Wednesday, July 14, 2004

Housing: Oh wait, there is a bubble

For literally years now the Federal Reserve banking system has been repeating the mantra "there is no housing bubble, there is no housing bubble". Well meaning but rather naive commentators have been unwittingly playing along by saying "Well prices are pretty high but it's not true everywhere. Maybe here isn't a bubble and maybe there is." I'm not sure where they get all these liars and patsies. One sure thing they're a domestic product.

Well bursting the bubble of naivete of anyone who actually was stupid enough to actualy believe the official pronouncements, the Federal Reserve is now saying "Oh wait, there is a bubble afterall." (MSNBC)

Home-price growth seen slowest since '70s
Fed estimates only 2.6 percent rise over next 3 years

The Associated Press
Updated: 11:27 a.m. ET July 14, 2004

WASHINGTON - U.S. house prices are likely to grow at the slowest pace in more than three decades as interest rates climb and land prices take a tumble over the next three years, researchers at the Federal Reserve have estimated in a new study.

The study, published on the central bank's Web site recently, asserts that if U.S. disposable income and short-term interest rates climb as much as Wall Street expects them to, nominal existing-house prices would increase a cumulative 2.6 percent over the next three years. That would mark the lowest rate since the government began keeping records in 1970. The number implies high odds that house prices will decline in inflation-adjusted terms.

The conclusions validate the unease of many private economists who fear the U.S. housing market, having benefited recently from rapid price gains that helped maintain strong consumer spending through a recession, may become a source of economic instability as interest rates climb.

Prices of existing homes rose by more than 20 percent cumulatively over the last three years, according to the National Association of Realtors. The association has been predicting only a modest slowdown for the next few years.

Anybody else remember what things were like in the seventies? They sucked. With the home property and commercial real estate asset market mired like in the seventies the whole economy is going to turn over like a fish going belly up. There's your "banner year" for you. Idiots. Of course they're well paid idiots, and perhaps cuing in that they're so well paid and so conveniently idiotic maybe they're not so much idiots as liars or self-deceivers.

Like this guy.
Bubble? Schmubble!!

Why then, is there little or no statistical likelihood of a bursting of the national housing hot air balloon? For starters, say McCarthy and Peach, the cost of mortgage money remains at near-record lows. Low rates, in turn, allow home buyers to pay higher prices for properties without stretching their household incomes.

McCarthy and Peach computed the ratio between annual principal and interest payments at prevailing mortgage rates on new single-family homes and median household incomes. Assuming a 30-year loan with 20 percent downpayment, the ratio is currently at or close to a 25-year low point -- 15 percent. Put in simpler terms, even with significantly higher real housing prices, home buyers' monthly outlays to pay for their mortgages are the lowest they've been in a quarter century, thanks to 40-year lows in mortgage rates.

"This is in sharp contrast to the conditions of the (hyperinflationary) 1970s and 1980s, when high home prices and high nominal interest rates combined to erode cash flow affordability," said McCarthy and Peach.

A significant increase in mortgage rates would throw a monkey wrench into this equation, of course, but probably not trigger a blowout decline in prices, absent other negative economic events such as a severe jump in unemployment or a decline in the rate of household income growth. [emphasis added]

Except of course that in the real world the job market is already souring, the conflicting forces of monetized inflation and capacity deflation, and various indicators of household economic health and spending (such as big ticket purchases like car sales) are already going south. So yes there's little chance of a bubble bursting unless certain things happening. Except they are happening right now. Mind you this guy is in the real estate business himself. He's willfully directed selective attention to turn a study that confirms a market correction into agreement with the exact opposite position. Amazing! Inconceivable.

Of course it's not simply going to deflate quietly from here on out. Nothing so pretty as that. Mortgage rates have been falling recently. That means there's going to be a surge, the sucker's rally. Cripes I couldn't even get a sandwhich at a deli shoppe the other day without some hungry young up-and-comer fresh-faced graduate from the business school there telling me that he was going to get into real estate with a bunch of friends of his. I told him the truth about where the market was going to go, and he just shrugged it off.

That's bubble behavior right there. Of course these anecdotes by themselves mean little, but when you have solid evidence like the Fed finally admitting that there's going to be rapid price depreciation in the next few years then those anecdotes become warning signs. Still you can understand why a crash like that will happen. Even though the empirical evidence and their own models tell them it must happen given the current market dynamics, they willfully select evidence that confirms only their predetermined assertion that it won't happen. Inconceivable!

Sorry, just channeling the Sicilian there for a moment (see 'The Princess Bride' film for reference). He's my personal archetype of the kind of people who give the terms "in theory" and "ivory tower" their most pejorative senses of the term. This in turn breeds contempt by the layperson who thinks they can finger things for themselves better than the so-called experts. Well the truth is that neither conventional wisdom or experts are very reliable. Education is either a very good thing or a very bad thing, depending on what you do with it.

The sick thing is the amount of money these so-called experts get paid for corrupting their discipline through expediency, veniality, or just plain pettiness and laziness.

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