Tuesday, April 30, 2013

Lower mortgage rates continue to drive house prices higher




The Case Shiller index grew at 1.2% in February - an annual rate of 14%. As the Fed pushed mortgage rates lower, the FHA loan limits, which were cut to fight the housing crisis, were scheduled to be raised.  Buyers and sellers rushed to close while financing was available at the higher limit, lowering prices.  Lobbying by real estate interests not only succeeded in reinstating the higher limits but also increased them in lower priced regions.  Prices rose in reaction to the easier financing reaching a peak of 1.1% in April 2012. Then growth tapered off 0.3% as the impact of the lower limits wore off.  But by then, housing was viewed favorably so lower mortgage rates now drove prices.  

The mortgage rate correlates at 70%. It would a better fit were it not for the run up in price from April to June of 2012 in reaction to the FHA limit increase.
The effect of the lower mortgage rates differs sharply by city (Metropolitan Statistical Area, MSA) as can be seen in the follow table.   Los Angeles grew from beginning of the expansion in 1997 until 2006 at an inflation adjusted growth of 282%.  The real price is now at 169%. The price decline from the peak in June of 2006 until the house purchase credit and lower FHA limits in May 2009 reporting correlates with the gain from the start of the bubble in 1997 to 2006, income growth, and city size at 92%.  


The Subtotals are cities that change in similar patterns throughout the cycle. They are summarized below:
  • ·       Prices in the three California cities increased to 266% and it is currently at 161% above start of the bubble.  Prices fell 5% in 2012 but rebounded 13%. Growth in the first two months of 2013 was 21% annualized. 
  • ·       The Resort cities lack of income growth caused them to drop quickly to a sustainable level until the current low mortgage rate raised them in 2012.
  • ·       The depressed cities were overvalued but slowly contracting until 2012.
  • ·       The recovered cities grew rapidly last year but from a low base.  Phoenix grew 23% last year but it is still only 107% of the level at the start of the bubble.
  • ·       The stable cities barely saw a bubble. Denver grew rapidly because it was depressed at the start of the bubble.  Prices in Dallas barely moved. 
Growth in the Case Shiller Cities could have peaked. California growth was flat in the last 3 months, but this was offset by higher growth in the depressed cities. It is very possible that Case Shiller growth will be less than the 14% annual rate in the first two months. National annual growth is 8%.
The Bulk of the nation’s housing is outside the area covered by the Case Shiller Index. It is the least effected by the Fed’s low rates and it is 84% of pre bubbles levels. The California cities have an average price of $626,000 -268 % above the national average.  They also grew more rapidly in 2009 with the house purchase credit.  So the prices of the markets that are above the average price receive the greatest increase from government programs to help housing. Outside the Case Sheller 20 City markets, which includes major metropolitan but is more rural, prices are one fifth of the California cities. While the California cities grew at 21% those in the areas not covered by the Case Shiller index grew at 3%.  The inventory shortage that is widely discussed is concentrated in California. The bulk of US housing is in markets with a large supply of housing.
Markets such as California are no longer competitive with other parts of the county, so business is slowly moving to lower cost areas.  California income growth is low and unemployment is high.  As investors swarm in they look at house prices at the low point and it looks attractive.  Long term, these prices are not sustainable.  Bidding up house price will lead to future long slow decline.
Tighter credit standards are nice but as price levels drop strategic defaults will rise as prices correct.  While housing is now a positive contributor to GDP, the goals of prosperity from reflating housing are not achievable. Housing is not the great investment it looked like in the boom years so consumers will want less of it. Simpler homes and less elaborate remodeling.   
Housing wealth the California and depressed cities in orange is $2.4 trillion above where it would be if the prices had grown with inflation. This number will grow as a result of low interest rates. These cities are 61% of the index and are 150% above the real price at the start of the bubble. The remaining 13 cities are 96% of the pre bubble price. The government action to correct housing resulted in a two tiered market. The sooner the Mortgage rates return to a sustainable level the less future pain in housing and lower the losses on the government guaranteed mortgages. 

Monday, April 15, 2013

How the Fed Accidentally restarted the housing bubble




To meet its unemployment goal, the Fed pushed mortgage rates lower in 2011.  At the same time, the FHA loan limits, which were lowered to fight the housing crisis, were scheduled to be raised in October 2011.  Buyers and sellers rushed to close while financing was available at the higher limit, lowering prices.  Lobbying by real estate interests not only succeeded in reinstating the higher limits but also increased them in lower priced regions in November.  Prices rose in reaction to the easier financing and then grew at a lower rate as its effects wore off.  This was compounded by the data reporting lag.  House price data is published five months after they are negotiated.  Data evaluable in April is from November negotiations.  However most analysts do not rely on monthly data because of Case Shiller’s quirks, they use year over year numbers, producing minimal understanding of what causes price changes. The graph below compares the monthly price changes to the mortgage rates.

Increases in January 2012 reported data raised price expectations and housing securities valuations. Mortgage rates correlate with price increases at 80%.  However, excluding the peak price increase months of April to June raises the correlation to 88%.  As the effects of the higher limits fell in July the mortgage rates began to drive the price increases. The price increases also correlate with the Fannie May price expectations survey at 60%.  In the past, lowering mortgage rates did not produce this result. The FHA change was the trigger that made lower mortgage rates more powerful. 
 Some economists pointed to housing inventory shortages, but the Inventory data has been known for months. If the standard of a bubble is prices that are not driven by housing fundamentals then this is a bubble.  Having forecast housing in the building products industry for 20 years, I know housing fundamentals only drive slow price movements.  House prices rise for years and then slowly correct to where the cycle started adjusted for inflation plus changes in consumer value for housing, demographics, and regional competitiveness. These factors are dominant but slow moving. Housing cycles are predictable. For example the price decline from the peak in June of 2006 until the house purchase credit and lower FHA limits in May 2009 reporting correlates with the gain from the start of the bubble in 1997 to 2006, income growth, and city size at 92%.
The Following Table illustrates the House price trends since the start of the bubble.
The Subtotals are cities that change in similar patterns throughout the cycle of expansion and contraction. Prices in the three California cities increased to 337% at the peak. In current dollars it rose to 266% and it is currently at 158% above start of the bubble.  Prices fell 6% in 2012 but rebounded 13%.  These cities also grew more rapidly in 2009 with the house purchase credit.  The Resort cities lack of income growth caused them to drop quickly to a sustainable level until the current low mortgage rate raised them in 2012.
The depressed cities were overvalued but slowly contracting until 2012. The recovered cities grew rapidly last year but from a low base.  Phoenix grew 23% last year but it is still only 105% of the level at the start of the bubble. The stable cities barely saw a bubble. Denver grew rapidly because it was depressed at the start of the bubble.  Prices in Dallas barely moved.  The Bulk of the nation’s housing is outside the area covered by the Case Shiller. It is the least effected by the Fed’s low rates and it is 84% of pre bubbles levels.
Markets such as California are no longer competitive with other parts of the county leading business to slowly move to lower cost areas.  The average house price in these California cites is $600,000. Income growth is low and unemployment is high.  As investors swarm in they look at prices at the low point and it looks attractive.  Long term these prices are not sustainable.  Bidding up house price will lead to future painful declines.
Other areas are also growing faster than is sustainable.  Tighter credit standards are nice but as price levels drop strategic defaults will rise as prices correct.  While housing is now a positive contributor to GDP, the goals of prosperity from reflating housing are not achievable. Housing is not the great investment it looked like in the boom years so consumers will want less of it. Simpler homes and less elaborate remodeling.    
Housing wealth the California and depressed cities in orange is $2.3 trillion above where it would be if the prices had grown with inflation. This number will grow as a result of low interest rates. These cities are 61% of the index and are 148% above the real price at the start of the bubble. The remaining 13 cities are 95% of the pre bubble price. The government action to correct housing resulted in a two tiered market. The sooner the Mortgage rates return to a sustainable level the less future pain in housing and losses on the government guaranteed  mortgages which will increase the budget deficits.

Tuesday, April 2, 2013

What is really going to happen to house prices?

Nick Timiraos, of The Wall Street Journal,[i] surveyed economists from Morgan Stanley, Bank America, and the National Association of Realtors who, in response to the 8.1% annual increase in the Case Shiller index, raised their forecasts for 2013 home price growth to 7.3% - a one month jump of 60%.  So why the surprise jump in forecasts?  A year and a half ago prices were falling and more people expected that they would continue to fall than increase.  
Prices released in the last week of March for January were negotiated in November. The five month reporting lag is enough to forget what happened when the prices were negotiated. This is compounded by the quirks in the Case Index that lead forecasters to work with annual changes rather than monthly results.  The trigger for the market change was FHA loan limit.  These were raised when the bubble burst and returned to the normal levels in October 2011.  Buyers and sellers rushed to close while financing was available at the higher limit, lowering prices.  Lobbying by real estate interests not only succeeded in reinstating the higher limit but also increased it in lower priced regions in November.  Prices rose in reaction to the easier financing and then dropped off as usual but by then attitudes toward the housing market shifted so prices continue to rise. This is illustrated in the comparison the following chart:

 


Source: Case Shiller: Fannie Mae Monthly national Housing Survey The survey was lagged two months to match up to the month the prices were negotiated.  

Economists pointed to inventory shortages, but the Inventory data has been known for months.  The forecasts are pushed up solely because prices are going up. Sir Isaac Newton on getting singed in an eighteenth century bubble commented: “I can calculate the motion of heavenly bodies, but not the madness of people.”  The latest month in the index grew at an annual rate of 15%.  The survey covers three months for which prices have yet to be reported.  Price expectations are continuing to soar so more forecast jumps can be expected.   Regressing the purchase sentiment would produce a high price growth number but it would not be accurate because the regional markets are too dissimilar.  However the magic of computer data bases makes it possible to produce a reliable estimate price growth in a couple of months. 
Timiraos reports that “economists see few signs of a bubble because credit standards remain conservative.  Even in markets that have large gains are still in line with their long term relationship with rents and income.”  If the standard of a bubble is prices that are not driven by housing fundamentals then this is a bubble.  Having forecast housing in the building products industry for 20 years I know this is not driven by housing fundamentals.  House prices rise for years and then slowly correct to where the cycle started adjusted for inflation and competitiveness regional competitiveness. The Following Chart illustrates the House price trends since the start of the bubble. The Case Shiller cites are unrepresentative of that National number represented by the FHFA index which has a similar methodology.  (Case Shiller has a national number but it is national all urban and it is meaningless.) The regions outside the Case Shiller cities called Heartland did not grow rapidly in the bubble and are valued at 80% of the inflation adjusted prices at the start of the bubble.  
   

The Case Shiller cities respond to FHA loan limits and house Price credits.  These actions have stopped the correction before urban prices bottomed out and are inflating prices in overpriced regions.
Price growth in most markets is not problem because inflation adjusted prices are below the level at the beginning of the bubble.  In Markets such as California where prices are off the chart a peak price of 266% to the current level 160% above start of the bubble, the economy is no longer competitive with other parts of the county.  Income growth is low and unemployment is high.  As investors swarm in they look at prices at the low point and it looks attractive.  Long term these prices are not sustainable.  Bidding up house price will lead to future painful declines.  Tighter credit standards are nice but as price levels drop strategic defaults will rise.
Federal Reserve Governor Jeremy Stein commented in February on incentives to take on excessive credit risk.[ii]  He stated: “the underlying economic environment creates a strong incentive for financial institutions to, say, take on more credit risk in a reach for yield, it is unlikely that regulatory tools can completely contain this behavior.  While monetary policy may not be quite the right tool for the job… it gets in all of the cracks… Changes in rates may reach into corners of the market that supervision and regulation cannot.”  This is one such a case.  The spurt for more favorable loan limits started the surge in prices but what drive prices now are low mortgage rates. Stein expects an increase in rates in 18 months. Which will be very damaging to the high priced markets?
There are markets that will be very profitable and others that look good, but are disastrous. Real estate remains a matter of location, location and timing


[i] Timiraos, Nick Home Prices Rise at Fastest Pace over Six Years  The Wall Street Journal march 27,2013 page A 14

[ii] Governor Jeremy C. Stein At the "Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter" research symposium sponsored by the Federal Reserve Bank of St. Louis, St. Louis, Missouri
February 7, 2013