Monday, April 27, 2009

Home Prices: A little higher! A little higher!

I'm getting tired of hearing that home prices still need to fall further. You can be the most bullish guy in the whole world on housing and you'd still have to admit that statistically home prices have to keep falling.

Consider how the major home price indices, both the FHFA and Case-Shiller, use repeat sales to calculate home price changes. Basically they look for homes that have sold twice, and measure the price change between the two sales periods. So if a home sells to the Skywalker family in 2004 for $100,000 and then to the Organa-Solo family in 2007 for $115,000, we'd call that one data point indicating that homes rose by 15% over those three years. (Do we think that Amidala's house was foreclosed on after she died? Or was there family money there?) Combine this with millions of other data points, and you can get some pretty solid estimates.

Now, I don't know of any better way to measure home price changes. Certainly I don't like using appraised values, especially in a market like this one. But the paired sales method is bound to lag reality in a market like this one.

Consider what we have in housing. Too many houses were built, and too many borrowers got funding that shouldn't. The former means there is too large a supply of homes, and the later means that foreclosures are creating even more supply of homes!

We in the financial business are used to things moving fast, but the housing market doesn't work like that. The foreclosure process is slow, and given the ever-changing world of government programs, I think many banks have been especially slow to initiate foreclosures. On top of that you have loan mods, a large percentage of which will re-default. For these reasons and others, I'm sure we will still be dealing with large numbers of foreclosures a year from now.

And remember that foreclosures aren't going to be evenly distributed across the country. They will be focused in areas where the bubble was worst. In other words, areas where there was already too much supply from builders! Areas where the gap between supply and demand is widest.

Demand for housing is also quite inelastic. I already have a home. Lower prices in and of itself doesn't incent me to buy another house, because I'd have to sell the one I have anyway. It isn't like when the Gap needs to clear out excess sweater inventory. They can make everything half off and unload it all. America needs to do a half-off homes sale, but can't actually get anyone to come to the mall to buy.

So it is inevitable that as actual transactions start to pick up, those transactions will show lower and lower prices, especially where foreclosures are high. Even when the housing situation stops getting worse, statistically, prices will keep falling. But we can't get to a bottom unless transactions pick up (which they have), and inventories are cleared out. The fact that increased transactions largely represent increased foreclosures is neither here nor there. We know foreclosures are coming. Let's get them out of the way.

Put all this together, and I'm watching stats like Existing Home Sales and NAHB confidence survey much more closely than today's Case-Shiller Index. On that basis, its reasonable to see the decline in housing finally abating. But only a fool would say that prices are about to bottom.


Paul W said...

One thing to point out is that the slowing rate of price decline will be more a function of the defaults moving out of subprime and into the higher priced neighborhoods. The losses to mortgages will continue, and the banks who have not marked them down to date are going to be posting large losses.

For more detailed information of how the composition and timing of NODs and foreclosures is changing, check out the blog at

kfunck1 said...

I don't follow, what is making you put more weight on Existing Home Sales and NAHB Confidence Surveys with respect to C-S? Because they have less lag?

Jake said...

I am interested to see how the new Macroshare based on the Case-Shiller will trade. DMM housing down, UMM housing up... Any thoughts?

Accrued Interest said...

K: Yes, but also that a higher level of transactions indicate that demand is actually reacting to lower prices. Lower prices without activity suggests price discovery. Think about the market for stuff like CDO^2. The marks were going persistantly lower as far back as mid-07. But there were no trades, so you couldn't say it had bottomed. The lower offer price wasn't being met with a bid.

Jake: I am going to be long DMM in some fashion.

kfunck1 said...

That makes sense, thanks for the clarification.

Lockstep said...

I have to disagree with you on this one. Fannie, Freddie, JPM, C, BAC all just finished a foreclosure moratorium and have now resumed a more rapid pace of foreclosure. Mish Shedlock posted a graph showing a huge spike in notice of defaults in March in correspondence with this event. Fannie and Freddie data is still months away, but there is still a huge shadow inventory still waiting to be moved. Give it another 12 months of smooth downside, and then start looking at homebuilder confidence.

Accrued Interest said...

Lock: I'm not saying things are getting good in housing. I think we have another year of extremely high foreclosures ahead of us, then another 2-3 years of elevated foreclosures.

I'm just saying that if we see a trend of increasing existing sales, that's a much better indicator of a bottom than the actual price indices.

lineup32 said...

The heart of the housing problem was and is a large expansion of credit. Fed flow of funds shows about 5 trillion in mortgage debt in the early decade that has risen to over 12 trillion today.
The problem is that Americans own mortgages not houses and cannot adequately service the 12 +trillion mortgage debt.
A bottom relative to transaction levels doesn't resolve the underlying issue which is how the average family will make those mortgage payments and still have enough income to participate in the overall economy.

Accrued Interest said...


I don't agree that the median home owner can't afford his mortgage (if that's what you mean). I certainly agree than many home owners can't afford their homes, but what's the long-term solution? Foreclose on those homes and get them into stronger hands.

That's why I say that an elevated level of transactions indicates progress. Now I can't say that we're there yet, because the level of existing home transations is a solid 20% lower than was typical before the bubble, and home inventories remain too high. So this isn't mission accomplished. I'm merely saying that if we start seeing existing home sales rise consistently, I'd be feeling more bullish, and it really wouldn't matter to me what Case Shiller says. Make sense?

Highest CD Rates said...

According to me Home Prices are bound to decline and hopefully they will follow the same trend till the world economy stabilizes. As per experts this could happen only by end of this year of mid of next year.