October 18, 2013
Why Was the Housing-Price Collapse So Painful? (And Why Is It Still?)
Foresight about the disaster to come was not the primary reason this year’s Nobel Prize in economics went to Robert Shiller (jointly with Eugene Fama and Lars Hansen). But Professor Shiller’s early claim that a housing-price bubble was full on, and his prediction that trouble was a-comin’, is arguably the primary source of his claim to fame in the public sphere.
Several years down the road, the causes and effects of the housing-price run-up, collapse, and ensuing financial crisis are still under the microscope. Consider, for example, this opinion by Dean Baker, co-director of the Center for Economic and Policy Research:
...the downturn is not primarily a “financial crisis.” The story of the downturn is a simple story of a collapsed housing bubble. The $8 trillion housing bubble was driving demand in the U.S. economy in the last decade until it collapsed in 2007. When the bubble burst we lost more than 4 percentage points of GDP worth of demand due to a plunge in residential construction. We lost roughly the same amount of demand due to a falloff in consumption associated with the disappearance of $8 trillion in housing wealth.
The collapse of the bubble created a hole in annual demand equal to 8 percent of GDP, which would be $1.3 trillion in today’s economy. The central problem facing the U.S., the euro zone, and the U.K. was finding ways to fill this hole.
In part, Baker’s post relates to an ongoing pundit catfight, which Baker himself concedes is fairly uninteresting. As he says, “What matters is the underlying issues of economic policy.” Agreed, and in that light I am skeptical about dismissing the centrality of the financial crisis to the story of the downturn and, perhaps more important, to the tepid recovery that has followed.
Interpreting what Baker has in mind is important, so let me start there. I have not scoured Baker’s writings for pithy hyperlinks, but I assume that his statement cited above does not deny that the immediate post-Lehman period is best characterized as a period of panic leading to severe stress in financial markets. What I read is his assertion that the basic problem—perhaps outside the crisis period in late 2008—is a rather plain-vanilla drop in wealth that has dramatically suppressed consumer demand, and with it economic growth. An assertion that the decline in wealth is what led us into the recession, is what accounts for the depth and duration of the recession, and is what’s responsible for the shallow recovery since.
With respect to the pace of recovery, evidence supports the proposition that financial crises without housing busts are not so unique—or if they are, the data tend to associate financial-related downturns with stronger-than-average recoveries. Mike Bordo and Joe Haubrich, respectively from Rutgers University and the Federal Reserve Bank of Cleveland, argue that the historical record of U.S. recessions leads us to view housing and the pace of residential investment as the key to whether tepid recoveries will follow sharp recessions:
Our analysis of the data shows that steep expansions tend to follow deep contractions, though this depends heavily on when the recovery is measured. In contrast to much conventional wisdom, the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis. In fact, on average, it is cycles without a financial crisis that show the weakest relation between contraction depth and recovery strength. For many configurations, the evidence for a robust bounce-back is stronger for cycles with financial crises than those without...
Our results also suggest that a sizeable fraction of the shortfall of the present recovery from the average experience of recoveries after deep recessions is due to the collapse of residential investment.
From here, however, it gets trickier to reach conclusions about why changes in housing values are so important.
Simply put, why should there be a “wealth effect” at all? If the price of my house falls and I suffer a capital loss, I do in fact feel less wealthy. But all potential buyers of my house just gained the opportunity to obtain my house at a lower price. For them, the implied wealth gain is the same as my loss. If buyers and sellers essentially behave the same way, why should there be a large impact on consumption? *
I think this notion quickly leads you to the thought there is something fundamentally special about housing assets and that this special role relates to credit markets and finance. This angle is clearly articulated in these passages from a Bloomberg piece earlier in the year, one of a spate of articles in the spring about why rapidly recovering house prices were apparently not driving the recovery into a higher gear:
The wealth effect from rising house prices may not be as effective as it once was in spurring the U.S. economy...
The wealth effect “is much smaller,” said Amir Sufi, professor of finance at the University of Chicago Booth School of Business. Sufi, who participated in last year’s central-bank conference at Jackson Hole, Wyoming, reckons that each dollar increase in housing wealth may yield as little as an extra cent in spending. That compares with a 3-to-5-cent estimate by economists prior to the recession.
Many homeowners are finding they can’t refinance their mortgages because banks have tightened credit conditions so much they’re not eligible for new loans. Most who can refinance are opting not to withdraw equity after the first nationwide decline in house prices since the Great Depression reminded them home values can fall as well as rise...
Others are finding it difficult to refinance because credit has become a lot harder to come by. And that situation could worsen as banks respond to stepped-up government oversight.
“Credit is going to get tighter before it gets easier,” said David Stevens, president and chief executive officer of the Washington-based Mortgage Bankers Association...
“Households that have been through foreclosure or have underwater mortgages or are otherwise credit-constrained are less able than other households to take advantage” of low interest rates, Fed Governor Sarah Bloom Raskin said in an April 18 speech in New York.
(I should note that Sufi et al. previously delved into the relationship between household balance sheets and the economic downturn here.)
A more systematic take comes from the Federal Reserve Board’s Matteo Iacoviello:
Empirically, housing wealth and consumption tend to move together: this could happen because some third factor moves both variables, or because there is a more direct effect going from one variable to the other. Studies based on time-series data, on panel data and on more detailed, recent micro data point suggest that a considerable portion of the effect of housing wealth on consumption reflects the influence of changes in housing wealth on borrowing against such wealth.
That sounds like a financial problem to me and, in the spirit of Baker’s plea that it is the policy that matters, this distinction is more than semantic. The policy implications of an economic shock that alters the capacity to engage in borrowing and lending are not necessarily the same as those that result from a straightforward decline in wealth.
Having said that, it is not so clear how the policy implications are different. One possibility is that diminished access to credit markets also weakens policy-transmission mechanisms, calling for even more aggressive demand-oriented “pump-priming” policies of the sort Dean Baker advocates. But it is also possible that we have entered a period of deep structural repair that only time (and not merely government stimulus) can (or should) engineer: deleveraging and balance sheet repair, sectoral resource reallocation, new consumption habits, new business models driven by both market and regulatory imperatives, you name it.
In my view, it’s not yet clear which policy approach is closest to optimal. But I am fairly well convinced that good judgment will require us to think of the past decade as the financial event it was, and in many ways still is.
*Update: A colleague pointed out that my example describing housing price changes and wealth effects may be simplified to the point of being misleading. Implicitly, I am in fact assuming that the flow of housing services derived from housing assets is fixed, a condition that obviously would not hold in general. See section 3 of the Iacoviello paper cited above for a theoretical description of why, to a first approximation, we would not expect there to be a large consumption effect from changes in housing values.
By Dave Altig, executive vice president and research director at the Atlanta Fed
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March 11, 2013
You Say You’re a Homeowner and Not a Renter? Think Again.
As we’ve said before, we’re suckers for cool charts. The latest that caught our eye is the following one, originally created by the U.S. Bureau of Labor Statistics (BLS). It highlights the relative importance assigned to the various components of the consumer price index (CPI) and shows where increases in the index have come from over the past 12 months.
It probably won’t surprise anyone that the drop in gasoline prices (found in the transportation component) exerted downward pressure on the CPI last year, while the cost of medical care pushed the price index higher. What might surprise you is the size of that big, blue square labeled “housing.” Housing accounts for a little more than 40 percent of the CPI market basket and, given its weight, any change in this component significantly affects the overall index.
This begs the question: In light of the recent strength seen in the housing market—and notably the nearly 10 percent rise in home prices over the past 12 months—are housing costs likely to exert more upward pressure on the CPI?
Before we dive into this question, it’s important to understand that home prices do not directly enter into the computation of the CPI (or the personal consumption expenditures [PCE] price index, for that matter). This is because a home is an asset, and an increase in its value does not impose a “cost” on the homeowner. But there is a cost that homeowners face in addition to home maintenance and utilities, and that’s the implied rent they incur by living in their home rather than renting it out. In effect, every homeowner is his or her own tenant, and the rent they forgo each month is called the “owners’ equivalent rent” (or OER) in the CPI. OER represents about 24 percent of the CPI (and about 11 percent of the PCE price index). The CPI captures this OER cost (sensibly, in our view) by measuring the cost of home rentals (details here). So whether the robust rise in home prices will influence the behavior of the CPI this year depends on whether rising home prices influence home rents.
So what is likely to happen to OER given the continued increase in home prices? Well, higher home prices, in time, ought to cause home rents to rise, putting upward pressure on the CPI. Homes are assets to landlords, after all, and landlords (like all investors) require an adequate return on their investments. Let’s call this the “asset market influence” of home prices on home rents. But the rents that landlords charge also compete with homeownership. If renters decide to become homeowners, the rental market loses customers, which should push home rents in the opposite direction of home prices for a time. Let’s call this the “substitution influence” on rent prices.
Consider the following charts, which show three-month home prices and home rents (measured by the CPI’s OER measure). It’s a little hard to see a clear correlation between these two measures.
So we’ve separated these data into their trend and cycle components (using Hodrick-Prescott procedures, if you must know) shown in the following two charts. Now, if one takes the trend view, there is a clear positive relationship between home prices and home rents. This is consistent with the asset market influence described above. But also consider the detrended perspective. Here, home prices and home rents are pretty clearly negatively correlated. This, to us, looks like the substitution influence described above.
So let’s get back to the question at hand. What do rising home prices mean for OER and, ultimately, the behavior of the CPI? Well, it’s rather hard to say because the link between home prices and OER isn’t particularly strong.
Not definitive enough for you? OK, how about this: We think the recent rise in home prices will more likely lean against the rise in OER for the near term as the growing demand for home ownership provides some competition to the rental market. But, in time, these influences will give way to the asset market fundamentals, and rents are likely to accelerate as returns on real estate investments are reaffirmed.
By Mike Bryan, vice president and senior economist, and
Nick Parker, economic research analyst, both in the Atlanta Fed’s research department
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October 19, 2012
Investor Participation in the Home-Buying Market
What is the investor share of the home-buying market, and in what direction is the trend moving? We have been asking ourselves this question for the past few months, because the answer can help to inform what type of housing recovery we are seeing. Is it being driven by owner occupants or investors?
If it is being driven by investors, does this signal an emerging aversion to homeownership? Or, instead, does this simply signal that owner occupants are unable access mortgage finance and that, for now, owner occupants will be unable to maintain the share of market they once held? If we see that the owner occupant share is increasing, this observation could offer some support that the housing recovery has legs. The conclusion that the investor share is increasing, then, may suggest that we will see home sales activity fall off once prices rise to the point that it no longer makes sense for investors to continue buying.
To help us pinpoint the share and trend in the investor participation in the home-buying market, we polled our real estate business contacts to get a better sense for our regional portrait of investor market share. When asked to describe the distribution of home buyers in their market, our business contacts from the Southeast (excluding Florida) noted that one-fifth of home sales, on average, were to investors. Once we added Florida into our tally of Southeast contacts, just over one-fourth of sales, on average, were to investors.
Since this was the first time we posed this question to our business contacts, we lacked information on the directional trend. To address this information gap, we asked our business contacts how sales to investors had changed between the second and third quarters of 2012. More than half reported no change or a slight decline in home sales to investors, unless you include the Florida observations. A closer look at Florida reveals that nearly two-thirds of our business contacts reported that sales to investors in Florida have increased over the past quarter. The investor dynamic in Florida all seems to add up, especially given the strong demand from international buyers and cash investors in South Florida. This dynamic was discussed in the latest issue of EconSouth.
We thought it would also be informative to ask our business contacts about their expectations for future investor home buying activity. For the Southeast less Florida, more than half of our business contacts indicated that they did not expect there to be much change in investor market share over the next year. For Florida, more than half of the business contacts continued to indicate that they expected share of sales to investors to increase.
While the intelligence gathered from our business contacts aligns nicely with external data sources, we still had a few concerns that made us question the directional trend of these data.
The first source of concern is two-fold. First, brokers serve as a key input to our business contact poll and others like it. In and of itself, this is not a big deal because brokers are valued business contacts that provide us with a frequent and timely pulse on changing conditions in local real estate markets. What is slightly problematic is that brokers often rely heavily on the Multiple Listing Service (MLS), which brings me to my second point. We have also been hearing through business contacts (and this is echoed in the media here) that the composition of the investor pool has shifted from primarily smaller mom/pop-type investors to larger institutional investors that, more often than not, purchase properties at auction or directly from banks. Often, these sales take place before the properties get listed on MLS.
So, how involved are brokers in transactions that take place before MLS? Is this particular slice of investment activity being picked up by our sources? If not, how much do we really know about the share and directional trend of investor participation in the home buyer market?
Media coverage (here, for example) of these institutional investors often describes scenes at local auction in which institutional investors outbid smaller investors and have gone so far as to expand their presence and show up at auctions where properties at the fringe (in less desirable locations) are being sold. This piece of information, alone, leads me to believe that these larger investors have displaced smaller investors. Therefore, it would not necessarily be correct to think of properties acquired by institutional investors as something in addition to the properties purchased by smaller mom/pop investors. Instead, many of the mom/pop investors have been priced out of the market and replaced by institutional investors.
Another related concern involves the timing and strategy of these institutional investors. Why would institutional investors flood local real estate markets at the same time that inventory is tightening and home prices are beginning to stabilize and modestly increase in many markets? Wouldn't this squeeze their yields and make it less desirable for them to continue to ramp up their efforts?
To help provide some insight into the institutional investor, I created a table of information to provide a profile on a few institutional investors often cited by the press. It is important to mention that this table was not intended to be all-encompassing and that the source of information is entirely secondary.
What this table implies is that institutional investors ramped up activity earlier this year and have indeed concentrated their investment activity within a handful of markets that were hit hard by the housing downturn. Acquisition strategies for these larger investors focus on mostly low-priced, distressed properties.
This makes sense. The markets hit hardest by the housing downturn are also the markets where distressed properties make up a significant portion of the available homes for sale. However, data from CoreLogic indicates that the share of distressed sales is steadily declining over time. As the distressed sales share continues to shrink and home prices continue to rise, it stands to reason that investment activity will shrink (or continue to shrink).
It was recently noted that Och-Ziff Capital Management Group LLC, a large institutional investor (not outlined in the table above), announced that it intends to exit this line of business. Perhaps it is just a matter of time before other large investors follow suit.
By Jessica Dill, a senior analyst in the Atlanta Fed’s Center for Real Estate Analytics
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September 17, 2012
Will the Housing Market Recovery Leave the Hardest-Hit Neighborhoods Behind?
The national news about residential real estate has been rosy. The latest figures from the U.S. Census Bureau and HUD find that sales of new single-family houses in July 2012 were up 3.6 percent over the June rate, and 25.3 percent above July 2011 numbers. The National Association of Realtors reported that existing-home sales grew 2.3 percent to a seasonally adjusted annual rate of 4.47 million in July from 4.37 million in June and are 10.4 percent above the July 2011 pace. The June S&P/Case-Shiller report on housing prices showed positive monthly gains across all markets in its 20-city composite for the second month in a row.
However, a large number of homes remain in the foreclosure pipeline and many of these properties are concentrated in certain neighborhoods, which is a particular challenge for recovery in these areas because research suggests that concentrated mortgage delinquency and foreclosure can depress housing prices (see discussions here, here, and here).
To examine this issue and the barriers to recovery in areas heavily affected by foreclosure, the Federal Reserve Bank of Atlanta's Community and Economic Development (CED) group conducted a poll to explore housing market conditions in the Southeast. We asked Neighborhood Stabilization Program administrators, HUD-approved housing counselors, and real estate brokers across the Sixth Federal Reserve District about price expectations and changes in supply and demand in the housing market. The poll was administered between August 7 and August 24. We received 224 responses to the poll and conducted an additional 23 interviews, all within the Sixth District, which includes all of Alabama, Florida, and Georgia, and parts of Louisiana, Mississippi, and Tennessee. The overall response rate to the poll was 30 percent (individual state response rates varied from 22 percent (Georgia) to 52 percent (Tennessee).
When we asked about their house price expectations over the next year (see the chart), we saw signs of bifurcation, with more than half (54 percent) expecting the overall jurisdiction to experience gains, but nearly half (48 percent) expecting the hardest-hit areas in those jurisdictions to continue to see price declines. (For our purposes, "hardest-hit areas" are defined as the top 10 neighborhoods in the area that had the most foreclosures. Also the differences across all parameters—price, inventory of homes for sale, and interest in home buying—between overall jurisdiction and the hard-hit areas are statistically significant.)
The differences between the overall jurisdiction and the hard-hit areas are less pronounced, though still present, when we asked respondents about changes in home buying interest and the number of homes for sale in the last six months (see the chart). Reflecting on the overall jurisdiction, 67 percent said that interest in home buying increased, and of those only 14 percent said it was a significant increase. Another 17 percent experienced decreased home-buying interest.
The "home-buying enthusiasm" found in overall jurisdictions is not as robust when respondents talked about hardest-hit neighborhoods. Although 46 percent mention that the interest in home buying in these areas has increased, it was offset by the 29 percent who noted a decrease in interest in home buying in these areas.
On the other hand, the inventory of homes for sale in the overall jurisdiction has increased in the last six months, according to 57 percent of the respondents (see the chart). (Of these respondents, 45 percent said the inventory increased modestly.) When referring to hardest-hit areas, almost half said that the number of homes for sale had increased in the last six months, 26 percent said it had remained the same, and 27 percent said the number had decreased. And while the trends in the overall jurisdiction and the hard-hit areas may not be wildly divergent in terms of the for-sale inventory, the causes may be different. In the overall jurisdiction, homeowners may be putting their homes on the market because they feel better about the potential returns, whereas it seems reasonable to suggest that in hard-hit areas the increase in inventory of homes for sale may reflect a continued foreclosure pipeline.
We then asked about the top barriers to house-price stabilization and recovery in the areas hardest hit by foreclosure. According to our respondents, the most significant barrier is the poor credit scores and financial history of people wanting to purchase homes in these areas (see the table). With tightened lending standards, fewer people are able to secure financing to buy homes. The next two barriers concern the continued flow of foreclosure starts in these areas. In these cases, the respondents suggest that foreclosures are initiated either because people owe more on their homes than they are worth or because of recent unemployment or underemployment of borrowers decreasing the ability to repay. Respondents also noted that low appraisals in hard-hit areas have undermined sales. Finally, the high concentration of vacant properties, likely perpetuated by the higher-ranked barriers identified in the poll, presents an image of disinvestment in the areas, making it difficult to attract new buyers.
It's important to recognize that even among hard-hit areas there are notable variations and expectations for the future. For example, responses to house price expectations in Florida's hard-hit areas were much more optimistic, with 36 percent expecting increases in the next year, compared to Georgia's hard-hit areas, where only 3 percent anticipated prices going up. Of course, there are metro areas where this "micro-recovery thesis," as Nick Timiraos of the Wall Street Journal puts it, is not at play. "Denver and Phoenix are experiencing price increases in almost every ZIP code," he notes. (A previous macroblog post provides another look at ZIP code–level house price analysis.)
By Karen Leone de Nie, research manager in the Atlanta Fed's Community and Economic Development (CED) department,
Myriam Quispe-Agnoli, an Atlanta Fed research economist and adviser to the CED research and policy team
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August 29, 2012
Rising House Prices: The Good Fortune Spreads
On the heels of a rash of pretty good news related to residential real estate—including yesterday's pending home sales report—the June S&P/Case-Shiller report on housing prices checks in with positive monthly gains across all markets in its 20-city composite for the second month in a row. What's more, the index posted its first year-over-year gain since last summer.
The early reviews found little to dislike, from Calculated Risk...
This was better than the consensus forecast and the change to a year-over-year increase is significant.
...to Carpe Diem...
More evidence that the U.S. housing market has passed the bottom and is now in a period of sustainable recovery.
[T]he housing market is steadily improving and is poised to contribute to economic growth this year. Modest economic growth and job gains are encouraging more Americans to buy homes.
The widespread nature of price firming evident in the Case-Shiller index is strikingly confirmed by looking at even more disaggregated data. The following chart shows June year-over-year price growth by zip code, before the crisis hit and since, based on data available from CoreLogic:
The sample represented by the chart covers about 21 percent of all of the zip codes in the nation, and is based (like Case-Shiller) on a repeat-sales methodology.
The striking aspect, of course, is that there haven't been price increases in the majority of the sample's zip codes since before 2007 (although there was improvement evident in 2010, followed by the re-emergence of broader weakness in 2011). Furthermore, the uniformity of the picture becomes even more apparent when you look market by market (across which the experience is not so uniform). Two of the big comeback stories—Miami and Phoenix—were uniform in the breadth of the suffering across their metro areas during the worst of the slump and are now just as uniform in recovery:
Folks in Atlanta, on the other hand—which remains the big negative outlier in the year-over-year Case-Shiller statistics—are just as uniform as Miami and Phoenix, but in the pain rather gain department:
Even so, the Atlanta market has had two consecutive months of Case-Shiller housing price appreciation and experienced the largest monthly percentage gains in the June report. It does appear that the rising residential real estate tide is raising most boats.
By Dave Altig, executive vice president and research director;
Myriam Quispe-Agnoli, research economist and assistant policy adviser; and
Jessica Dill, senior economic research analyst, and all with the Atlanta Fed
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May 13, 2011
Just how out of line are house prices?
In Wednesday's post, I referenced commentary from several bloggers regarding the sizeable decline in housing prices reported by Zillow earlier this week. As I discussed yesterday, the rat-through-the-snake process of working down existing and prospective distressed properties is likely far from over, and how that process plays out will no doubt have an impact on how much prices will ultimately adjust.
Recently, Barry Ritholtz's The Big Picture blog featured an update of a New York Times chart that suggests there will be a significant adjustment going forward:
Prior to the crisis, I was persistently advised that the better way to think about the "right" home price is to focus on price-rent ratios, because rents reflect the fundamental flow of implicit or explicit income generated by a housing asset. In retrospect that advice looks pretty good, so I am inclined to think in those terms today. A simple back-of-the envelope calculation for this ratio—essentially comparing the path of the S&P/Case-Shiller composite price index for 20 metropolitan regions to the time path of the rent of primary residences in the consumer price index—tells a somewhat different story than the New York Times chart used in the aforementioned Ritholtz blog post:
According to this calculation, current prices have nearly returned to levels relative to rents that prevailed in the decade prior to the housing boom that began in the late 1990s.
Of course, the price-rent ratio is not the most sophisticated of calculations. David Leonhardt shows the results from other such calculations that suggest prices relative to rents are still elevated, at least relative to the average that prevailed in the 1990s. But the adjustment that would be required to bring current levels back into line with the precrisis average is still much lower than suggested by the Ritholtz graph.
How much farther prices fall is, I think, critical in the determination of how the economy will fare in the immediate future. Again, from President Lockhart:
"The housing sector also has indirect impacts on the economy. In particular, the direction of home prices is important for the economy because changes in home prices affect the health of both household and bank balance sheets. …
"The indirect influence of the housing sector on consumer activity and bank lending would almost certainly aggravate housing's impact on growth."
Here's hoping my chart is more predictive of housing prices than the alternative.
Update: The Calculated Risk blog does a thorough job and concludes that we don't have "to choose between real prices and price-to-rent graphs to ask 'how far out of line are house prices?' I think they are both showing that prices are not far above the historical lows."
Update: The Big Picture's Barry Ritholtz points me to his earlier argument against reliance on price-rent ratios.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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May 11, 2011
Is housing hurting the recovery?
Though the week is only half over, I'm going to nominate Stan Humphries and Zillow as bearers of the week's most distressing economic news:
"Home values fell three percent in the first quarter of this year, marking a pace of decline not seen since 2008 when the housing recession was at its worst. Home values fell one percent between February and March and 8.2 percent from March 2010."
"Previously, we anticipated a bottom in home values by the end of 2011. But with values falling by about 1 percent per month so far, it's unlikely that will happen. We now believe a bottom will come in 2012, at the earliest."
At The Curious Capitalist, on the other hand, Stephen Gandel says he's not so sure:
"To be sure, housing prices have fallen this year. But the Zillow numbers out today make the housing market look worse than it is. The problem is with how Zillow tracks home prices. Unlike other measures of the housing market, Zillow's numbers are not based on actual sales, but on estimates of what its model thinks your house, along with every other house in America is worth. Zillow's model is similar to how an appraiser figures out what your house is worth. It looks at past sales of houses that are similar to yours and then guesses what your house is worth. But by the time those sales are fed into Zillow's system they are months old. … If the housing market is turning, Zillow is going to miss it."
Is the housing market turning, particularly with respect to prices? Tough to say. If you want your glass half full, these words from the New York Fed's Liberty Street Economics might be the tonic for your tastes:
"This post gives our summary of the 2011:Q1 Quarterly Report on Household Debt and Credit, released today by the New York Fed. The report shows signs of healing in household balance sheets in the United States and the region, as measured by consumer debt levels, delinquency rates, foreclosure starts, and bankruptcies…
"Delinquency rates are generally down…
"New foreclosures fell nationally and in the region. About 368,000 individuals in the United States had a foreclosure notation added to their credit report between December 31 and March 31, a 17.7 percent decrease from the 2010:Q4 level. New foreclosure rates fell from 0.19 percent to 0.15 percent for all individuals nationwide…"
What may be the most important aspect of the report is highlighted by the Financial Times's Robin Harding: "…fewer new mortgages going bad, and some bad mortgages getting better." In fact, for the first time since the crisis began, the percentage of mortgages transitioning from 30 to 90 days delinquent to current exceeds the percentage transitioning to seriously delinquent (90-plus days).
There is, of course, plenty of material for the housing-price bears. For example, the flow of seriously delinquent mortgages is quite elevated.
According to estimates from CoreLogic, the supply of "distressed" homes is greater than 15 months at the current pace of sales:
"Most analysts now expect that the housing market won't bottom out until sometime next year. Until that happens, it's unlikely that that the sluggish economic recovery we're seeing right now will improve much."
The view here at the Atlanta Fed—and the answer to the question posed in the title of this post—was provided earlier today by our president, Dennis Lockhart, in a speech given to the Atlanta Council for Quality Growth:
"…can we have high-quality growth while the residential real estate and commercial real estate sectors continue to be so weak? Not completely, in my opinion. The recovery will progress, but it will not be robust until we work through the economy's serious imbalances, including those in the real estate sector.
"As I look ahead, I think the most reasonable assumption is that improvement of the real estate sector will lag an otherwise improving economy. But I am encouraged by the fact that the economy is increasingly on firmer footing."
I will let you decide whether that glass is half-empty or half-full.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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September 10, 2010
Policy may have created the housing bubble, but which policy is to blame?
There is little dispute that misguided policy choices led to the housing boom-bust cycle from which we are still recovering. The debate about which policies were most culpable, however, rages on. The latest chapter in this dispute is now available in the proceedings from this year's edition of the Kansas City Fed's Jackson Hole Economic Policy Symposium.
In defense of monetary policy, Charles Bean, Matthias Paustian, Adrian Penalver, and Tim Taylor—all of the Bank of England—write this:
"We argue that while relatively low policy rates compared to past experience contributed to the growth in credit and the rise in house prices in the run-up to the crisis, they played only a modest direct role."
Stanford University's John Taylor (still) isn't buying it:
"Their conclusion differs from mine for several reasons. First, they do not take account of much empirical work completed since the 2007 Jackson Hole conference. For example, Jarocinski and Smets (2008) of the European Central Bank estimated a VAR [vector autoregression] for the United States and found evidence that 'monetary policy has significant effects on housing investment and house prices and that easy monetary policy designed to stave off perceived risks of deflation in 2002-04 has contributed to the boom in the housing market in 2004 and 2005.' In a more recent study focusing directly on deviations from policy rules, Kahn (2010) of the Federal Reserve Bank of Kansas City finds that ‘When the Taylor rule deviations are excluded from the forecasting equation, the bubble in housing prices looks more like a bump.' "
I added the links to the papers cited by Taylor because they are thoughtful challenges by thoughtful people, and they deserve to be considered (though the Jaroconski and Smets article requires some tolerance of relatively sophisticated econometrics). That insightfulness, of course, does not mean they are completely persuasive; I still have my doubts.
Most of you are familiar with this picture of the "Taylor rule" referenced above—which prescribes a funds rate target based on the deviations of output from its potential and the deviation of inflation from a presumed target of 2 percent—compared with the actual path of the policy rate:
Bean et al. make note of a speech from the beginning of the year by Chairman Bernanke in which he in turn notes (among other things) that the period in which policy deviates from this particular Taylor rule is also a period in which the lending standards were dramatically relaxed. To give but one example, data collected by my colleague Kris Gerardi indicate that in Massachusetts the median loan to value ratios (LTVs) for all borrowers rose from 0.82 in 2000 to 0.9 in 2006. For subprime borrowers, LTVs rose during that period from 0.85 to 1.0. The statistical results cited in Taylor's response do not control for such developments, making it difficult to come to a strong causal conclusion.
Second, this observation (from the Bean et al. paper) introduces even more uncertainty regarding the robustness of the chain of events leading from low interest rates to the housing bubble:
"Chart 1 shows that both UK and euro-area policy rates were less noticeably out of line with their respective Taylor benchmarks. That too is striking. Indeed, in the United Kingdom, they were actually above the benchmark for much of the relevant period, even though the United Kingdom saw one of the larger run-ups in debt and house prices during this period. And, in the euro area, countries such as Spain experienced substantial house price booms, while countries such as Germany did not. That need not imply that monetary policy was innocent in the run-up to the crisis…But this is hardly compelling evidence for assigning the central role to monetary policy, suggesting that other factors were more important."
As the Bank of England authors suggest, monetary policy was not necessarily innocent. But at a minimum, it's worth keeping in mind that the monetary policy transmission mechanism is a good bit more complicated than any simple story would indicate.
By Dave Altig, senior vice president and research director at the Atlanta Fed
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November 20, 2009
Housing back in the news
Housing back in the news
Two reports released this week remind us of the difficulties still confronting the residential real estate market. First, the consumer price index (CPI) showed continued moderation. Yes, the overall number was up 3.4 percent on a monthly annualized basis, and even the core measure ticked up 2.2 percent. But over half of the core rise was related to rising new and used car prices following the expiration of the cash-for-clunkers program. The Cleveland Fed's median CPI, which isn't influenced by these outliers, was up only 1.2 percent and still suggestive of some considerable disinflationary pressure.
What does the CPI have to do with housing? Well, the shelter component of the index, which is derived largely from rents, was unchanged and has risen only 0.7 percent over the past year (see chart below). This performance represents unprecedented lows for this, the largest of the major CPI categories, and is a good indication of the downward price pressures being felt in the residential housing market.
More directly related to the state of housing was Tuesday's report on new home starts, which dropped sharply. Starts fell 10.6 percent in October, a surprising decline for a series that appeared to bottom out in April and stabilize in recent months. But perhaps a few bumps along the road to recovery are to be expected.
Some say that the falloff in new home construction last month was likely the result of uncertainty over the continuation of the first-time homebuyers program. That's a possibility, but here's something else to consider: There may be a lot more housing inventory out there than the official numbers suggest.
In recent months it appears that home prices as measured by the S&P/Case-Shiller Index have stabilized and begun to improve while home sales have picked up notably and listing inventories of new and existing homes have fallen. However, these listing inventories fail to capture a large share of the market including homes for sale by owner, potential buyers on the sideline waiting to see improvement, and foreclosure properties that have not yet made it to market but likely will eventually.
RealtyTrac reported that foreclosure activity slowed for the third straight month in October, down 3 percent from the previous month. However, those receiving notices of defaults increased 2 percent after declining 12 percent the prior month. Bottom line, foreclosure filings remain at high levels.
Amherst Securities released a report in September that took a stab at calculating the current shadow inventory of foreclosure properties using the Truilia listing database. In light of increased sales and slowing foreclosure filings, let's see how things are going:
Comparing the September report and the November numbers, we see that listing inventories declined 3 percent, which is to be expected with the pick-up in existing home sales numbers that the National Association of Realtors has been reporting in recent months. However, the shadow inventory of foreclosed homes grew by 9 percent (real estate owned, or REO, properties grew by 4 percent), helping to drive total inventory up 2 percent from September to November.
Homebuilding was a driving force in the economy in the years leading into the recession. Looking forward, though, the homebuilding industry is continuing to face significant obstacles, including inventory challenges. Those challenges translate into homebuilders being understandably wary to move ahead on new construction until foreclosures and REO inventories measurably subside. Thus, the homebuilding challenge continues.
By Whitney Mancuso, senior economic research analyst, and Mike Bryan, vice president, both in the Atlanta Fed's research department
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February 24, 2009
Foreclosure mitigation: What we think we know
One of the most important challenges facing policymakers today is reducing the rate of mortgage foreclosures. It is a goal many think is at the heart of a sustained recovery in the U.S. economy. But as past attempts to reduce financial stress on homeowners have shown, the task is not easy. One of the complicating factors in formulating successful foreclosure mitigation policy is getting at the heart of the relationship between negative equity (the situation where the remaining mortgage balance is greater than the value of the house) and actual foreclosure.
Economic theory poses one categorical prediction about this relationship, which is that negative equity is a necessary condition for default. In other words, if a borrower is not in a position of negative equity, then he or she should never default. This conclusion follows simply from the fact that positive equity implies a borrower can sell the house, pay off the mortgage, and keep the difference—a better outcome under any circumstance compared with stopping payment on the mortgage and leaving the home.
What economic theory does not say is that if a borrower has negative equity, he or she should always default. The reason for this is that the owner could always default in the future, and thus there is value in waiting to see if house prices recover. Now, this value to waiting differs across borrowers and is sensitive to both the depth of negative equity and a borrower's financial situation. Why does a borrower's financial health matter? Well, the cost of waiting includes the monthly mortgage payment the borrower must continue to make. Borrowers who have plenty of wealth and a steady stream of income will be more willing to continue making payments than borrowers who are in financial distress, perhaps related to an unemployment spell or some other adverse financial shock.
So why does all of this matter in terms of thinking about a successful foreclosure mitigation program? Well, the appropriate policy prescription depends on the particular reason a borrower is currently considering default. I think it is useful to break things down in terms of three (not necessarily mutually exclusive) groups of mortgage borrowers:
- those in unaffordable mortgages from the very beginning, who were implicitly relying on increasing house prices to refinance or sell for a profit;
- those who have been hit by an adverse, but temporary, income/financial shock; and
- those who purchased the house for strictly investment purposes and now see little or no hope of making a profit.
Borrowers may find themselves with unaffordable mortgages for many reasons. One might be an unscrupulous mortgage broker, who steered the borrower into an unaffordable subprime loan in order to generate high origination fees. Another, related situation would be an unaffordable interest rate reset on a subprime adjustable-rate mortgage. Finally, some mortgages may be permanently unaffordable because a buyer misrepresented income or assets during the origination process, a situation made easier by the growth of low documentation mortgages.
A large part of the administration's new housing plan—summarized succinctly by the New York Times, with lots of commentary (negative and positive) rounded up at Economist's View—is reasonably interpreted as being directed squarely at borrowers in the unaffordable-mortgage group. If policy is to be aimed at helping this group, the prescription is to offer the borrower a permanent reduction in monthly payments, whether it comes from lowering the interest rate, lengthening the maturity, and/or reducing the outstanding principal balance on the loan. The measuring stick often used in such plans is the debt-to-income ratio (DTI), which is the borrower's monthly mortgage and/or total required debt payments relative to his or her gross monthly income. While the administration's plan would succeed in lowering DTIs, the policy is temporary in nature (five years), and it is unclear what would happen to these borrowers after the plan runs its course—especially if negative equity is still an issue.
Many borrowers might have been able to afford their mortgages while employed but can no longer do so after they have lost their jobs. When housing prices are rising and homeowners enjoy positive equity, then distressed borrowers are able to sell their homes to pay off their mortgages. Alternatively, such borrowers can undertake cash-out refinances to gain some much-needed liquidity. Note that problems can occur for people in this situation even when positive future equity is a realistic hope. If the borrower is unemployed and liquidity constrained, the cost of waiting to default is very high and potential future price gains are of little value. Default in this case is much more likely, even though future prospects might be reasonably good. In this case, foreclosure-prevention policy could simply be used to eliminate the financial friction. In this case a lender would offer "forbearance," in which the borrower pays significantly lower payments for some period, with the arrears made up (with interest) later on. In this light, it is notable that the administration's key payment reduction plan has a five-year window.
However, one important concern regarding the plan is that servicers/investors don't have enough incentives to substantially decrease current DTI ratios. For example, if a household has a DTI of 60 or 70 because of a job loss, the servicer is responsible for modifying the loan to get DTI down to 38 and then still has to kick in a 50 percent match to further reduce it to 31. The costs borne by the servicer/investor are much larger than those borne by the government, which may not be such a bad thing in principal but in practice may result in low participation rates.
Note also that while permanent relief is the prescribed course for borrowers in the unaffordable-mortgage group, temporary relief is indicated for those in the temporary economic distress group. This highlights the difficulties in constructing policies when the underlying sources of stress differ by individual. The existence of a class of borrowers that purchased and financed residential real estate primarily for investment purposes further complicates matters. People in this group are in much different circumstances than those in the other groups and will default much more ruthlessly. A so-called "ruthless defaulter" has given up hope of positive future equity and hence there are no potential price gains to value. Under the theory of ruthless default, one effective policy intervention is to lower the outstanding balance of the mortgage so that positive equity—or even the hope of positive equity in the near future—is restored. Alternatively, the lender could forestall default at least temporarily by cutting the monthly payment below the cost of renting an otherwise observable house.
Aimed as it is at owner-occupied housing, the administration's plan does not offer direct assistance to those in the investment class. That may not be too surprising, as it is hard to generate much political sympathy for a group carrying a label like "ruthless defaulter." In addition, the perverse incentives of government assistance that usually go by the name of moral hazard are arguably more severe for individuals who purchase properties for investment purposes. However, abandoned properties do add to the stock of unsold homes, independent of who owned them or why they owned them. This does not necessarily argue for policy relief for investment buyers, but it is potential issue that bears watching.
Finally, there may be commentators with the view that loan modifications are a failing proposition as a few studies have shown extremely high default rates on modifications performed in early 2008 (for example, see OCC and OTS Mortgage Metrics Report, Third Quarter 2008). But, according to the table below (based on my calculations), the problem seems to be that the wrong type of modification was being performed. Approximately two-thirds of the modifications performed by servicers in the first two quarters of 2008 had the effect of increasing the principal balance of the mortgage and, as a result, also increased the borrower's monthly mortgage payment. In light of the above discussion, we should not be surprised by high re-default rates on these loans. On the other hand, there is reason to believe that successful implementation of payment reduction programs may indeed help to stem the pace of foreclosures.
By Kristopher Gerardi, research economist and assistant policy adviser at the Atlanta Fed
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