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  Working with seasonally adjusted data brings up unexpected problems and unpublished adjustments, but as this example demonstrates, without understanding monthly data, it is impossible to understand price trends.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.