With a rate dependent housing market, risks still linger
Earlier this week I detailed why I believe future housing markets will be very interest rate sensitive. The current market environment is completely controlled by interest rate policy at the federal reserve and distressed loan processing policy at the major banks. The combination of demand stimulus and supply control caused the housing market to bottom in 2012. Of course, since these are market manipulations, the future direction of home prices is uncertain. The market has many more headwinds than tailwinds.
It’s possible that home prices have hit a bottom, but heavy government involvement to stabilize the mortgage market and the broader economy has made it harder to gauge the durability of recent home-price gains, says Yale economist Robert Shiller, the co-creator of the S&P/Case-Shiller index that bears his name.
The Case-Shiller 20-city index was up by more than 8% in November from its February 2012 trough as falling supplies of homes for sale and stronger demand have boosted prices. Developments spoke with Mr. Shiller on Monday about his outlook for U.S. housing markets right now. What follows is an edited transcript:
WSJ: Did we finally hit a floor in home prices last year?
Mr. Shiller: The trend in home prices seems to be up now. It has been going up. That’s upward momentum, which by my general rule of forecasting has been good for the future. I’ve been tentative about that. It may well be the turning point.
But I’m not sure about that. I’m more worried than most people that it could be a short-lived turnaround. It could be like the 2009-10 upturn where we saw home prices rising right after President Obama took office and right after the home-buyer tax credit was instituted. In that upturn there were some cities that did quite spectacularly. And then that fizzled. I’m not too sure that this one will extrapolate either.
OCHN: The main similarity between the 2009-2010 bear rally and the rally today is the presence of artificial market stimulants. In 2009-2010 we had both federal and state tax credits that pulled demand forward. The folly of this became apparent when sales volumes plummeted and prices followed in the 18 months after the tax credits expired.
There are two main differences between then and now. First, the stimulus is different. Today there are no tax credits, but we have record low interest rates through an unprecedented policy by the federal reserve designed to drive down mortgage rates. I think there is tremendous risk that when this stimulus is removed, so will the major source of demand in the market. However, Bernanke has pledged to keep interest rates this low for several more years. He hopes his statements will provide confidence that interests rates won’t rise and pull the rug out from beneath the market. Unfortunately, there is dissension at the federal reserve’s policy-making board, and Bernanke is up for reappointment in 2014, and he won’t likely get the job. If he is replaced by someone with less compunction about stealing from seniors on fixed incomes, then interest rates may rise sooner than most expect. This uncertainty is the opposite of what the federal reserve wants.
The second difference between the first bear rally and this one is that lenders learned how to control of the flow of distressed properties. Back in 2009, lenders weren’t as adept as can-kicking as they are today. With the regulatory and financial pressures largely removed, lenders can allow delinquent mortgage squatters to take a free ride back to the peak where the banks will finally execute them.
WSJ: Why are you more worried than most people?
Mr. Shiller: Part of the reason the indexes have gone up is because the foreclosure boom has receded. Foreclosed homes sell at a lower price, and the share of those sales has been falling. People might be deceived by this by looking at the indexes. The question is whether the gains will be sustained.
OCHN: I am also worried about this because the slowdown in foreclosure processing is not because they ran out of delinquent borrowers to foreclose on. Contrary to media spin, mortgage delinquencies are trending higher. Squatters are enjoying a free ride, and the banks are endlessly can-kicking with hopes that rising prices will restore collateral value behind their bad loans.
There isn’t any sign of the real enthusiasm we saw during the last bubble. The question is whether this could be the very vague beginning of a new boom? I guess it could. I just don’t know. Then there are issues with what the government does to support housing. They’re doing everything they can. They say they’re going to stop some day. When will people start worrying about that?
OCHN: People will not worry until interest rates go up. Until then, they will falsely assume interest rates will remain low forever, and when they want to sell years from now, a buyer who makes more money will be able to borrow at the same low rates of today to allow them to sell with a hefty equity check. It’s much more likely that wages will continue to stagnate in the face of high unemployment, and interest rates will be higher meaning a future buyer will be less leveraged and unable to provide the large check at the closing table.
WSJ: There are some people who look at the double-digit annual price increases in Phoenix and elsewhere and wonder whether we’re seeing new “mini-bubbles.” Is that a concern you share?
Mr. Shiller: Home prices are back down to a reasonable level. Why should they go up a lot? It means you have to have a succession of eager buyers that would bid them up. Historically major bubbles tend to occur at widely separate intervals. Once it bursts, usually, historically, people are fed up for a long time.
OCHN: The Ponzis aren’t fed up. Ponzis want another chance at free mortgage money. For the rest of humanity, the lingering fears of another crash should keep expectations of appreciation to much more reasonable levels. People may become more positive about housing, but not irrationally so.
WSJ: Could it be possible that prices are rising by double digits in these places simply because they fell below their long-term relationship with incomes and rents, and are now bouncing back off of that?
Mr. Shiller: Phoenix overshot. Prices got too low. In real terms it was down well over 50%, maybe close to 60%. Now it’s bumped up. It doesn’t look out of line either way now.
OCHN: Prices clearly overshot to the downside in markets like Phoenix and Las Vegas. That was the main feature that attracted me to the Las Vegas market.
WSJ: What do you make of the investor activity in the market right now? A lot of these buyers are all cash buyers—no leverage—buying on rental return. Are you worried about any return of speculative purchases?
Mr. Shiller: In a housing debacle, I’m sure some houses are underpriced, and there is probably a profit opportunity for some people who are going to choose carefully. I’m not surprised that this is going on. There seems to be a shift in public tastes for the time being at least for rental. So this business doesn’t surprise me. It seems to be an appropriate response.
OCHN: It is an appropriate response. Cash returns are better than most alternatives, thanks to Bernanke’s lowering of interest rates to zero, and the potential for rebound appreciation is large. Further, REO-to-rental is superior to principal forgiveness.
The hidden, latent problem with is activity is its impact on the move-up market. The move-up market will suffer for another decade because the equity that ordinarily would have accrued to first-time homebuyers is instead being diverted to loanowners and hedge funds. Between those two sources, about 40% of future move-up market demand is eliminated.
WSJ: For somebody with a stable job, who plans to live somewhere for more than a few years, is this a good time to buy a house?
Mr. Shiller: I think it’s OK, especially because mortgage rates are so low. This isn’t a time to get a flexible-rate mortgage! Get a 30-year, fixed rate mortgage. Rates are so low. They have gone up a little, but they’re still very low. That’s a real opportunity. Prices are not particularly low, but they’re not particularly high.
For someone with a stable job and a long ownership horizon, this is an excellent time to buy — assuming they can find a property in this depleted market. The cost of ownership is much lower than historic norms, and despite rising prices, properties are still less expensive to own relative to rents than they’ve ever been.
WSJ: What’s your outlook for home prices?
Mr. Shiller: It’s especially hard to say. We could be looking at a 1-2% increase a year for the next five years. That’s a reasonable scenario—1-2% a year, and it might go up more than that. I don’t know. My main message is that it’s a market with risk in it. We don’t know the future. That’s the most important message to convey.
Some people perceive me as a bear because like Dr. Shiller, I am cautious and anchored in reality. Most industry shills are dismissing the obvious problems facing the market and claiming happy days are here again. If we had inventory available today, happy days would be here right now. Despite the high prices, interest rates make them affordable. People can buy a nice house, comparable to an affordable rental, without having to stretch their finances beyond the breaking point. These should be the best of times, but lenders are intent on withholding inventory to drive prices up to help recover their capital. Loanowners and homeowners alike are happy to go along for the ride. By the time the banks get their way, prices will be high and marginally affordable, and with the prospect of rising interest rates in the future, another generation might be trapped underwater in houses that refuse to appreciate. Risks still linger. Buyer beware.