Wednesday, November 28, 2012

Case Shiller Growth down 60%



Case Shiller quarter to quarter growth down 60%
Case Shiller’s 20 city index grew at 1.1% in the third quarter vs. 2.8% in the previous quarter.  This appears more pessimistic than Case Shiller’s announcement that growth compared to the prior year is up 3.6%. What they don’t say is that 3.5 percentage points of that growth was in the first and second quarter as prices surged in response to an increase in FHA loan limits. 
The chart below illustrates the monthly change in the Case Shiller index.  The November report for September contains prices that were agreed to in July.  The reporting lag is long enough to forget what happened when the commitments were made.  This graph dates from when the price was accepted.


Source: Case Shiller
FHA loan limits were scheduled to return to the pre bubble level in October 2011.  As October approached buyers and sellers rushed to close while FHA financing was available with the higher maximum, further lowering prices.  Lobbying by real estate interests not only succeeded in reinstating the $729,750 loan limit, but also increased the limit in the lower priced regions by 10 Percentage points to 125% of the median regional home price in November. 
Because Prices fell in the fourth quarter 2011 reporting period, the Case Shiller comparison to prior year will continue to increase even as the monthly growth deteriorates.  Case Shiller recommends comparing its index to the prior year, contending that the seasonally adjusted index is misleading.  It is.  Working with seasonally adjusted data brings up unexpected problems and unpublished adjustments, but as this example demonstrates, if you understand monthly data, it is possible to understand price trends. 

The Case Shiller 20 city index is reasonably accurate, but unrepresentative of the national prices.  House prices in these cities are more than twice the national level.  While the Case Shiller Price index declined 34% since the peak in 2006, prices outside these regions declined only 13%.  As the reaction to the FHA limits wares off the monthly Case Shiller data are likely to resume its decline while in less urban areas prices will continue to increase.  Since the Case Shiller cites have so much of the nation’s housing wealth this will be a drag on the economy.  


Monday, November 12, 2012

Housing has recovered but Case Shiller index will fall



Case Shiller index monthly trend 
Case Shiller recommends comparing its index to the prior year, contending that the seasonally adjusted index is misleading.  It is.  Working with seasonally adjusted data brings up unexpected problems and unpublished adjustments, but as this example demonstrates, if you understand monthly data, it is possible to understand price trends.  The October Case Shiller data covers August house closings but the bulk of the contracts were agreed to in June.  The chart below illustrates the monthly change in the Case Shiller index. Prices increased in December 2011 and rose to a peak before falling off in the last two reporting periods.




Source: Case Shiller
The reporting lag is long enough to forget what happened when the commitments were made.  FHA loan limits which were raised to a maximum of $729,750 to ease the housing crisis were cut to the normal level of $625,000 on October 1, 2011.  As October approached buyers and sellers rushed to close while FHA financing was available with the higher maximum, further lowering prices.  Lobbying by real estate interests not only succeeded in reinstating the $729,750 limit but also increased the limit in the lower priced regions by 10 Percentage points to 125% of the median price on November 18, 2011.  
The prices rose in reaction to the easier financing but that is wearing off.  Prices outside the Case Shiller stabilized and should continue to rise. The Case Shiller cities are well above the start of the bubble and they are likely to resume falling.
The Case Shiller 20 city index is reasonably accurate, but unrepresentative.  House prices in these cities are twice the national level.  While the Case Shiller index declined 34% since the peak in 2006, prices outside these regions declined only 13%.  The Case Shiller National index contains only urban areas so it is meaningless. Data from Federal Housing Finance Administration (FHFA) index for the 20 Cities matches closely with the Case Shiller index. The reason for the differences in the indexes is that they cover different geography. The performance of regions outside the Case Shiller is determined by weighting this index by percent of national housing and subtraction it from the FHFA index.    This is illustrated below.

 The Case Shiller 20 City markets responded to the combination of the $8,000 house purchase credit and higher loan limited begun in 2009 and 2010 and to the expanded loan limits in 2011. Housing markets outside the Case Shiller 20 cities bottomed out in the second quarter of 2011 and they are recovering.  These markets are less than half the price of these and much more stable.  The lower priced cities in the Case Shiller index are also recovering.  The housing bubble differed sharply by city as housing cycles do, and the recovery will too.   Most of the more expensive Case Shiller cities still face major declines as the effect of the higher loan limits wares off.  



Sunday, July 22, 2012


What's behind Case Shiller’s recovery?  Hint it’s not housing
Case Shiller’s June report of April activity is widely considered a sign of housing recovery.  The seasonally adjusted index increased 1.2 % in the month –equivalent to an annual increase of 15%.  This sounds too good to be true.  It is true, but the index will resume falling. 

Case Shiller recommends comparing its index to the prior year, contending that the seasonally adjusted index is misleading.  It is.  Working with seasonally adjusted data brings up unexpected problems and unpublished adjustments, but as this example demonstrates, without understanding monthly data, it is impossible to understand price trends.  April data covers house closings in February, March, and April.  April data is the first of three batches, March the second batch and February the third.  February was down 0.2% while March and April were up 0.7% which totaled 1.2%.  Purchase commitments are usually made two months earlier.  Thus the April batch is largely made up February purchase commitments.  The following chart plots the monthly price changes in the month most commitments occurred; so April data is shown in February.  

The reports lag the purchase commitment by 5 months – enough time to forget what happened when the commitment was made.  FHA loan limits which were raised to a maximum of $729,750 to ease the housing crisis were cut to the normal level of $625,000 on October 1, 2011.  As October approached buyers and sellers rushed to close while FHA financing was available, further lowering prices.  Lobbying by real estate interests succeeded in reinstating the $729,750 limit plus increasing the limit in the lower priced regions by 10 Percentage points to 125% of the median price on November 18, 2011.  The April reporting period was the first month in the last five that the Case Shiller did not increase.

The Markets where prices fell most from the peak of the bubble and the highest priced markets received the greatest increase.  The Case Shiller 20 cities are ranked by the improvement in prices.  For example, the market with the greatest improvement in the last three months compared to the prior three months is San Francisco.  The price decline in the prior three months swung to an increase, for an improvement of 5.7%.  This city experienced a 39% drop from the peak of the bubble.  The average house price is $598,000.

Prices in all cities increased, except Detroit which was facing bankruptcy.  Supply and demand for houses cannot create such uniform improvement.  As the market adjusts to the higher loan limits prices will resume declining as they were before the loan limit change.  With 3.2% down payment for FHA mortgages where the FHA loses 64% of value on foreclosure, it takes only a small decline to make this a big loser for the taxpayers.  More generous loan limits provide a short lived improvement.  Although it is difficult to forecast the past, when June price commitment data is available at Halloween, the index will be scary.

Despite the above comments, housing is recovering.  Housing markets outside the Case Shiller 20 cities bottomed out in the second quarter of 2011 and they are recovering at a steady but unspectacular 3% per year.  These markets are less than half the price of these and much more stable.  The lower priced cities in the Case Shiller index are also recovering.  The housing bubble differed sharply by city as housing cycles do, and the recovery will too.  Most of the more expensive Case Shiller cities still face major declines.

Monday, June 25, 2012


The Housing Recovery is one year old outside the Case Shiller cities
Measured by the FHFA (Federal Housing Finance Administration) Index, housing is flatting out, but prices in Case Shiller cities are still falling.  The Case Shiller 20 city index is reasonably accurate, but unrepresentative.  House prices in these cities are twice the national level.  While the Case Shiller index declined 34% since the peak in 2006, prices outside these regions declined only 14%.  FHA data for the 20 cities in the Case Shiller is close to the Case Shiller index. Both indexes are accurate they just measure different geography.  
This is summarized below


Heartland prices bottomed out in the first quarter of 2011 and they have been increasing through the first quarter of 2012. In the last three months, Case Shiller cities benefited from reinstatement of higher FHA loan limits which is a one-time pop. 
So in the heartland prices are improving but the Case Shiller cites in California and the Northeast (New York and Boston) are falling.  The US housing market in recovery will differ sharply by region which it always does.  The recovery is good news unless you own property in cities like Los Angeles which is 213% above the start of the bubble and has a substantial decline ahead.  Dallas, a Case Shiller city where the prices are 128% above start of the bubble, is similar to a heartland city.  Los Angles fell 40% since the peak while Dallas fell 5%.  Adjusted for inflation Heartland regions have lost 18% off their value the Case Shiller cities gained 20%.  The differences are unsustainable.

Thursday, June 21, 2012


Case Shiller results are a onetime pop due to changed FHA loan limits

The May Case Shiller 20 city index comparison to prior year shows encouraging signs of recovery.  Case Shiller recommends this comparison contending that the seasonally adjusted index is misleading.  It is.  Working with seasonally adjusted data brings up unexpected problems and unpublished adjustments, but as this example demonstrates, without understanding monthly data, it is impossible to understand price trends.
The following table illustrates the effect of changes in FHA loan limits.  Los Angeles prices in fourth quarter 2011 fell at an annual rate of 10%, but  first quarter 2012 prices increased by 1%, an improvement of 11 points between quarters.  Los Angeles prices fell 40% from June 2006 to March 2012 but they still averaged $519,000.  Price trends in 18 of the 20 cities improved over the prior quarter while 2 low priced cities remained stable.  This sounds too good to be true, and it is.
May data covers house closings in March through January 2012.  The purchase commitment is usually made two months earlier from November to January.  Thus index publication lags purchase commitment by an average of 5 months – enough time to forget what happened 5 months earlier
The FHA loan limits which were raised to a maximum of $729,750 to ease the housing crisis were cut to the normal level of $625,000 on October 1, 2011.  As October approached buyers and sellers rushed to close while FHA financing was available, further lowering prices.  Commitments made from May to July declined at an annual rate of 5%.  The decline accelerated to 8% in the next three months.  Lobbying by real estate interests succeeded in reinstating the $729,750 limit plus increasing the limit in the lower priced regions by 10 points to 125% of the median price on November 18, 2011.  As a result the next three months, the 20 city index was flat - an annual improvement of 9 percentage points.
The highest priced markets received the greatest increase.  In volatile markets with average prices of $519,000 the quarterly price change improved at an annual rate of 10%.  In the lower priced stabilized markets with an average price of $184,000 the improvement was only 3%.  Higher loan limits have the greatest impact in high priced markets.  Markets with the largest decline have the greatest improvement.  Excluding, Detroit which was facing bankruptcy and Atlanta where the high unemployment is leading to high foreclosures, the annual rate improvement has a 75% correlation to the fall in prices.  Of course, this annual rate only occurred for one quarter so the 9 percent annual rate is 2.9% per quarter.  
The first quarter results will change when data for two months of March and one month of February is added to the index.  Usually these adjustments are small, but changes in loan limits have resulted in substantial adjustments.  The Case Shiller cities will resume declining as they were before the loan limit change.  With 3.2% down payment for FHA mortgages where the FHA loses 64% of value on foreclosure, it takes only a small decline to make this a big loser for the taxpayers.  More generous loan limits provide a short lived improvement.  Although it is difficult to forecast the past, when May price negation data is available at Halloween, the index will be scary.
The good news is that housing markets outside the Case Shiller 20 cities are recovering. These markets are less than half the price of these and much more stable. 

Sunday, April 22, 2012

Housing recovery is national, excluding Case Shiller


The Case Shiller 20 city index is reasonably accurate, but unrepresentative.  House prices in these cities are twice the national level.  While the Case Shiller index declined 34% since the peak in 2006, prices outside these regions declined only 13%.  This is summarized below.



Price Indexes: Case Shiller, FHFA and Heartland

The Heartland index (GREEN) is the sum of FHFA (Federal Housing Finance Administration) data for regions outside the Case Shiller 20 SMAs.  It contains volatile urban and upscale SMAs, but it consists largely of lower density areas.  The 20 Case Shiller SMAs (BLUE) and FHFA data for these SMAs track with reasonably consistency.  Case Shiller’s national index contains only urban areas so it is meaningless.  The FHFA index extended with FHA and private sales is used as the national index (RED).

Case Shiller peaked at 258% of the price at the beginning of the cycle in 1997, while the Heartland peaked at 136%.  When measured by Case Shiller, the house purchase tax credit and higher loan limits raised prices, but in the invisible Heartland markets they had little effect. 

How far do prices have to for housing to recover?


Housing Price Forecast


The following table illustrates the status of the 20 Case Shiller cities.  For example, Los Angeles peaked in 2006 at 358% of the starting price.  By December 2011 it was 212% - a drop of 41%.  In the last three months, prices fell at an annualized rate of 10%.  By contrast the recovered cities now average 116% of the price at the start of the bubble - about the same as the Heartland index.

After a severe downturn prices move up and down with national and regional economic pressures.  For example, Detroit’s brush with bankruptcy led to a decline in the fourth quarter, causing total recovered markets to decline, but Detroit was still higher than in the first quarter.  Case Shiller declined at an annualized rate of 8% in the fourth quarter - triple the second quarter rate.  Case Shiller data timing problems in markets such as Atlanta overstated the decline, but three months data illustrates trends not seen in annual comparisons.

Why Case Shiller Cities will fall so much

 

Prices at the start of the cycle reflect premium prices in locations such as Los Angeles.  These Urban areas limit expansion of the housing supply when demand goes up.  They delay new construction and increase the cost of permitting.  All of this increases prices creating the conviction that prices will increase forever.  

This atmosphere infects lower priced markets but prices do not rise rapidly because new housing is built to meet demand.  For example Cleveland, Charlotte and Dallas reached peak prices of 137% to 134% of the beginning of the cycle just like the Heartland regions.  Cleveland which is heavily automotive declined by 19%, Charlotte in a less depressed market dropped 11% and Dallas 7%. 

Credit expanded rapidly during the housing bubble. This easy money had a limited impact in most of the country but it ignited a price explosion in markets where housing could not be built rapidly built to meet demand.  Investors soon entered the market to flip houses.  The credit expansion was an accelerant, the same as throwing gasoline on the fire in high priced markets.  Government programs to address the housing crisis increased prices in the cities where the prices took off with the credit expansion, but this was a temporary boost. 

There are no economic fundamentals that explain for why prices in the Case Shiller cities rose 258% in nine years.  Most forecasters say that prices will soon bottom out, but they cannot point to economic fundamentals to explain why prices of cities like Los Angeles and New York should remain well above the level at the start of the bubble, when prices is the bulk of the country did not keep up with inflation.

The U.S. has a history of regional housing cycles.  Higher price increases in the expansion lead to sharper declines in the contraction.  This works because price declines are self-reinforcing.  They increase foreclosures and put off buyers.  The cycles are much longer than people outside the industry expect.  I worked for both American Standard and Kohler in planning and acquisitions.  Both of these organizations knew that local contractions went on for years even when national prices were increasing and set local budgets accordingly. 

Housing cycles do not coincide with business cycles, so an economic recovery will help, but not end a housing contraction.   The price expansion lasted 9 years.  Contractions usually last 80% as long as the expansion.  (A full discussion of North American cycles can be found in Cunningham and Kolet, Bank of Canada working paper 2007-2.)  Because the house purchase tax credit and FHA financing interrupted the contraction, it will last longer.  They will not end in some markets until 2016. 
 

Why Housing cycles are usually a round trip


Some cities to rise in attractiveness and others fade over decades.  But historically the housing cycle usually ends up the same place as it started adjusted for the normal annual growth in value.  In a high priced city such as Los Angeles, homes are more expensive because land is the bulk of the price.  A home buyer in Los Angeles is speculating in land.  A buyer in Dallas is actually buying a house.

At the start of the cycle in 1997, Los Angeles prices were 164% of Dallas prices, but they were 440% above at the peak.  Now they are 280%.  If prices do not go back to the previous relationship, local businesses will leave because costs are uncompetitive.  For example, Boeing consolidated some of its Los Angeles operations in Oklahoma City.  More and more businesses and jobs are moving out.  Businesses may stay but functions are outsourced.  It does not help that higher property tax revenue in the boom leads to the granting of permanent overly generous local government benefits.  The higher housing costs make local business and consumer services more expensive.  Dentists, restaurants plumbers all become more costly.  Employees are happy to leave, as are businesses that are not tied to local customers.  

With inflation at 141% of 1997, the Dallas price of 125% is 16 percentage points below inflation.  For Los Angeles prices to return to 64% above Dallas prices would have to fall to $300,000 from $875,000 in 2006. It now averages $517,000.  Given the damage to the Los Angeles economy, prices may actually have to fall below $300,000.  So if the programs to stop declining house prices had succeeded, Los Angeles long term job losses outside housing would have been disastrous.

When purchasing real estate or mortgage backed securities it is critical to understand were prices are going to end up.  Forecasts biased on a knowledge of housing cycles are drastically more accurate than other approaches  

Larger FHA Deficit


The attraction of the housing fix is that GDP will surge and jobs will come back so why not ignore the off budget costs and try?  The problem is not that Los Angeles prices are falling.  The problem is that they were not allowed to fall to a sustainable level.  Buyers who took advantage of the $8000 tax credit and 3.5% down FHA financing to buy a house in Los Angeles are already underwater.  Joseph Gyourko estimates that the FHA’s one trillion fund which HUD projects with a positive balance is $50 to $100 billion negative.  Case Shiller declines projected in the analysis will increase this loss significantly.  

The result of this expensive experiment proves that propping up unsustainable house prices in volatile cities is impossible.  The least painful solution is for the prices to come down to a sustainable level to minimize the loss of jobs in overpriced cities.