Thoughts on the housing market from the Dallas Fed

The Fallacy of a Pain-Free Path to a Healthy Housing Market.

Home prices falling anew

S&P/Case-Shiller shows home prices dropping in all twenty cities tracked:

Home prices took a shockingly steep plunge on a monthly basis, an indication that the housing market could be on the verge of -- if it's not already in -- a double-dip slump.

Prices in 20 key cities fell 1.3% in October from a month earlier, an annualized decline of 15%, according to the S&P/Case-Shiller index released Tuesday. Prices were down 0.8% from 12 months earlier.

Month-over-month prices dropped in all 20 metro areas covered by the index. Six markets reached their lowest levels since the housing bust first began in 2006 and 2007.

Merry Christmas

Now you know why the U.S. Senate approved the New START treaty right before Christmas.

I'm on vacation for the next week or so. I'll be blogging again in the New Year.

Flat home prices expected for 2011

Economists expect home prices to be flat in 2011 after declining about 1% in 2010:

Home prices won’t show any year-over-year appreciation in 2011, according to the latest average of 110 forecasts from economists and housing analysts surveyed by MacroMarkets LLC.

The survey shows that economists expect home prices to fall by 0.17% in 2011 as measured by the S&P/Case-Shiller index of home prices in 20 U.S. cities. The average forecast for 2010 calls for the Case-Shiller index to ultimately show that home prices ended the year down 1.13%.

Overall, economists expect home prices to rise by 7.2% over the five-year period ending in 2014. In May, that forecast called for a 12% rise in prices over the span.

The effect of declining home prices on small business borrowing

The Federal Reserve Bank of Cleveland has a new economic commentary on the declining housing bubble's effect on small business borrowing. Here's the conclusion:

Everyone agrees that small business borrowing declined during the recession and has not yet returned to pre-recession levels. Lesser consensus exists around the cause of the decline. Decreased demand for credit, declining creditworthiness of small business borrowers, an unwillingness of banks to lend money to small businesses, and tightened regulatory standards on bank loans have all been offered as explanations.

While we would agree that these factors have had an effect on the decline in small business borrowing through commercial lending, we believe that other limits on the credit of small business borrowers are also at play and could be harder to offset. Specifically, the decline in home values has constrained the ability of small business owners to obtain the credit they need to finance their businesses.

Of course, not all small businesses have been equally affected by the decline in home prices. While many small business owners use residential real estate to finance businesses, not all do. Those more likely do so to include companies in the real estate and construction industries, those located in the states with the largest increases in home prices during the boom, younger and smaller businesses, companies with lesser financial prospects, and those not planning to borrow from banks. These patterns are also evident in the data sources we examined.

The link between home prices and small business credit poses important challenges for policy makers seeking to improve small business owners’ access to credit. The solution is far more complicated than telling bankers to lend more or reducing the regulatory constraints that may have caused them to cut back on their lending to small companies. Returning small business owners to pre-recession levels of credit access will require an increase in home prices or a weaning of small business owners from the use of home equity as a source of financing. Neither of those alternatives falls into the category of easy and quick solutions.

Lunar eclipse photo

Here's a photo I just took of tonight's lunar eclipse. The eclipse is still occurring as I write this.

What about the Silent Generation?

In discussing a new Pew Research Center study finding that Baby Boomers are feeling gloomier than other generations, CNN makes a glaring error:

"Most Americans are pretty glum three years into a Great Recession and a jobless recovery, but even in that context, the baby boomers stand out," said Paul Taylor, co-author of the study and vice president of the center.

In contrast, the study found only 60% of millennials — individuals between the ages of 18 and 29 — had a bleak view of the way things are going today.

And about 76% of respondents older than baby boomers, also called the "greatest generation," were dissatisfied with the status quo.

The "greatest generation" is not the generation that came right before the baby boomers.

The baby boomers are the generation of Americans born after World War II. What Tom Brokaw called the "greatest generation" is the generation that was in early adulthood during the Great Depression and World War II, and participated in the war effort. In between not being born and adulthood is an period called "childhood."

Americans who experienced childhood during the Great Depression or World War II are known as the "silent generation." They are too old to be baby boomers and too young to have participated in World War II. The silent generation is what makes up most of today's senior citizens, since the greatest generation has been gradually dying off for a while now.

This error was made by CNN, not the Pew Research Center.

Of course, I should point out that what we call a generation in societal terms is generally somewhat shorter than a generation in biological terms. A true generation should be about 25 years, because that's roughly the age that people in developed countries have children. But in cultural and societal terms, generations are defined by the common experiences of people within a certain age range. These common experiences are generally delineated by external events that don't neatly map to 25-year intervals.

Did cheap credit and easy lending cause the housing bubble? No!

Research by Edward L. Glaeser and Joshua D. Gottlieb of Harvard University, and Joseph Gyourko of the University of Pennsylvania argues that the housing bubble was not primarily caused by cheap credit and easy lending.

Abstract:

Between 1996 and 2006, real housing prices rose by 53 percent according to the Federal Housing Finance Agency price index. One explanation of this boom is that it was caused by easy credit in the form of low real interest rates, high loan-to-value levels and permissive mortgage approvals. We revisit the standard user cost model of housing prices and conclude that the predicted impact of interest rates on prices is much lower once the model is generalized to include mean-reverting interest rates, mobility, prepayment, elastic housing supply, and credit-constrained home buyers. The modest predicted impact of interest rates on prices is in line with empirical estimates, and it suggests that lower real rates can explain only one-fifth of the rise in prices from 1996 to 2006. We also find no convincing evidence that changes in approval rates or loan-to-value levels can explain the bulk of the changes in house prices, but definitive judgments on those mechanisms cannot be made without better corrections for the endogeneity of borrowers’ decisions to apply for mortgages.

Conclusion:

Interest rates do influence house prices, but they cannot provide anything close to a complete explanation of the great housing market gyrations between 1996 and 2010. Over the long 1996-2006 boom, they cannot account for more than one-fifth of the rise in house prices. Their biggest predictive influence is during the 2000-2005 period, when long rates fell by almost 200 basis points. That can account for about 45% of the run-up in home values nationally during that half-decade span. However, if one is going to cherry-pick time periods, it also must be noted that falling real rates during the 2006-2008 price bust simply cannot account for the 10% decline in FHFA indexes those years.

There is no convincing evidence from the data that approval rates or down payment requirements can explain most or all of the movement in house prices either. The aggregate data on these variables show no trend increase in approval rates or trend decrease in down payment requirements during the long boom in prices from 1996-2006. However, the number of applications and actual borrowers did trend up over this period (and fall sharply during the bust), which raises the possibility that the nature of the marginal buyer was changing over time. Carefully controlling for that requires better and different data, so our results need not be the final word on these two credit market traits.

This leaves us in the uncomfortable position of claiming that one plausible explanation for the house price boom and bust, the rise and fall of easy credit, cannot account for the majority of the price changes, without being able to offer a compelling alternative hypothesis. The work of Case and Shiller (2003) suggests that home buyers had wildly unrealistic expectations about future price appreciation during the boom. They report that 83 to 95 percent of purchasers in 2003 thought that prices would rise by an average of around 9 percent per year over the next decade. It is easy to imagine that such exuberance played a significant role in fueling the boom.

Yet, even if Case and Shiller are correct, and over-optimism was critical, this merely pushes the puzzle back a step. Why were buyers so overly optimistic about prices? Why did that optimism show up during the early years of the past decade and why did it show up in some markets but not others? Irrational expectations are clearly not exogenous, so what explains them? This seems like a pressing topic for future research.

Moreover, since we do not understand the process that creates and sustains irrational beliefs, we cannot be confident that a different interest rate policy wouldn’t have stopped the bubble at some earlier stage. It is certainly conceivable that a sharp rise in interest rates in 2004 would have let the air out of the bubble. But this is mere speculation that only highlights the need for further research focusing on the interplay between bubbles, beliefs and credit market conditions.

This is essentially what I've been arguing from the beginning: The bubble was primarily the fault of home buyers who saw real estate as a way to get rich quick. Some fundamental factor in the late 1990s caused the initial rise in home prices, but then psychology (greed) took over and home buyers were willing to pay any price for a home because "real estate is the best investment you can make" and "home prices never go down." (If something is the best investment you can make and the price will never go down, then the price you pay doesn't matter.)

Unlike most people (including politicians and journalists who dare not blame the voters/viewers), I remember the home owners during the bubble who insisted I should buy a home because real estate is such a great investment. I remember them telling me how much their home had gone up in value. I remember them telling me I was throwing money out the window by renting. I remember being kicked out of my home because of a (failed) condo conversion by real estate investors chasing the rising prices. This is the psychology that causes bubbles! Since the collapse of the bubble, however, home buyers cannot be blamed. THEY WERE DECEIVED! THEY WERE CHEATED! Instead, they look for a scapegoat (greedy bankers) to blame for their own greedy decisions. This paper essentially says the banksters ain't to blame.

As for the initial fundamental cause of the rise in home prices, I've been going with the Bernanke explanation of a global savings glut, but this paper seems to throw a monkey wrench into that one.

What factors create better schools? Lessons from the international tests...

Asia-Pacific economies absolutely dominated the most recent PISA international student assessment tests.

Shanghai, China took the top spot in all three subject areas—reading, math, and science. Other Asia-Pacific outperformers were South Korea, Hong Kong, Singapore, New Zealand, Japan and Australia.

Our neighbor to the north, Canada, also outperformed the international average in all three subject areas. The United States, however, was mediocre. So were the big five European Union countries—Germany, France, United Kingdom, Italy and Spain.

Here are some finding from the OECD about what causes educational outperformance:

• Successful school systems provide all students, regardless of their socio-economic backgrounds, with similar opportunities to learn.
• Most successful school systems grant greater autonomy to individual schools to design curricula and establish assessment policies, but these school systems do not necessarily allow schools to compete for enrolment.
• School systems considered successful tend to prioritise teachers’ pay over smaller classes.
• The greater the prevalence of standards-based external examinations, the better the performance.
• Schools with better disciplinary climates, more positive behaviour among teachers and better teacher-student relations tend to achieve higher scores in reading.
• After accounting for the socio-economic and demographic profiles of students and schools, students in OECD countries who attend private schools show performance that is similar to that of students enrolled in public schools.

Health insurance mandate ruled unconstitutional

Ilya Shapiro explains the constitutional significance:

Today is a good day for liberty. By striking down the unprecedented requirement that Americans buy health insurance — the "individual mandate" — Judge Henry Hudson vindicated the idea that ours is a government of delegated and enumerated, and thus limited, powers.

But this should not be surprising, for the Constitution does not grant the federal government the power to force private commercial transactions.

Even if the Supreme Court has broadened the scope of Congress' authority under the Commerce Clause — it can now reach local activities that have a substantial effect on interstate commerce — never before has it allowed people to face a civil penalty for declining to buy a particular product. Hudson found therefore that the individual mandate "is neither within the letter nor the spirit of the Constitution."

Stated another way, every exercise of Congress' power to regulate interstate commerce has involved some form of action or transaction engaged in by an individual or legal entity. The government's theory — that the decision not to buy insurance is an economic one that affects interstate commerce in various ways — would, for the first time ever, permit laws commanding people to engage in economic activity.

Under such a reading, which judges in two other cases have unfortunately adopted, nobody would ever be able to plausibly claim that the Constitution limits congressional power. The federal government would then have wide authority to require that Americans engage in activities ranging from eating spinach and joining gyms (in the health care realm) to buying GM cars. Congress could tell people what to study or what job to take...

As for the oft-invoked car insurance analogy, being required to buy insurance if you choose to drive is different from having to buy it because you are alive. And it is states that impose car insurance mandates, under their general police powers — which the federal government lacks. ...

As Hudson said, "Despite the laudable intentions of Congress in enacting a comprehensive and transformative health care regime, the legislative process must still operate within constitutional bounds. Salutatory goals and creative drafting have never been sufficient to offset an absence of enumerated powers."