A mysterious demand for housing

By postulating that there is a demand for housing, in an economy rapidly shedding jobs, tightening credit requirements, and casting a huge number of citizens into the 'no-credit-at-all' category (bankruptcy/foreclosure), Hubbard and Mayer conclude:

A reduction of mortgage interest rates to 4.5% (or, given yesterday's Fed action, to a lower level) is superior to other proposals that focus only on stopping foreclosures, or on reforming the bankruptcy code to keep people in their homes. Stopping foreclosures, however meritorious, may not limit the dangerous decline in house prices as much as proponents claim. It could work the other way. Stripping down mortgage balances in bankruptcy would likely raise future mortgage interest rates and lower the availability of mortgages, reducing house prices.

Loan modifications are a reduction in interest paid, right? They also directly and quickly affect the structural challenges. An interest-rate only mechanism could extend the 'debt-depression' for years.

There is a realtor-survey Businessweek data point going around that some 40% of existing home sales are foreclosures. You have to bet that is because of price, not quality or location, right?

Given the problem is so serious, why 'bet the farm' that an artificially reduced rate will bring the desired equilibrium? Given all the hope-for-the-best approaches that have already failed, across a range of problems, wouldn't the direct approach, modifying some loans, actually be more robust?

The Businessweek study:

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That's especially true in California. In the second quarter of 2008, seven in 10 existing-home sales in San Joaquin and Merced counties were of properties that had gone through foreclosure in the previous 12 months, according to DataQuick, a La Jolla (Calif.) real estate information company. In Sacramento County, six in 10 sales involved foreclosures.

It's no wonder that prices in these markets are tumbling: Distressed sales have a way of dragging prices down for entire communities. Aaron Smith, senior economist at Moody's Economy.com, says markets in which foreclosed homes dominate listings suffer from a kind of "negative feedback loop."

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Housing Set to Overshoot

New building is set to go to zero, apparently. Permits for new construction clocked a measly 616K, s.a.r., which is nearly 50% below a year ago and an all-time low.

The impact of this on employment is material.

On both scores, housing prices look set to overshoot to the downside, without a plan to smooth over this adjustment from the "boom" period.

Construction job losses - across all segments - account for some 30% of all job losses so far.

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Housing Storm

Expectations for home price declines are notably worse than where they stood last December.

The latest expectations set (as of May 22nd), with the one-year outlook (approximately) highlighted.

FUTURES	08May	08Aug	08Nov	09Feb	09May	09Aug	09Nov
Composite	-2%	-6%	-11%	-12%	-15%	-11%	-15%
Boston	-2%	-3%	-4%	-3%	-5%	-5%	-6%
Chicago	-2%	-4%	-6%	-9%	-11%	2%	-11%
Denver	-1%	-4%	-6%	-8%	-1%	-1%	-10%
Las Vegas	-4%	-10%	-20%	-18%	-20%	-20%	-22%
Los Angeles	-4%	-9%	-19%	-21%	-25%	-8%	-27%
Miami	-3%	-8%	-15%	-18%	-21%	-12%	-20%
New York	-1%	-3%	-5%	-8%	-10%	-13%	-17%
San Diego	-3%	-7%	-13%	-17%	-18%	-11%	-18%
San Francisco	-3%	-8%	-14%	-18%	-20%	3%	-22%
Washington	-3%	-7%	-11%	-13%	0%	0%	-16%

Here's the set on file from December 19th, with the one-year outlook (approximately) highlighted.

FUTURES	08Feb	08May	08Aug	08Nov	09Feb	09May	09Nov
Composite	-2%	-4%	-6%	-7%	-8%	-9%	-10%
Boston	-2%	-5%	-6%	-6%	-8%	-9%	-12%
Chicago	-1%	-2%	-3%	-4%	-4%	-5%	-6%
Denver	-1%	-3%	-4%	-7%	-8%	-9%	-12%
Las Vegas	-3%	-5%	-7%	-8%	-10%	-12%	-13%
Los Angeles	-2%	-4%	-6%	-7%	-8%	-9%	-11%
Miami	-3%	-6%	-10%	-14%	-14%	-16%	-17%
New York	-3%	-5%	-7%	-8%	-9%	-11%	-12%
San Diego	-2%	-4%	-5%	-6%	-8%	-10%	-12%
San Francisco	-2%	-4%	-6%	-8%	-10%	-13%	-15%
Washington	-3%	-5%	-6%	-8%	-8%	-10%	-11%

These are the changes. As you can see, expectations have mostly worsened in the one-year outlook, as it stood last December.

Change since Dec-19	08Feb	08May	08Aug	08Nov	09Feb	09May	09Nov
Composite		2%	0%	-4%	-4%	-6%	-1%
Boston		3%	3%	2%	4%	4%	7%
Chicago		0%	-2%	-3%	-5%	-6%	8%
Denver		1%	0%	1%	-1%	8%	12%
Las Vegas		2%	-3%	-12%	-8%	-8%	-7%
Los Angeles		1%	-4%	-12%	-13%	-16%	3%
Miami		4%	1%	-1%	-4%	-5%	5%
New York		5%	4%	3%	1%	1%	-1%
San Diego		1%	-3%	-7%	-9%	-8%	1%
San Francisco		1%	-2%	-6%	-8%	-7%	18%
Washington		2%	-1%	-3%	-5%	9%	11%

How did you do if you hedged by selling the futures contracts? Well, the calcs are imperfect (no spot prices available), but using the month C-S index values, here is an approximation (below). So far, these have been pretty good hedges, with the futures prices actually falling more than the estimated fall in spot prices in most cases.

For people in Las Vegas and Los Angeles, where spot prices have fallen by an estimated 17% and 16% since the last read in December, that would be a ton of good news.

Hedge Perf since Dec-19	08Feb	08May	08Aug	08Nov	09Feb	09May	09Nov
Composite		-2%	-1%	2%	4%	6%	-3%
Boston		-3%	-3%	-2%	-4%	-5%	-7%
Chicago		-1%	1%	2%	5%	6%	-8%
Denver		-2%	0%	-1%	1%	-8%	-12%
Las Vegas		-2%	3%	10%	8%	7%	7%
Los Angeles		-2%	1%	6%	7%	13%	-8%
Miami		-4%	-2%	1%	3%	3%	-7%
New York		-3%	-3%	-1%	0%	1%	2%
San Diego		-2%	2%	6%	9%	8%	-1%
San Francisco		-2%	2%	7%	8%	7%	-18%
Washington		-2%	1%	3%	5%	-9%	-11%

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Housing Storm - The Same

Home starts and foreclosures this week indicate that the national housing markets remain stressed, but not getting rapidly worse.

Fixed mortgage rates have ticked up slightly in the past few weeks.

The futures markets appear to have reassessed the prospects for Los Angeles downward. However, these markets are extremely thinly traded, from what I can tell, so it is hard to make firm conclusions.

Case-Shiller Real Estate Index Contract Futures by Month
% rise or fall from last Index reading

FUTURES	08Feb	08May	08Aug	08Nov	09Feb	09May	09Nov
Composite	-2%	-4%	-7%	-9%	-9%	-9%	-14%
Boston	-2%	-5%	-6%	-6%	-8%	-9%	-12%
Chicago	-1%	-2%	-3%	-4%	-4%	-5%	-6%
Denver	-2%	-3%	-4%	-7%	-8%	-9%	-12%
Las Vegas	-4%	-6%	-7%	-9%	-10%	-12%	-13%
Los Angeles	-3%	-6%	-8%	-12%	-14%	-11%	-16%
Miami	-4%	-7%	-11%	-14%	-15%	-18%	-18%
New York	-2%	-3%	-6%	-6%	-8%	-9%	-11%
San Diego	-2%	-4%	-6%	-6%	-8%	-10%	-12%
San Francisco	-3%	-5%	-6%	-7%	-10%	-13%	-15%
Washington	-3%	-5%	-6%	-8%	-8%	-10%	-11%

Changes since Nov-28	08Feb	08May	08Aug	08Nov	09Feb	09May	09Nov
Composite	0%	0%	-1%	-2%	-1%	0%	-4%
Boston	0%	0%	0%	0%	0%	0%	0%
Chicago	0%	-1%	-1%	0%	0%	0%	0%
Denver	0%	-1%	0%	0%	0%	0%	0%
Las Vegas	-1%	0%	0%	-1%	0%	0%	0%
Los Angeles	0%	-1%	-2%	-5%	-6%	-2%	-6%
Miami	-1%	-1%	-1%	0%	-1%	-2%	-1%
New York	1%	2%	1%	2%	1%	2%	1%
San Diego	0%	-1%	-1%	0%	0%	0%	0%
San Francisco	-1%	-1%	0%	1%	0%	0%	0%
Washington	0%	0%	0%	0%	0%	0%	0%

Changes include changes to term interest rates, that may affect futures prices.

RealtyTrac suggests that the real test for foreclosure rates will come in the next quarter, which makes sense if there are seasonal patterns and Nov-Dec is a seasonally weak period.

Many of the foreclosure series have months during which the foreclosure rate spikes.

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Expectations Market for Home Price Declines

The CME futures markets on the Case-Shiller home price indexes predict the following home price declines for these markets and for the national, composite average:

Table 1. Contracts by year-month, at last traded price.

FUTURES	08Feb	08May	08Aug	08Nov	09Feb	09May	09Nov
Composite	-2%	-4%	-6%	-7%	-8%	-9%	-10%
Boston	-2%	-5%	-6%	-6%	-8%	-9%	-12%
Chicago	-1%	-2%	-3%	-4%	-4%	-5%	-6%
Denver	-1%	-3%	-4%	-7%	-8%	-9%	-12%
Las Vegas	-3%	-5%	-7%	-8%	-10%	-12%	-13%
Los Angeles	-2%	-4%	-6%	-7%	-8%	-9%	-11%
Miami	-3%	-6%	-10%	-14%	-14%	-16%	-17%
New York	-3%	-5%	-7%	-8%	-9%	-11%	-12%
San Diego	-2%	-4%	-5%	-6%	-8%	-10%	-12%
San Francisco	-2%	-4%	-6%	-8%	-10%	-13%	-15%
Washington	-3%	-5%	-6%	-8%	-8%	-10%	-11%

These suggest that those who are worried about massive declines (20%+) in the upcoming year, due to foreclosures in their home markets or whatever, can still successfully hedge against that further decline.

Those who just want to hedge against a non-specific, generalized fall have less opportunity in the long-term contracts and would need to look toward rolling near-term contracts over.

These are not heavily traded contracts, presently, although interest may pick up.

This note is for informational purposes (commentary) only. Don't buy or sell anything just based on this or any other note here.

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The Roof Over Your Head, Formerly Known as Piggy Bank

NEW HOME PRICE DATA

The Case-Shiller home price indexes came out today, for period ending September.

There is not an accelerating decline overall, but the slip did broaden in the month, as a few more cities in the composite showed a fall than had earlier (in fact, all 20 of them fell in the period for the first time, some just slightly).

NO ACCELERATION, YET

Among the major markets, New York, Boston, and Washington, their was a decline in the rate of fall. San Francisco, which has been moving down very slowly, showed a downtick. Chicago did as well, but that market did not have nearly as much a run-up as did the other majors. Last month's sharp figure for Los Angeles did not repeat.

Phoenix, which is not a large part of the overall national market, put in a pretty bad number, if there is follow-through on it. A retirement destination, this has been one of the hot markets in the past fifteen years.

I don't have the geographical patterns of mortgage delinquencies (or defaults) and sub-prime lending. The notion that foreclosures are going to greatly accelerate the home-price decline is not in the national numbers, right now.

PARTS OF THE MARKET HIT FOR DIFFERENT REASONS, SO FAR

Markets like Miami, Tampa, Los Angeles, and San Francisco, that have had the largest run-ups, might be vulnerable to forced selling (foreclosure). Other markets, in the so-called non-coastal areas, might be subject just to the general credit and economic woes of working out the exuberant lending practices of the Bush era.

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Housing Bubble Snapshot

Notes:
-1990 episode was fairly concentrated, with some markets 'stalling' while others dipped.
-2007 episode, so far, has been both more uniform and mixed. More markets have dipped, but some have also leveled out this year.

Table 1. Peak-to-Trough comparison, 1990 Real Estate "Bust" to 2007 Real Estate "Adjustment". (markets that started a decline prior to December 1994).

Episode:	1990s				2007
City	Peak	Trough	Dur- ation	%	Peak2	Trough2	Dur- ation	%
Los Angeles	Jun-90	Mar-96	69	-27%	Sep-06	Aug-07	11	-6%
San Diego	Jul-90	Mar-96	68	-17%	Nov-05	Aug-07	21	-9%
Boston	Jul-88	Feb-92	43	-17%	Sep-05	Feb-07	17	-8%
New York	Sep-88	Apr-91	31	-15%	Jun-06	Aug-07	14	-4%
San Francisco	Jun-90	Feb-94	44	-12%	May-06	Aug-07	15	-5%
Dallas - TX	Oct-89	Feb-94	52	-8%	Jun-07	Jul-07	1	0%
Washington	Apr-90	Apr-91	12	-6%	May-06	Aug-07	15	-8%
Seattle - WA	Jul-94	Dec-94	5	-1%	Jul-07	Aug-07	1	0%
Minneapolis - MN	Nov-94	Dec-94	1	-1%	Sep-06	Aug-07	11	-4%
Tampa - FL	Sep-94	Nov-94	2	0%	Jul-06	Aug-07	13	-11%
Chicago	Oct-94	Dec-94	2	0%	Sep-06	May-07	8	-2%
Cleveland - OH	Nov-94	Dec-94	1	0%	Jul-06	Apr-07	9	-5%
Portland - OR	Nov-94	Dec-94	1	0%	Jul-07	Aug-07	1	0%
Miami	no drop		-	-	Dec-06	Aug-07	8	-9%
Phoenix - AZ	no drop		-	-	Jun-06	Aug-07	14	-8%
Las Vegas	no drop		-	-	Aug-06	Aug-07	12	-8%
Denver	no drop		-	-	Aug-06	Mar-07	7	-4%
Detroit - MI	no drop		-	-	Dec-05	Jun-07	18	-13%
Atlanta - GA	no drop		-	-	Jul-07	Aug-07	1	0%
Charlotte - NC	no drop		-	-	Aug-07	Aug-07	0	0%
Composite	Oct-89	Feb-94	52	-8%	Jun-06	Aug-07	14	-5%
Composite-20	n.a.	n.a.	n.a.	n.a.	Jul-06	Aug-07	13	-5%

*items shaded lightly indicate markets in which a downward trend started, but has stopped, either as a permanent trend reversal or as a hiccup.

Seven markets really entered into price declines in the 1990 episode. Housing starts bottomed in January, 1991 (below 1 million units). The Fed raised rates in 1994, when the other markets listed slowed.

Only the three California markets had long, slow declines. The New York and Boston markets peaked first and actually started up circa 1991.

Prices did "bounce" a bit after the falloff that started in the early 1990s, mostly. Not surprisingly, the market with the steepest per-period run-up, Los Angeles, also had the largest decline. An 18-month, post-correction bounce trims the peak-to-trough loss to 22%, however. Four of the other markets came around 12%, with the last two closer to 5%.

Annualized, all of the price declines come out to 4-6% (see next table).

Table 2. Peak-to-Peak comparisons and rise at annual rates

Episode:	1990s		2007
City	Dur- ation	%Ann	Peak2	Dur- ation	%-Ann	Peak-to -Peak	Prior peak to now
Miami	-	-	Dec-06	144	10%	12%	10%
Phoenix - AZ	-	-	Jun-06	138	9%	11%	9%
Tampa - FL	2	0%	Jul-06	140	9%	11%	9%
Las Vegas	-	-	Aug-06	140	9%	10%	8%
Seattle - WA	5	-1%	Jul-07	151	8%	9%	9%
Minneapolis - MN	1	-1%	Sep-06	141	7%	8%	7%
San Diego	68	-3%	Nov-05	116	14%	7%	6%
Chicago	2	0%	Sep-06	141	6%	7%	6%
Portland - OR	1	0%	Jul-07	151	6%	7%	7%
San Francisco	44	-4%	May-06	147	10%	7%	6%
Denver	-	-	Aug-06	140	6%	7%	6%
Los Angeles	69	-5%	Sep-06	126	13%	6%	6%
Washington	12	-6%	May-06	181	7%	6%	5%
New York	31	-6%	Jun-06	182	7%	5%	5%
Detroit - MI	-	-	Dec-05	132	4%	5%	3%
Boston	43	-5%	Sep-05	163	8%	5%	4%
Atlanta - GA	-	-	Jul-07	151	4%	5%	5%
Charlotte - NC	-	-	Aug-07	152	3%	4%	4%
Cleveland - OH	1	0%	Jul-06	139	3%	4%	3%
Dallas - TX	52	-2%	Jun-07	160	4%	2%	2%
Composite	52	-2%	Jun-06	148	9%	6%	6%
Composite-20	n.a.	n.a.	Jul-06	n.a.	n.a.	n.a.	n.a.

The current episode, on closer inspection, also has some concentrations, if one considers the peak-to-peak growth in prices: Miami, Pheonix, Tampa, Las Vegas. Assuming that a "normal" growth in prices might be in the range of 3-7% for most regional employment and income dynamics, the price drop need to bring returns back to the averages. Over the next three years, Miami and Tampa, for instance, might need further price drops in the 15-20% range to get back to "normal" returns. Three of the other markets are in the 10-15% range. The remainder could stay flat and returns would be be "normalized" either right now or in the next 2 years.

Altogether, without a rising rate environment and based solely on "normal" levels of return, it doesn't look like a housing crisis is in the works, except in some markets that will correct further.

Of course, a recession (weak income dynamics) could force price falls to be less gradual and have greater amplitude, but those would be compounding cyclical factors, not "bubble" factors. However, many of these factors were also present in the 1990s slump.

In fact, a similar fall in prices, peak-to-trough, comes up with a duration of the episode about equal to the prior one, passing from peak-to-trendline-growth in just about 3 years, or sometime in 2009.

Chart1. House prices on a log-level scale. The current downturn could very much look like the prior one - down somewhat, but not sharply, followed by a period of flat, if there is an underlying uptrend in prices, as shown.


The only way to really scare yourself is to imagine that the trendline re-based at the end of the 1990s, say, as a result of the end of the large decline in mortgage rates to a new, lower level. Such a re-basing suggests that most of the "gains" in the 2000s might have been not driven by the fundamentals.

Re-basing, however, is not supported by an economic model of the fundamentals driving the housing market, outside local supply and demand and cost-of-construction increases.

A basic, consumption-based model, without sophistication, suggests that the trend series growth analysis has some underpinnings.

Chart 2. A consumption-based model for growth in house prices

src: all data from Census Bureau surveys

Both the model and the trend series suggest an overall price decline of maybe 8-11%.

Most of the stress will therefore come on the payments side, the credit part of the market, as part of rate-resets or income uncertainties (cyclical unemployment). A 10% decline will wipe out the equity of those with loan-to-value less than 90%, and drag out the time it will take the markets to clear and tighter credit standards will keep such people from moving on to new housing.

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data: Case-Shiller indexes, through August 2007. There are other indexes for housing prices than these and other methodologies. Some market participants, like FannieMae, do not have exposure to all segments of the markets, because they are limited by the dollar amount of so-called "conforming loans".

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