Looking into Case Shiller Numbers

The following article was reprinted from Seeking Alpha…..
So what do I think about the western suburbs? The Case Shiller report didn’t tell us anything we didn’t already know. Tax credits expired, volume has fallen off considerably, but all in all Boston fared better than the rest of the country. Inventory is building, mid July there were approximately 185 homes for sale in Newton, today there are 238, an increase of just over 25%, while the high-end homes (priced above 2 million) were languishing during 2010, 11 homes are under contract or sold in the past 3 months. This is a simple supply and demand business, when inventory rises two things will happen, volume will decrease and prices will (should) drop. Seller capitulation usually happens too late in the game; the seller stuck on an arbitrary number will continue to follow the market rather than set the new market pricing. I do not see Newton, Brookline dipping much more, except on homes that have been on the market for 6 months; it was time to lower your price 4 months ago. Jobs, consumer confidence, and low mortgage rates will keep the market stable for the foreseeable future. I look forward to realistic sellers pricing their properties appropriately, buyers who realize the value and seize the opportunity to purchase their next home.

By Dirk van Dijk

In July, home prices started to slip again, but unevenly across the country. The Case-Shiller Composite 10 City index (C-10) rose 0.03% on a seasonally adjusted basis, and is up 4.01% from a year ago. The broader Composite 20 City index (which includes the cities in the C-10) fell by 0.13% on the month and is up 3.13% from a year ago.

In June, the year-over-year gains were 5.02% for the C-10 and 4.22% for the C-20, so it looks like the year-over-year gains are rolling over. Of the 20 cities, only four posted gains on the month, while 16 saw prices fall. Year-over-year, 10 metro areas saw gains and 10 suffered losses. In June, 15 were up year over year and 5 were down.

There is a seasonal pattern to home prices, and thus it is better to look at the seasonally adjusted numbers than the unadjusted numbers. Most of the press makes the mistake of focusing on the unadjusted numbers. While the 4.01% rise in the C-20 is good news, it hardly makes up for the damage that was done in the popping of the housing bubble, and it is also unlikely to last.

From the April 2006 peak of the housing market, the C-10 is down 29.05% while the C-20 is off by 28.55%. The Case-Shiller data is the gold standard for housing price information, but it comes with a very significant lag. This is July data we are talking about, after all, and it is actually a three month moving average, so it still includes data from May and June.

In July, existing home sales fell off a cliff (and posted a very anemic rebound in August, see “Used Homes Rebound Slightly”) after the homebuyer tax credit expired. In the process, the inventory-to-sales ratio shot up to 12.5 months, an all-time record high, before falling to 11.6 months in August.

That is still higher than at any point during the implosion of housing prices that took place in 2007 or 2008. Housing prices are going to fall again in coming months.

Numbers by City – Best and Worst

There were only four cities that saw prices rise on a seasonally adjusted basis, but fortunately they were fairly big cities. New York posted the largest gain with a 0.96% raise, followed by Washington DC with a 0.58% rise. The other two winners on the month were Chicago, up 0.10%, and Boston, up 0.03%.
The cities faring the worst on the month are an interesting group since many were among the worst hit early on, but which have started to rebound over the last year. It looks like that rebound might be running out of steam. Others have been seemingly perpetually on the list of hard-hit cities. Worst hit was Phoenix, where prices fell 1.66% on the month followed by Las Vegas, off another 1.44%. Tampa was down 1.40% while the Twin Cities (Minneapolis/St. Paul) fell 1.21%.

On a year-over-year basis, the strongest cities are in California, which was an early poster child for the housing bust. San Francisco leads the way with a 11.06% rise, followed by San Diego, up 9.26%. LA completes the Golden State sweep with a 7.50% year-over-year increase. DC was up 6.51% and the Twin Cities were up 6.28%. Phoenix also is one of the biggest year-over-year gainers with a 3.40% increase, despite being the biggest month-to-month loser.

On the downside, Las Vegas continues to roll snake eyes for those that gamble on its housing market, down 4.82% over the last year. At the other end of the spectrum is Charlotte, NC, which early on in the bust seemed immune from the national trend. It is down 3.49% over the last year. Tampa is more in the Las Vegas camp, down hard early and still falling, off 3.29% over the last year. Chicago is down 1.74%. Seattle was the only other city to see a decline of more than 1% in the last year, down 1.62%.

The graph below tracks the cumulative declines for each city over time. If the red bar is shorter to the downside than the yellow bar for a city, it indicates that prices in that city have risen since the start of this year. In every city prices are below where they were in April 2006, but there is a huge variation.

Las Vegas is the hardest hit, with prices down 57.20% from the peak, followed by Phoenix down 51.86%. At the other end of the spectrum are Dallas, where prices are down only 3.77% and Denver where they are down 8.89%. (Note: the percentage declines I am quoting are from when the national peak was hit; the numbers in the graph are relative to that city’s individual peak, so there is a little bit of difference.)

The homebuyer tax credit was propping up home prices, but now with that support gone, prices are resuming their downtrend. People had until June 30 to close on their houses, and they had to agree to the transaction by April 30. That pulled sales into those months that might otherwise have happened in July or August. The credit was up to $8,000, so almost nobody would want to close their deal in early July and simply leave that money on the table.

The tax credit is a textbook example of a third party subsidizing a transaction. When that happens, both the buyer and the seller will get some of the benefit. The buyer gets his when he files his tax return next year, the seller gets hers in the form of a higher price for the house. Since the tax credit is now over, that artificial prop to housing prices has been taken away.

Sales of existing houses simply collapsed in July, dropping 27.2% on the month. The extremely high ratio of homes for sale to the current selling pace is sure to put significant downward pressure on prices. There is still quite a bit of “shadow inventory” out there as well. That is, homes where the owner is extremely delinquent in his mortgage payments and unlikely ever to make up the difference, but that the bank has not yet foreclosed on or foreclosed houses that have not yet been listed for sale.

Take a good hard look at the second graph (also from Calculated Risk) and tell me what you think is going to happen to housing prices over the next few months. A normal market has about six months of supply available, during the bubble, the months of supply generally ran closer to four months, and prices were soaring.

It was not until inventories climbed above the six month mark that prices started to fall. They really collapsed as the months of supply moved into the double digits. The extensive government support for the housing market, including the tax credit, but also the Fed buying up $1.25 Trillion in mortgage paper to artificially depress mortgage rates helped boost sales and bring the months of supply back down. Now that support is over, and the months of supply far exceed the worst we saw during the heart of the bust (note: the graph is not updated to include the August data).

The tax credit was not a very effective means of stimulus, but it did help prop up prices, and that is a pretty important accomplishment, even if it proves to be ephemeral. The credit cost the government about $30 billion. A large part of that money went to people who would have bought anyway, but perhaps would have done so in July or August rather than May or June. To the extent it rewarded people for doing what they would have done anyway, it did nothing to stimulate the economy.

Also, turnover of existing houses really does not do a lot to improve the economy. It is the building of new houses that generates economic activity. It is not just about the profits of Lennar (LEN) or D.R. Horton (DHI). A used house being sold does not generate more sales of lumber by International Paper (IP) or any of the building products produced by Berkshire Hathaway (BRK.B). It does not put carpenters and roofers to work. New homes do.

The Downward Spiral

While housing prices are important to the economy, the level of turnover in used houses is not. Home equity is, or at least was, the most important store of wealth for the vast majority of families. Houses are generally a very leveraged asset, much more so than stocks. Using your full margin in the stock market still means you are putting 50% down. In housing, putting 20% down is considered conservative, and during the bubble was considered hopelessly old fashioned.

As a result, as housing prices declined, wealth declined by a lot more. For the most part, we are not talking vast fortunes here, but rather the sort of wealth that was going to finance the kids’ college educations and a comfortable retirement. With that wealth gone, people have to put away more of their income to rebuild their savings if they still want to be able to send the kids to college or to retire.

The decline in housing wealth is a very big reason why retail sales have been so weak. With everyone trying to save, aggregate demand from the private sector is way down. If customers are not going to spend and buy products, employers have no reason to invest to expand capacity. They have no reason to hire more workers.

Also, as housing prices fell, millions of homeowners found themselves owing more on their houses than the houses were worth. That greatly increases the risk of foreclosure. If the house is worth more than the mortgage, the rate of foreclosure should be zero. Regardless of how bad your cash flow situation is — due to job loss, divorce or health problems, for example — you would always be better off selling the house and getting something — even if it is less than you paid for the house — than letting the bank take it and get nothing.

By propping up the price of houses, the tax credit did help slow the increase in the rate of foreclosures. Still, 23% of all houses with mortgages are worth less than the value of the mortgage today. Another five percent or so are worth less than five percent more than the value of the mortgage. If prices start to fall again, those folks will be pushed under water as well.

On the other hand, it is not obvious that propping up the prices of an asset class is really something that the government should be doing. After all, it is hurting those who don’t have homes and would like to buy one. Support for housing goes far beyond just the tax credit. The biggest single support is the deductibility of mortgage interest from taxes.

Since homeowners are generally wealthier and have higher incomes than those that rent, this is a case of the lower middle class subsidizing the upper middle class. Also, even if they are homeowners, people with lower incomes are more likely to take the standard deduction rather than itemize their taxes. The mortgage interest deduction only applies if you itemize.

It is also worth keeping in mind in the current debate over extending the Bush tax cuts for just 97% of the population as Obama has proposed, or for 100% of the population as the GOP insists on, that the $250,000 per couple threshold is for adjusted gross income, not the top-line income. Thus, a couple with income of $274,000 (in wages) but who pay $2000 a month in mortgage interest, would not see an increase in their taxes at all. Also, it greatly favors the old, who bought their houses long ago, over the young who have yet to buy a house.

Prices Will Go Down

The real problem, though, is now that the tax credit is over, prices will find their more natural level. Fortunately relative to the level of incomes and to the level of rents, housing prices are now in line with their long-term historical averages, not way above them as they were last year.

In other words, houses are fairly priced, not exactly cheap by historical standards, but not way overvalued either. That will probably limit how much price fall over the next six months to a year to the 5 to 10% range, rather than the 30% decline we saw from the top of the bubble. That, however, is more than enough of a decline to do some serious damage.

The Case-Shiller report was more of less in line with expectations. The second leg down in housing prices is starting, but fortunately will probably be a much shorter leg than the first one.

Still, that is bad news for the economy. Used homes make very good substitutes for new homes, and with a massive glut of used homes on the market, there is little or no reason to build any new ones. Residential investment is normally the main locomotive that pulls the economy out of recessions. It is derailed this time around and there seems to be little the government can do to get it back on track.

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