Wednesday, May 18, 2005

US Home Prices 250% Of Real Values: Economist

Princeton University economist and columnist for the NY Times, Paul Krugman, was open in his assessment of the US housing market while making a speech overseas. "Macro indicators suggest that the market is speculative mania. Day trading cannot be sustainable. There is a real bubble mentality in the US housing market,' Prof Krugman said, adding that prices of US housing were 250% of their real values."

"A fall in the housing market and investment would spur a US recession and lead to capital outflows. 'There would be a difficult contraction in the US economy. I think there is 50% chance for a major break in the situation in the US next year.'"

"Prof Krugman said the US economy was currently unsustainable, with the huge current account deficit and overinvestment in the housing market eventually leading to an economic recession and wiping out the US's role as 'the world's importer of last resort.'"


At 12:41 PM, Anonymous Anonymous said...

Now THAT's taking a position.

He might get more heat than the prez of Harvard did for the latter's unwelcome ovservations.

At 12:50 PM, Anonymous Anonymous said...

Stupid question, 250% overvalued equals what % drop to reach fair value?

At 12:55 PM, Anonymous snowball said...

1 - 1 / (1 + 2.5) = .71

The home prices would need to drop 71% or so to get back to fair value.

At 12:56 PM, Anonymous Anonymous said...

(2.5 - 1)/2.5 = 60%

60% drop to reach fair value

At 1:00 PM, Anonymous Anonymous said...

Oops, ignore my previous calculation. That was assuming 250% OVERvalue. The article actually says 250% of real value, meaning 150% OVER.

60% is correct.

At 1:01 PM, Anonymous Anonymous said...

Assume the title is "US Home Prices 100% of Real Values: Economist",

then snowball's formula yields:
1 - 1/(1+1) = .50 = 50%

my formula yields:
(1-1)/1 = 0 = 0%

which means the prices is fair valued.

At 1:02 PM, Anonymous Anonymous said...

60% brings us back to what, 2003? Didn't the boom start in 1996?

I can't believe I'm saying this, but is Krugman being mild in his assessment?

At 1:02 PM, Anonymous numbersguy said...

Simple calculation:

250 / .165 + 899 * 16/78 (.22 / 1.75 - .66) = x

Then divide "x" by the number of raisins in Fresno, multiply by the number of pistachios in Barstow, add that to the number of plastic surgeons (board-certified only please) in Beverly Hills and, finally, divide that by the number of honest mortgage brokers in Sarasota.

No problemo...

At 1:07 PM, Anonymous Anonymous said...

"60% brings us back to what, 2003? Didn't the boom start in 1996?

I can't believe I'm saying this, but is Krugman being mild in his assessment?"

For the nation as a whole?

There's the inflation adjustment too, home prices should increase a little.

At 1:08 PM, Anonymous Anonymous said...

I can believe this statement. Before last fall when I sold to rent, I owned and lived in a condo in the Minneapolis downtown district. This area has seen some massive development in the last couple of years, there are currently 6000 condo units planned or under construction, more than tripling the prior housing stock in the neighborhood.

As the president of my HOA at the time, I was doing some research to renew our "replacement cost" insurance policy on the building. Since I had no idea how much coverage we should have to cover "replacement cost", I started putting in a few calls to contacts I had with the various private investment/development groups that are part of the new deluge of condos in the area. The average construction cost of the answers that I could get was approx. $150/sq.ft, including land purchase costs. The medium to high-end units are currently selling in the $250-$300/sq.ft range. Do the math - that's a 70-100% profit for the developers, minus marketing and selling costs!!! It's no wonder that every abandoned and derilict old warehouse in the area is being converted to swanky new open-floor loft condos! The only blocks that are not being redeveloped have serious EPA contamination issues.....

In short, I believe downtown Minneapolis may be 170-200% of real values, and we're not even close to the bubble areas on the coasts!!!

At 1:10 PM, Anonymous Anonymous said...

To first 1:02 anon -- careful with the math. A 60% decrease does not undo a 60% increase.

e.g. Start at 100k, increase 60% to 160k, decrease 60% to 64k.

So, he's saying that 500k house should only really be worth about 200k. Around here (northern CA) that probably gets us back to around 1998 or 1999 price levels.

Of course, maybe I'm the one making the mistake here. Have any houses in your area gone from 200k to 500k in just the past 2 years? That would be quite an increase, even in the bubbliest areas.

Second 1:02 anon -- I tried using your formula, but I got a division by zero error.

At 1:14 PM, Anonymous Anonymous said...

I'm first anon 1:02 -- I have seen studios, priced at 79K in 1997, now at 315K+ today. I'm in bubblicious New York City.

At 1:27 PM, Anonymous Anonymous said...

Okay, I'll add some levity...

Actual Bubble House for sale (for 3 million dollars)

At 1:43 PM, Anonymous frank said...

Some condos near me in Tysons Corner, VA were only 100k and change depending on condition in 2001. Now they are approaching $350k. So that's right along these lines. But I don't see them falling that far.

At 1:46 PM, Anonymous Peninsula Renter said...

I can believe a 60% drop. Here in the SF Bay Area, that would send a median priced house from roughly $750K to $300K.

At $300K, a house becomes affordable for the median household. Imagine that!

Great work with the blog, Ben.

At 1:47 PM, Anonymous Anonymous said...

Here's a real life example. I bought a 1BR condo in Arlington, VA, across the Potomac from DC, in 2000 for $100k; my next door neighbor just sold the idential unit for just under $400k. That's a 300% jump in less than 5 years. If the Arlington market were to drop 60%, or $240k, my unit would still be worth about $160k. It seems to me that Krugman's 250% is about on the mark, or maybe a bit low, at least for the Washington metro area.

At 1:51 PM, Blogger red144 said...

Here's a real life example. I bought a 1BR condo in Arlington, VA, across the Potomac from DC, in 2000 for $100k; my next door neighbor just sold the idential unit for just under $400k. That's a 300% jump in less than 5 years. If the Arlington market were to drop 60%, or $240k, my unit would still be worth about $160k. It seems to me that Krugman's 250% is about on the mark, or maybe a bit low, at least for the Washington metro area.

At 1:56 PM, Anonymous Anonymous said...

"Have any houses in your area gone from 200k to 500k in just the past 2 years? That would be quite an increase, even in the bubbliest areas."

Yup. Check out the Home Price Check for Boston, New York, CA, etc.

You will see that prices have AT LEAST doubled.

For example, in my area, 1 UNIVERSITY RD, CAMBRIDGE, MA 02138

prices have gone from $250K in 1998 to $500K today.

At 1:58 PM, Anonymous Anonymous said...

I actually forsee a 50% drop in many cities. It's going to be brutal, and most people cannot even imagine this.

OR if salaries rise quickly (e.g., 25%), home prices might only drop by 25% or so.

BUT if salaries don't budge enough...LOOK OUT BELOW!

At 1:58 PM, Blogger The Original Anon said...

As much as I'd like to believe it, 60% sounds too high to me. Even with this bubbly behavior in the last few years, U.S. homes are still cheaper than in Western Europe or developed Asia, where population densities and savings rates are higher. Longer term, houses will get more expensive in the U.S., inflation adjusted. My near-term prediction is for a return to 2002 levels, when the creative mortgages really started. For most areas, that's substantially less than a 60% drop.

At 2:03 PM, Anonymous Anonymous said...

Actually in San Diego a return to 2002 levels would imply at least a 50% drop - scary huh ?

At 2:08 PM, Anonymous Anonymous said...

Western Europe higher than the US? Well not in France!

A 60% fall would be huge. Doubt it would ever happen. A 20% fall would be bad enough

At 2:10 PM, Anonymous snowball said...

60% drop is correct for prices that are 250% of real value. My formula was answering anon 12:50 PM.

Just to add another anecdote:

I just sold a condo in the SF Bay Area (San Jose) in March. For our condo complex, a 60% drop would send the price levels squarely back to the summer of 1997.

Sounds pretty reasonable to me.

At 2:13 PM, Blogger John Law said...

there is no reason I can think of at all that would make a home(or condo) would go from $100,000 to $300,000. there is NO way that demand can rise that fast. there would have to be a huge amount of population growth or the relocation of a good company.

this is all about the availabliity of money and the blow-off is going to happen because of subprimes.

when the money reverses it's course, the housing market isn't going to have subprime to hold it up. affordablility, and therefore high housing prices, isn't there w/o those riskly loans. houses will go back to normal long-term affordability levels and then some. they have to or nobody will be able to afford a house.

At 2:14 PM, Anonymous flyboy said...

(In short, I believe downtown Minneapolis may be 170-200% of real values, and we're not even close to the bubble areas on the coasts!!!)

I don't know about those percentages, but clearly Mpls is getting ahead of itself.

I get up to Mpls (from Calif) about four times a year for biz (since 1990) and have always enjoyed the city for its friendly, cosmopolitan style. In that time, the downtown area has certainly improved and there are better restaurants, etc. Still a dearth of decent hotels, though a few nice ones.

But in the last couple of years, I have noticed all the condo/loft development and have wondered who on earth is going to fill all these places. Now I read that another 6,000 or so are planned. Puh-leeze. Mpls is nice and all. But it's not exactly growing that fast.

This is no boomtown. It's a nice, stable city in a nice, stable state. Tossing thousands of condos/lofts onto the market in a short period of time is going to flood the place with supply for years to come. Seems like this is just a factor of developers gettting greedy and able to access cheap financing. Sell-through is going to be much tougher unless they can offload these places to speculators who will be left holding the bag for years.

In a slow-growth market like Mpls, real estate is a zero-sum game. If there is a big demand for condos downtown, then it simply means that SFH's will suffer. There's not enough demand to support all this new construction, at least not now. Most of the population growth in Mpls has been immigrants/minorities who are pretty low-income, not the market for these pricy condos.

So I know that there is a national bubble when I hear 6,000 loft/condos being built in places like Mpls. This is a developer bubble, a credit and financing bubble.

At 2:18 PM, Blogger desi dude said...

why some people are here scared of 50/60% ,esp if you are not home owners?

Housing should reflect the salary and as some one put it earlier, 3* gross is a the median home price, for some premium(!) areas like LA it could be 4*GROSS.

At 2:24 PM, Anonymous Ghostwriter said...

Bad news for anyone banking on a mere fall of 60% in value: There is a building boom taking place right now which is creating a glut of supply. The supply glut is hidden from view by investors and interest-only ARM buyers who will soon not only reduce demand, but will also exit the market in droves, making this new supply clear to anyone with eyes. When the dust has settled, the considerable increase in supply since 1997 will translate into a return to the lower, new fundamental value than where we started before bubble-heads took over the market.

At 2:24 PM, Anonymous Anonymous said...

You people are too optimistic. This is not a function of a housing market, this is a function of a credit market. When the credit market goes (soon) people won't be able to borrow-period. Throw in bankrupcies, foreclosures, wiped out speculators, recession and possible depression and you will be able to buy real estate at 90-95% discount to todays prices. That is if you have cash of course. Not many people will at that stage of the game.

Depression and soup lines here we come.

At 2:27 PM, Anonymous great caesar's ghost said...

Exactly right flyboy.
I've been trying to tell my co-workers that MPLS is overbuilding to the nth degree for its population and economic growth. They claim that condo/loft living is the new lifestyle. It's a demographic trend for empty-nesters. When I ask them to whom these new empty-nesters are going to sell their 5 bedroom surburban mcmansions to in order to finance the transition to a condo "lifestyle", the conversation usually ends. Abruptly.

At 2:42 PM, Anonymous Anonymous said...

Ben: Humbly suggest putting this in its own separate spot on the blog. So comic it's tragic. Reuters should be ashamed for using Fannie and Freddie as its only on-point sources...

At 2:53 PM, Blogger Thomas said...

Anonymous 2:24

90-95% correction? Riiight. That takes an $800,000 house back to $40,000 -- i.e. it takes us back to 1977, pre-inflation.

There are plenty of people who'd be able to pay all cash for housing at that price. Long before we got to that point, of course, sellers would adapt to a credit crunch by offering seller financing themselves.

I'm all for prudent bearishness, but apocalyptic scenarios rarely pan out within any useful time frame. Just ask John the Revelator. Let's see if we can keep the bear case at least moderately credible, shall we?

At 2:54 PM, Anonymous Anonymous said...

The poster near the top of the thread who actually did the legwork to price out the replacement cost of his condo is the only person here with any facts to back up his thoughts.

In the end the value of a residence is it's replacement cost. Fact is there is a ton of empty land in the USA. And building a wood frame housing box does not cost that much more in California than it does in Alabama.

In our current crazed speculative market a developer might buy land for $50,000 a lot, spend $40,000 a lot on roads and utilities, build a house for $100,000 and then sell the package for $500,000. Buyers rush in because they are caught in a speculative frenzy of greed and fear and cheap money is available.

But eventually markets correct and the house is really only worth $190,000 plus a fair profit to the builder. When the cheap money dries up and bankruptcies mount the speculators will bail out and the market will be flooded. When that happens (and it's inevitable) sellers will be lucky if they can sell for the fair replacement value since most areas are now overbuilt relative to population.

At 2:54 PM, Anonymous Anonymous said...

2:24 Anon, if prices frop 90% most people here can buy with cash. Let me see, a 1M home can be had for 100K cash, not bad. But I will probably settle for a 500K home for 50K. Don't want to wait at the soup line. Need cash for my own soup.

At 2:57 PM, Anonymous Anonymous said...

If prices drop even 50% get ready to meet your new Chinese neighbors.

At 3:00 PM, Blogger desi dude said...

just a reality check

16412 Greenlake Ln
Cerritos, CA 90703
a Town Home currently listed at Price: $539,000

same home sold in 1996 183K. Assuming some improvements, what could be the real value! ala krugman for this property?

At 3:01 PM, Anonymous Anonymous said...

A 40% drop is very possible if wages don't pick up.

In many bubble areas, median home prices are $500K, but median household income is AT MOST $100K.

Three times gross income would give a home price $300K.

That's where prices should settle down to.

At 3:01 PM, Anonymous Frank said...

Ok I just bumped into my neighbor. I mentioned condos that had just breached $100k in early 2001. This in Tysons Corner, VA, near Wash DC. I got the scoop about the lates condomania. A $359k unit is now on the market.

I know about these because I had an option to buy one for $120k in early 2002. (Too rapid appreciation I thought! Kick myself very hard...) And it wasn't in great shape. It sold for $140k in the summer of 2002. (It was never put on the open market). So we have gone from $140k to $360k in 3 years!!! NOOOO, not really a bubble.... DC never sees falling property prices.... govt workers... catch up to NYC.. no reason that we should have lower prices... strong demand..... immigrants from El Salvador...

Everyone who has bought in this development has been an amateur investor since 2004, possibly late 2003. I thought it was insane when they hit $275k in the late summer.......

These units are not very nice. They are condo conversions from the 1980s boom. They are tired 1960s rental units with some cosmetic upgrades.

So it's exactly a 60% decrease to get back to mid-2002 in this sub-sub-market.

I do think that higher end houses have increased less percentage wise and will obviously fall less % wise. But there are some horrendous places selling for high prices. There will be a flight to quality in the down market. All this crap about "preserving real estate value" by doing xyz will regain meaning.

I think it's funny when you hear people doing these minor things to there house and proudly state that they are increasing the value of their home. Dude, we are in an insane bubble.... in the short term, your cosmetic improvements mean nothing in this bull market stampede.

At 3:15 PM, Anonymous Anonymous said...

anonymous wrote (at 2:54 pm), In the end the value of a residence is it's replacement cost. Fact is there is a ton of empty land in the USA. And building a wood frame housing box does not cost that much more in California than it does in Alabama.

Wrong. While there's lots of land in the US, there's little demand for much of it.

Suppose, for example, you really want to take a job in the Washington, DC, area. How useful is (say) land in the middle of the Wyoming dessert to you? Answer: it's completely useless.

The key notion is (Ricardian) land rent. Land that is highly desirable due to its location has higher rent.

At 3:17 PM, Anonymous JJL said...

First off I must say I love this blog and especially the comments section. It amazes me to find good, solid analysis from regular joes like me. That said, lets look at todays inflation data. Excluding gasoline, food, etc (Housing? wish it was a component) inflation was tame. This sent the message no large interest rate move up. This sent the message easy money for another year at least, and hence KBH +6.6%, BZH +8%, LEN +4.7%!! As convinced as I am that we are in a speculative mania in real estate, I am now as of today of the opinion that the Fed cannot stop this thing or the calamity that would follow would be too much to bear. I think we are looking at a long term trend here, and yes I am bitter. I have saved a good deal of cash, I have moved my salary up double digit percentages every year for 7 years, my wife and I save and invest, and we cannot afford real estate in our area without changing our financial plan drastically. I am ready to give up, buy a house and eat bread and water for years just so I can get in. The only thing I am sure of is that when I buy, that will be the big signal of a downturn!

At 3:18 PM, Anonymous Anonymous said...

"As much as I'd like to believe it, 60% sounds too high to me. Even with this bubbly behavior in the last few years, U.S. homes are still cheaper than in Western Europe or developed Asia, where population densities and savings rates are higher."

You just explained why 60% is not too high. A higher population density and savings rate (ie better fundamentals) should support higher prices. Taken in this context, the U.S. would be about as bubbly as Europe right now. A 60% reduction would simply wipe out the gains of the last 5 years, which isn't at all unrealistic.

At 3:21 PM, Anonymous Anonymous said...

While I believe in a bubble (in much of the US) as much as anyone else, what this discussion fails to take into account is the role of interest rates and mortgage payments.

If rates go down, prices will go up, because the size of a mortage with a given monthly payment will go up. And what people can afford is determined by their monthly mortgage payments.

So price alone isn't the right barometer. It's more like "ratio of required monthly mortgage payment to median income," or "ratio of cost of buying to cost of renting."

Note that if interest rates go way up, it's going to be bad news. It won't necessarily be bad news for indebted owners. Rather, it will be bad news for
* those holding ARMs
* those holding fixed mortgages who have to sell (e.g. must relocate)
* the holders of fixed-rate mortgage debt (though for all I know, maybe we taxpayers will get screwed via FNMA, etc...)

At 3:22 PM, Anonymous Anonymous said...

"Taken in this context, the U.S. would be about as bubbly as Europe right now. A 60% reduction would simply wipe out the gains of the last 5 years, which isn't at all unrealistic."

Plus, US is the land of the McHouse, the McHouseWithCheese and the McMansion. We build 'em fast, we build 'em cheap and move on to greener pastures at the drop of a hat. Europe and Japan are much less mobile

At 3:26 PM, Anonymous Frank said...

RE being cheaper than in W Europe. I dunno, you would have to look at the numbers carefully.

There are few countries with wide open space. One that does have it, Sweden, is the same as the US. Extremely bubbly in Stockholm while the market is dead in rural areas. That of course increases the gap and might be a good thing for rural areas that have seen steadily declining population.

In order to fuel a bubble you need a high level of intrinsic demand and easy credit and the right psychology.

Look at Germany. House prices are intrinsically high but have been declining since 1975. In Japan they have been declining since 1992.

The big mistake by bubbleheads is that high intrinsic demand DOES NOT mean require escalating prices.

At 3:29 PM, Anonymous Loren said...

I don't know about Japan, but Europe has much better quality construction.

The average US house is only supposed to last 65 years or so. Look at a good property appraisal - or go to a neighborhood with 65 year old houses.

Of the houses I've lived in the one built in the 1950's was in the best structural shape - newer houses are built ok - as long as water never gets into the structure(Compressed wood chips and sawdust).

At 3:29 PM, Anonymous Anonymous said...

"While I believe in a bubble (in much of the US) as much as anyone else, what this discussion fails to take into account is the role of interest rates and mortgage payments."

Interest rates were about 7% in 1998 and prices were $200K.

Now interest rate are about 5.5% and prices are $500K.

Salaries have not changed much between 1998 and today.

Do the math, and you realize that even with todays interest rates, housing is way overvalued.

Rates DO NOT need to rise to crush this housing bubble. It *IS* collapsing due the lack of buyers.

At 3:29 PM, Anonymous Anonymous said...

"As much as I'd like to believe it, 60% sounds too high to me. Even with this bubbly behavior in the last few years, U.S. homes are still cheaper than in Western Europe or developed Asia, where population densities and savings rates are higher."

In Japan RE is still falling as it has for the last decade. Worse Japan has negative population growth. Same with many European Countries. I am sure immigration helps stablize many European populations and can help recover a post bubble market but not Japan's.

Also, Everyone is forgetting that the US is facing a major energy crisis. Many folks will not be able to afford a tripling of energy costs on top of higher interest rates, stagnant wages, high unemployment.

Even with a major world recession, oil prices may continue to rise if we have actually reached Peak Oil. World oil producting then goes into decline and or the expense of producing oil dramatically increases.

Learn now folks this is not a hoax.

At 3:32 PM, Anonymous Anonymous said...

" I am ready to give up, buy a house and eat bread and water for years just so I can get in. "

JJL...don't do it man!

Just think it through. WHO is going to buy the next level to create the next price jump; where are they going to come from? We already have everyone buying, with credit qualification standards that can only get tighter.

Speculators are soaking up much of the current supply, buying multiple units. It's mania demand, not real, lasting demand.

Look at the huge over supply soon to be for sale....even in non bubble places like MN and Kansas City.

It's hard to wait it out, but just hold on for one more year and it will have turned.

At 3:36 PM, Anonymous Anonymous said...

"Even with a major world recession, oil prices may continue to rise if we have actually reached Peak Oil. World oil producting then goes into decline and or the expense of producing oil dramatically increases.

Learn now folks this is not a hoax."

Please start your own blog (or stay there) if you are going to post Peak Oil blog ads several times per day. This blog relates to an ongoing bubble that has nothing to do with peak oil.

At 3:40 PM, Anonymous powerpuffgirl said...


You make some good points. Markets can do ANYTHING on a daily basis, regardless of fundamentals. This is just more irrational exhuberence.

Yes, we are in a mania, and it may continue for a while longer. But CA is already showing significant signs of slowing even though rates have been going DOWN for the better part of a year. Be sure to check out Dataquick's sales volume numbers for Arpil. This is a tremendously bearish warning sign.

At some point, RE will not appreciate beyond the ability of people to pay. We have crossed that point in CA at least, and maybe even in some other markets as well.

Therefore, regardless of what the Fed does, or what the speculators in the housing market or on Wall St. do, this thing will begin to unravel very soon. Don't lose the faith, and don't become a debt slave for years.

anon 2:24 great points. This isn't a RE bubble, per se, but more of a credit bubble generally.

At 3:44 PM, Anonymous Anonymous said...

JJL, think about it, when someone like yourself is ready to throw the towel in, then everybody else must already be in.

At 3:56 PM, Anonymous JJL said...

Thanks to everyone here again. No, I will not give in, but it hard not to feel like the biggest sucker in the world. I am not getting any younger and waiting out the credit bubble blowout is the hardest thing to do. It helps to come to housing bubble blogspot and read rational thoughts. BTW, I live in northern Massachusetts about 36 miles from Boston and you cannot touch a house that is over 1000sqft and wasnt built when Abraham Lincoln was shot for less than 350k. A quality home with some grass and a sewer hookup goes out past 420k. These home sold for about 130-200k as lately as 1999-2000. Good luck to all in similar problem areas.

At 4:05 PM, Anonymous Anonymous said...

Hi jjl,

I'm a Bostonian too. Came here in 1997 to do my graduate work. Graduated and got stuck renting in Somerville due to the lack of affordable housing.

Currently in my early 30s and waiting for those $400K homes to come down to a reasonable price is truly frustrating.

I'd think that $300K might be affordable to most of us new buyers, but I wonder if prices will undershoot?

At 4:22 PM, Anonymous JJL said...

Wow, close to boston is just brutal for price anonymous. Again, I ask what will be the catalyst for a housing downturn? I think it can only be interest rates, and since rates will not rise due to fed, no end in sight. If someone has clue what will finish the following statement, post it here and win a prize:
I am not buying that house, townhouse, condo, because of or due to (BLANK). Good Luck all.

At 4:25 PM, Anonymous Anonymous said...

I am not buying that house, townhouse, condo, because of or due to...


At 4:27 PM, Anonymous Don said...

Blank = 'Because I can't get financing'

Did you see the guidance issued by the Federal Reserve on high LTV lending?

Financing is just not going to be available pretty soon, regardless of what interest rates are.

At 4:28 PM, Anonymous Anonymous said...

Weekly mortgage apps down.

At 5:06 PM, Anonymous Anonymous said...

I think the Fed will use a back door. Instead of overtly raising rates rapidly, the gov't. institutions will (belatedly) coerce lenders to adopt the minimal sane standards one would expect in a long-term-loan industry. The start is/will be some sort of down payment - no more 103% loans. Then it will be verification that the loan is for a principal residence. Then there will be pressure against stated-income loans.

There will always be, of political necessity, lending available for the poor. This was the charter of Fannie Mae. The 1989 flip by a jellyfish Congress loosed the flood of bad lending we see today.

Inflation alone may force general interest rates up some more, but the Fed will blame other things for mortgage rate increases. Regardless, if ARM rates come within 1/2% of fixed rates and lenders drop the 7 and 10 year option, there will be fewer takers.

It's all going down -- only a matter of what paint the powers-that-be choose for the canvas.

At 5:33 PM, Anonymous punchbowl said...

I'd like to point out that Krugman said that current prices are 250% of their value, not that prices will drop to exactly their value when they correct. Indeed, I expect them to overcorrect quite a bit, and I expect it to be a classic credit crunch, with the decline seriously exacerbated by higher lending standards. A reasonable assumption, for example, is that 20% down again becomes the rule. How much cash does the median first time home buyer have? Multiple by five, and you have your median "starter home" -- and in many houses in many areas, this will mean more than a 60% drop. The longer the boom goes on, the more potential first-time buyers are sucked in, and the lower this number gets. That is, the longer the boom goes on, the steeper and deeper the correction will be. Murray Rothbard: where are you?

At 5:37 PM, Anonymous Anonymous said...

I think Murray is watching over us.

At 6:01 PM, Blogger CalculatedRisk said...

Most housing "busts" actually deflate slowly over multiple years. In economic terms, real estate prices display strong persistence and are sticky downward. Sellers tend to want a price close to recent sales in their neighborhood, and buyers, sensing prices are declining, will wait for even lower prices.

I wrote about this: Housing: Speculation is the Key

Of course there are examples of a housing collapse (like Florida in the '20s).

At 6:05 PM, Anonymous Anonymous said...

Looks like 10 year treasuries are down again, so fixed rate mortgages are lower.

I think we are about to see another refi boom. Probably alot of borrowers will dump their IO loans for a fixed rate product.

Unfortunately this will also prolong the bubble. Damn!

At 6:11 PM, Blogger deb said...

Most recent IO buyers cannot qualify for the fixed, that's why they are on the IO in the first place.

At 6:38 PM, Anonymous kailuabruddah said...

War on Poverty = failure
War on Drugs = failure


War on Savers = (for now) success

At 7:13 PM, Anonymous Alex Norman said...

I have read posts here and on CR's blog with great interest, and found much to think about.

CR is right, Japan's housing prices have slid for 15 years and it took almost 7 for So Cal to get back to trend after 1990.

However, with the rise of ARM, no-money down, I/O mortgage products, fueled by the greed of mortgage finance co's and the fear of first time home buyer at getting priced out of EVER owning a home, much of this bubble is speculation by another name.

Because so many people are leveraged so far, they are more likely to walk away faster when the turn starts.

This does not including the pure speculators...

Not only is this bubble unprecedented in terms of magnitude, at least in the last 150 years of US history (see Schiller), there is more debt than ever before.

In Japan, when their bubble burst, Japanese people still saved 40% of their income. Currently US household saving is under 2%.

I fear that beyond the Moral Hazard Universe Greenspan has created, it has simply been too long since most Americans have experienced any major hardship/uncertainty (despite 9/11!!) and long ago gave up the practice of "saving for a rainy day."

As a result, today's 30-something "new era" homeowners leveraged up to their eyeballs, will know real suffering for the first time.

For these reasons, I fear that the bubble may burst more violently and in a shorter period of time than in the past...

(respectfully to CR, whose observations and analysis I find to be top-notch)

At 7:28 PM, Anonymous Anonymous said...

In Dupont Circle in DC there are one bedroom condos (circa 60s/70s) that are going for high 300s to low 400s that went for as little as 98k in 1998. 495 square foot studio just went for 275k (or approx. $555 per square foot) and from 100k to 375k for a one bedroom, that's a 275% increase in about 7 years. Now this is DC and jobs are stable, but so are incomes. A 60% decrease from 375k would be 150k. That's still a 50% increase over the 1998 sales price and a slight appreciation over inflation (or a healthy 5% increase per year) -- which is Shiller's point, over the long run real estate tends to go up only a little more than general inflation. Add to that that this is a pretty transient town, people move in, people move out, up and down, so it doesn't make sense to overpay for housing vs. renting because of the associated transaction costs to move out or up. While the DC market is small in comparison to the swaths of surburbia in CA, FL and AZ, we definitely have a bubble going on here as well.

At 7:34 PM, Anonymous Anonymous said...

I'm sitting here reading this blog, when someone rings my doorbell. It's the realtor lady who lives down the street. She's going door to door looking for people to buy houses (we rent). She's the third realtor to come by the house today, the first two just left flyers.
This is the consensus of the three flyers we received today in our North Park, San Diego neighborhood:

Average list price for 1000sf house is $582,000 and average selling price is $568,000.

Average days on the market: 31

Compared to April 2004, when average days on the market was 15, the number of sales for this April was half of where it was a year ago. But price still going up.

We'll keep renting the same house for 1800 bucks a month. Landlord has agreed to renew our lease for another year. We will wait and see what happens to real estate in San Diego. Not too many buyers left that can/will afford these prices.

At 8:13 PM, Blogger cl said...

Great to find this blog. I posted to it last night but in an outdated section so here goes again. JJl- here is some info that may help. I live in the greater Boston area and I've been closely monitoring the market in 2-3 towns in the north burbs for over a year now. Granted it's a small sample but I think it's a fairly accurate snapshot of the area sales and prices. I track the original asking prices, all price reductions and final sales prices. The realtors stats can be misleading because they always reference the latest price as the Asking price. 95%+ of the homes I’ve tracked are selling below their final asking price, but when you look at the original asking price it’s often 5-10% below and in many cases much more. Of course there are exceptions to this and some of these houses were overpriced to begin with- but this is the general trend. I've seen several very nice homes (550-650K range) in very desirable neighborhoods selling 60-80K off what similar homes in the same neighborhood sold for the previous spring.
I KNOW prices are down here even though the latest news this month was about the MASSACHUSETTS 12.5% price increases (year over year). But the truth is, the most recent median house price is 10K below it's high of last June. In the previous month it was 20K below. In 2004 there was a big bump up in the MAY & JUNE housing prices so it hasn't shown up in the year over year numbers yet- but it will shortly. Next month that number may fall from 12.5% to around 3-6%. By June it could go negative. After a very SLOW fall many sellers lowered their prices and others took their houses off the market to wait for the spring. The people who kept their houses on the market were lucky because in January the sales came back strong for 2-3 months even though prices remained relatively flat. Probably a lot of fence sitters came out to buy before the rates and the prices went up in the spring.
Then in April (which is typically the heart of the HOT spring market) things started to slow down again and within the last month it's slowing even more. More and more houses coming on the market but very slow sales. The only things still moving quickly are the condos and the homes at the low end (350's-430's) but there is starting to be an increased inventory and price reductions here as well. The mid to higher end homes have been stagnant since last July, with considerable price reductions on some of them when the sellers had to move it. Of the houses that didn't sell last fall, many came back on this spring at their lowered fall prices. A few tried to bump up a little but came back down in a couple weeks. Some house have been on and off for sale for 6-8 months.
Now if you read the local real estate news in the Globe it all sounds rosy. Nobody even mentions the median price reduction even though the information is there for anyone to see at: Of course the MA realtors assoc. puts the spin on the numbers (the elections, the red sox (loved that one!), more houses selling at the low end are bringing the numbers down, etc.-( that’s partially true because not a lot is selling in the upper price range) But the truth will be out soon. Just recently the Private Mortgage Insurers put Boston at the top of their list for most likely area to lose value this year! I was surprised we beat out California who has way surpassed us in Bubblonia.

Here's a question: We sold our house last spring and are renting. We plan to sit it out for a while but are concerned about where to park our cash from the sale. If this thing goes down ugly the banks may in jeopardy. The dollar is losing value, too. Somewhere I read gold & silver but they are going down now, too. Anybody know of any great books or references on how/where to invest in a housing downturn?

At 8:46 PM, Anonymous Anonymous said...

JJL i get you, recent crappy news from Treasury Bills and gloomy prospects of short term rates being dangerously close to long term will cause a recession and refi boom (dump ARMS for fixed because rates WILL go down). It makes me really mad. This bubble will last longer and it wont pop as severe because alot of ARM's I/O's will get out through fixed mortgages.

But i am not buying, it's the principle, i am not going to create an instant millionaire out of a 22 yr old "investor" who never even saw the house he bought 6 months ago and is now seeling it.
Ill rather rent!

At 9:00 PM, Anonymous Anonymous said...

8:46 Anon, don't worry. Do you really think that those ARM I/O people can really afford 30-yr FRM? They do ARM I/O because that is the only thing they can afford.

Even without rising interest rates the housing market will fall on its own weight. There are almost no more fresh buyers who can afford the high price and are not already in our bubble camp.

At 9:27 PM, Anonymous Anonymous said...

cl 8:13, awesome post about the real estate market in Boston!

I love this blog.

At 10:55 PM, Anonymous Anonymous said...

I live in a suburb just north of Wahsington DC. Prices have skyrocketed here. My friends in the neighborhood (some are owners and some are renters) are split on wether or not there is a bubble in the DC area. Some argue there is, others argue that there is not b.c. DC area has strong job growth and a housing shortage. Thos who argue there is cite the IO / ARM issue.

Right now I live witha few friends in rented townhouse. The place would sell for about 550K. Our rent is $2250 a month plus utilities.

At 11:25 PM, Anonymous Anonymous said...

Anon 8:13 p.m.

Very interesting info on Boston. I live in the San Diego area and have been tracking three areas very closely for over a year. The EXACT same thing has happened here. I am noticing homes that were for sale last summer coming back on the market (they were taken off because of a very slow fall/winter), and they are being priced at exactly the same price as last year. Guess what? They still aren't selling! I also noticed the same rush in around February/March when homes started flying off the shelves again (much to my dismay). Things have slowed down considerably in the last month or so -- and this is supposed to be the busy season! Notice DataQuick's California sales numbers...volume is down (slightly) from March to April. This is not the usual pattern for this time of year. I think May will be even lower. Some homes that are well-priced sell, but most just sit there. Some new inventory coming on lately. Most people are sitting tight because they can't move up. Even with low interest rates, property taxes make the monthly payments unaffordable. The numbers just don't pencil out.

Good luck to all!

At 11:48 PM, Anonymous Anonymous said...

This will clearly end in tears :-).
JJL and others, if you held out untill now it'd be really sad to give in now and become one of the greatest fools ;-).

At 4:30 AM, Anonymous JJL said...

Thanks for all the solid input here. I really appreciate being able to have dialogue that is intelligent about something as emotional as real estate. CL is correct, the areas I track are displaying about a 5-10% decrease is price this spring so far versus last years spring. While that seems encouraging, I still believe that without an interest rate increase that finally lifts long term mrtgage rates prices will climb this summer again. I personally know people so leveraged and stretched that they are using plastic lawn furniture for their new homes living room because they have no money. The only thing that will push them over the edge is a higher payment on their ARM loan. If that does not happen, they will stick it out and keep telling me how rich they will be in a few years when they sell. I think we are still looking at 2-3 years before the market finally has to face the reality of the credit boom. Oh well, at least Episode III is out now, there is a reason to be smiling! Good luck all.

At 6:10 AM, Anonymous Anonymous said... asked about safe places to place your cash, in light of banks possibly failing in a RE crash.

Robert Prechter's book "Conquer The Crash" has a section devoted to exactly this topic. The book is about 4 years old, and most of his predictions haven't come to least yet.


At 6:25 AM, Anonymous Anonymous said...

This website shows how much money we renters in the DC area are losing per hour. It should be fun to watch when the numbers start going down...

At 7:31 AM, Anonymous Ghostwriter said...

CL --

My wife and I sold our Northern CA condo last fall and moved south to San Diego. We rolled our home equity gain into Vanguard's Short-Term Treasury mutual fund, and will keep it parked there until the storm clouds over So Cal's real estate market have at least begun to lift.

The underlying asset is protected by the full faith and credit of the US government, and is pretty close to what finance professionals mean by a "risk free asset". What you are doing is essentially trading current dollars/liquidity for future dollars paid within the next several months, with a market-based adjustment (the interest payment) to take into consideration anticipated inflation. Because the term is short, the value is little affected by interest rate shocks (the kind which might occur if the Bushies are overly successful at getting China to revalue its currency). If banks fail, no matter -- the US government cannot afford to default on its treasury debt because doing so would be tantamount to commiting economic suicide. (You might research the consequences to the economies of countries which have defaulted on their debt obligations in modern times, such as Russia and Argentina, if you are unsure of what I speak).

Note: There is currency risk in this strategy -- ultimate diversification would require you to diversify across a broad basket of foreign currencies, but this is probably not worth the hassle if your goal is to eventually buy a home in the US after this credit bubble is history.

At 8:01 AM, Anonymous Ghostwriter said...

Given the large number of comments here about the connection between recent conundrum-related drops in long term bond yields and the future course of the bubble, it seems worth reiterating a few points that have been already made, and adding a few more:

1) In normal economic conditions (like those which do not currently prevail in the U.S. housing market), home mortgages are offered at a lower interest rate than the market would bear, but credit is rationed by loan underwriting standards. What this means is that not everyone who can fog a mirror can get a loan.

2) The recent drop in long-term bond rates is probably related to a flight-to-quality from risky bets made by hedge funds. The unravelling of these bets may have serious economic consequences of their own, which are as of now hidden from view, and have been strangely interpreted as a bullish signal on Wall Street ...

3) Despite the fact that generally declining long-term bond yields for ten or so years now have unleashed a torrent of pent-up demand for housing, there is little evidence that future declines in long-term rates will have much further effect on housing demand. In a nut-shell, the Feds (the Fed, FDIC, etc.) and the main-stream financial press seem to have suddenly undergone a collective paradigm shift about whether there is a housing bubble.

Mark today as the first time a front-page article in the Wall Street Journal mentions "Housing Bubble" in the caption. Fed officials including
none other than Sir Alan Greenspan himself have recently made numerous uncharacteristically blatant remarks to indicate that the housing bubble is squarely in their gun sights. This gig is up. Investors sell now, or lose your shirts.

4) How does this relate to the effect of long-term rates on housing demand? Even if interest rates remain low, lending standards are about to revert to their historical norms, where borrowers will have to provide solid evidence of their ability to repay a mortgage. This will cut the legs from under the speculative demand which fuels the bubble, regardless of where long-term interest rates head in the foreseeable future.

At 8:13 AM, Anonymous Anonymous said...

This is pretty much going to be the pin that pops the bubble:

When they come out with new lending guidelines, there will not be anyone else left to buy your expensive home. The only ones left now are those who depend on IO/neg am/80-20's to do so.

At 11:52 AM, Anonymous Anonymous said...

This guy is just blowing smoke out of his ass. If he had any experience or understanding of the microeconomics of housing booms and busts he should know that during bubbles banks foreclose on the mortagees and buy back the properties at foreclosure auctions, holding hold onto them until the market turns around. This way banks preserve the value of their mortgaged property portfolios and take a double deduction for the defaulted loan and repurchase expenses. I know this from personal experience bidding against banks at mortgage foreclosure autions in housing bubble ridden Massachusetts.

At 4:34 PM, Blogger Thomas said...

11:52 -- Of course banks buy at foreclosure sales. The question is, how long do they hold the foreclosed properties? My understanding is that it's not long -- they don't like being on the hook for carrying costs (taxes, insurance, maintenance) and often are motivated sellers.

At 12:59 PM, Anonymous Anonymous said...

Boston area is insanely inflated.
I'm too missing out on this boom,
but one thing I know for sure is that now IS TOO LATE. Now one is much better off renting - one sleeps much better without thinking how much this house of cards will collapse. It is just simply not a good investment any longer. For 3k I can rent a very good house and that is only close to what I'd have to pay in interest + taxes + fixing, etc +
I wouldn't sleep well. Damn stupid to buy now. Now, I can get a very good place to live for 2k that makes buyng completely dumb.
See you 50% down from here.

At 1:17 PM, Anonymous Anonymous said...

Ben, could you add a date to the timestamp? After the collapse it would be fun to read people's opinions.

At 4:58 PM, Anonymous Anonymous said...

my 2 cents worth:

when rents can't come close to genrating positive cash flow things are out of whack.

Take the DC are renter who said he and his roommates pay $2250/month for a house that would sell for $550k. I checked out a mortgage calculator for a $440k loan(which is generous, who has $110k (20%) to put as a down payment and not expect positive returns) the payment was $2498/month. It goes higher with only 5% down. So if you were to buy that house at the market price you would have to eat several hundred dollars of mortgage, as well as all of the taxes and insurance and repairs. Pretty irrational pricing and anyone who holds on to that property is implicitly betting on continued appreciation, or is lucky enough to have gotten in early and have a nice equity stake in the property.


Post a Comment

<< Home