Nov072012

50 years for house prices to reach peak levels without another bubble, Shiller

Many markets in Orange County barely corrected during the bubble collapse. Many of the most desirable markets are already selling for more than peak values due to the stimulus intended to revive the rest of the national market. This will be the story over the next few years as some markets inflate mini-bubbles in reaction to stimulus while some markets languish under the weight of shadow inventory liquidations. Over time, the substitution effect will kick in and the markets will reestablish the equilibrium they once had prior to the housing bubble. Of course, that assumes politicians stop stimulating and manipulating the housing market at some point — an assumption that may be proven false.

Nobody who isn’t kool aid intoxicated believes house prices rise much more than the level of inflation. Intelligent people understand trees cannot grow to the sky. If house prices consistently went up in value faster than price or wage inflation, over time, people would lose their ability to afford to buy houses because debt-to-income ratios would have to rise to accommodate the higher prices. Either that, or all new buyers would have to substitute to inferior housing products so that the highest wage earners in the market end up buying one-bedroom condos in Santa Ana because it’s the only property affordable to anyone.

Dr. Shiller’s graph of real house prices suggests that prices have not risen when adjusted for inflation over the last 120 years. There have certainly been periods when this was true. When examining the last 30 years of data, it appears house prices have risen faster than inflation.

In my opinion, there are two plausible answers for why house prices have risen faster than inflation over this period. First, there has been much more new construction over the last fifty years than in the 70 years which preceded it. New construction always sells for a higher value, so aggregate values go up. In theory, Case-Shiller corrects for this phenomenon by looking at the prices of individual homes. This is one reason Case-Shiller is more accurate than tracking the median to evaluate the relative price change of specific houses.

Second, and more importantly, interest rates have declined dramatically and steadily over the last 25 years. Some amount of the gain is due to lower borrowing costs. House prices are bound to inflate faster than incomes rise when borrowing costs decline over a long period of time. In fact, as I demonstrated in Orange County monthly cost of ownership falls to 1980s levels, Buyers today in Orange County have the same monthly cost of ownership as buyers in 1989. The only reason home prices are any higher today than 1989 is because interest rates fell from 10.77% in April 1989 to 3.5% in October 2012.

 

So how long will it take for prices to get back to peak levels? If you had asked me a year ago, I would have said anywhere between 10 and 25 years. However, based on the recent collusion among the banks to withhold inventory, we may see peak prices much sooner than that — assuming banks can continue to keep properties off the market and interest rates make peak prices financeable and affordable.

Shiller: Housing Market Could Take 50 Years to Fully Recover

Published: Wednesday, 31 Oct 2012 | 3:54 PM ET — By: Drew Sandholm

From housing starts to home prices, renowned economist Robert Shiller acknowledged “there are a lot of positive signs” for the U.S. housing market right now, but told CNBC Wednesday it’s still unclear if a recovery is actually in place.

After all, Shiller noted the housing futures market for single-family homes was only “mildly optimistic” before superstorm Sandy struck the U.S.’s East Coast with expectations for just 3 percent growth per year over the next four years.

“If it goes up 3 percent a year that means that, in real terms, housing is just about flat,” Shiller said. “It’s not a recovery to write home about.”

The futures markets are not predicting a robust national recovery. Most of the judicial foreclosures states will likely see declines over the next few years as liquidations finally take place. The Southwest with its restricted inventory is also further along in the recycling process. While the east coast languishes, the west coast will rise faster than the national average.

Shiller is probably best known for helping create the Standard & Poor’s/Case Shiller index, a widely-followed measure of housing prices, which recently revealed that U.S. home prices rose 2 percent in August compared to one year ago. Meanwhile, the NAHB/Wells Fargo Housing Market Index — a survey of homebuilders — recently climbed sharply higher.

Despite the onslaught of positive indicators for the housing market, Shiller told CNBC’s “Futures Now” it’s possible for the housing market to return to full strength, but it will take a while.

“It can get big as it was again maybe in 50 years. This housing bubble was a once-in-a-lifetime thing, I imagine,” Shiller said. “Although, you know, the market might be more volatile, so the future is always unknown.”

If we had any real protections in place to prevent a future housing bubble, it would take a very long time for many markets to recover. It’s a bit like the Nasdaq waiting to hit 5,200. How long will that take?

To make his case, Shiller noted how the investing culture has changed over the years, thereby greatly affecting the housing market.

“50 years ago, hardly anyone thought of houses as investments, but now, people are focused on it like never before,” Shiller said, adding that homebuilding was so rampant in markets like Phoenix and Miami, it quickly drove up home prices to where one could see the bubble forming very early on. “The funny thing about this recent experience is it became so nationwide. Housing markets aren’t supposed to be correlated all over the country like that. It was a rare phenomenon.”

Going forward, though, Shiller doesn’t expect history to repeat itself anytime soon, if ever.

I think it will. We have done nothing substantive to prevent the next housing bubble, and with all the bailouts and their associated moral hazard, we have increased the level of kool-aid intoxication in the general population. I predict we will start to hear more kool-aid talk over the next few years as everyone takes on a selective amnesia to the events of the last six years.

“My general idea is that we’re not going into a nationwide boom and not many places will show booms in the next few years,” he said.

With the unlimited stimulus of the federal reserve, I think we will see a boom. As far as the banks are concerned we must see a boom because otherwise they will never have collateral backing behind many of their bad bubble-era loans, particularly the billions in worthless second mortgages they hold on their books. Banks need collateral behind these bad loans so they can recover capital when they finally do foreclose. Without higher prices, banks will face billions in write-downs they simply can’t afford. They’ve been writing down bad debts as quickly as they earn more, but at current rates, it will still take them decades to complete their task. If prices are higher, they can avoid all these losses, so they get Bernanke to reduce mortgage rates well below what’s reasonable, and they withhold inventory to force prices higher. It’s a matter of survival for them.

Banks must reflate the housing bubble to recover from the last one. It’s inevitable. And despite the hardship the last one caused, everyone will play along, the Ponzis will borrow and spend, the economy will recover, and everyone will act surprised when the next bubble deflates. It won’t be different next time.