisputable rule to spot asset price effervescence: if stock prices come crashing down by 40 percent or more, it means there was indeed a bubble, and it just burst.

"You don't know until its over," Mr. Meyer says. "Or at least until it's too late to intervene and avoid it."

Mr. Hassett of the conservative American Enterprise Institute thinks housing prices will be pretty much O.K. He acknowledges there might be some bubble dynamics at play in some regions. But he argues that for the most part people are paying more for homes because their incomes are higher and interest rates are lower, reducing the cost to own a home.

Mr. Hassett expects that rising interest rates would raise this cost and home prices would then decline proportionately. But he sees no reason to expect a catastrophic decline. "I don't think a catastrophe is very likely," he says.[emphasis added]
*NOTE: The DJIA is currently today below 10,000.

Okay not only is he from the American Enterprise Institute, but he wrote an entire book explaining why the DJIA would shoot up to 36,000 from 11,000 and he was demonstrably wrong. Why should he have any credibility at all? Who is in the other corner?
"The end result will be a loss of $2 to $3 trillion in housing wealth, and a downturn that is even worse than the fallout from the stock market crash," wrote Dean Baker, co-director of the liberal Center for Economic Policy Research...

But Mr. Baker argues that house prices have been running faster than inflation since 1995 - the first time they have done so since World War II. Meanwhile, rental prices are falling in real terms, indicating that demand for housing is weak. And builders are rushing to add new units - threatening to glut the market.

Mr. Baker thinks that Mr. Greenspan has been too supportive of the boom in housing prices, and could have made the case that housing prices were starting to behave irrationally.

Mr. Baker is so convinced that the bubble will burst that two months ago he sold his condo in Washington.

"I would be a fool to hang onto a place through the collapse of a bubble," he says.

In the other corner we have an expert arguing based on facts, and even more importantly he's willing to put his own money where his mouth is - selling his property in anticipation of a bubble correction. So for the idea of a bubble we have two experts, reknowned, arguing from facts, and either with a track record of success in calling the market or willing to put their money where their mouths are. Opposing their opinion are two "experts", one of which admits that the arguments boosting tech stock prices were flawed but hopes we beleive him anyway and another one who was catastrophically and obviously wrong but again hopes we believe him anyway. Is there a contest at all?

Why are these other guys even quoted instead of paraphrased? Why does the reporter even bother to say "But maybe not." about whether or not there will be a real estate bubble correction? Why is the article entitled even "The Perils of Predicting Financial Bubbles"? No predictions can ever be sure completely, but this amount of hedging is ridiculous. I have to give the reporter Mr. Porter credit for reporting information which would lead anyone reading carefully to discredit the counter-bubble people. However his own reporting should have told him that this was not a "coin flip" situation. Based upon the preponderance of evidence and the credibility of the experts involved, the conclusion definitely slants more toward the bubble-case than the anti-bubble case.

This just happens to be borne out by emerging well-reported facts (TheStreet.Com):
No End Yet to Housing Boom

By TSC Staff
11:14 AM EDT

Sales of existing homes went through the roof in June.

The number of homes sold hit a record annualized rate of 6.95 million last month, up 2.1% from May and 17.4% from a year ago, according to the National Association of Realtors, a real estate trade group.

A decrease was widely expected with the consensus forecast of economists forecasting a rate of 6.67 units, vs. May's 6.81 million rate which was revised higher.

Mortgage rates rose for much of June, tracking the 10-year Treasury note, ahead of the Fed's highly anticipated and well-telegraphed decision to raise short-term interest rates for the first time in more than a year. By historical standards, however, mortgage rates are still low.

The average interest rate for 30-year fixed-rate mortgages inched up to 5.96% from 5.95% a week ago, while the average on 15-year fixed-rate mortgages decreased two basis points, or 5.34%, according a Mortgage Bankers Association report last week. The average rate for one-year adjustable rate mortgages, or ARMs, was unchanged at 3.93%, the MBA said.

Sales gains from a month ago were the sharpest in the Midwest and the West and the weakest in the South. The West also had the greatest year-over-year increase.

The median national sales price was a record $191,800 in June, up 9.6% from the previous year. The greatest appreciation was in the Northeast, where prices rose 15.9% from the year-ago period. Prices in the Midwest increased the least -- 7%. [emphasis added]

That's ugly. Didn't the oldman say that the uptic in interest rates and then their subsequent fall would be sure to suck in a sucker's rally? It has apparently happened by all evidence. Yet people question whether or not there is a bubble. There is a bubble. The only question is hard landing or soft, sharp price depreciation or price stagnation trading "sidewise" for many years until fundamentals catch up, and in the long term liquidation of overpriced assets or restructuring debt and raising income.

Yet this article makes it seem superficially if there were some reasonable basis for thinking otherwise. It doesn't have to happen. Certainly an asteroid could take out the United States tomorrow. Jesus Christ could descend from the clouds on high and inaugerate the Second Coming. However barring unusual and unexpected occurrences of an unforeseeable nature, then there is every reason to conclude that events will play out as foreseen.


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