johnnymk

That Hissing Sound
By PAUL KRUGMAN NY Times
Published: August 8, 2005

This is the way the bubble ends: not with a pop, but with a hiss.

Housing prices move much more slowly than stock prices. There are no Black Mondays, when prices fall 23 percent in a day. In fact, prices often keep rising for a while even after a housing boom goes bust.

So the news that the U.S. housing bubble is over won't come in the form of plunging prices; it will come in the form of falling sales and rising inventory, as sellers try to get prices that buyers are no longer willing to pay. And the process may already have started.

Of course, some people still deny that there's a housing bubble. Let me explain how we know that they're wrong.

One piece of evidence is the sense of frenzy about real estate, which irresistibly brings to mind the stock frenzy of 1999. Even some of the players are the same. The authors of the 1999 best seller "Dow 36,000" are now among the most vocal proponents of the view that there is no housing bubble.

Then there are the numbers. Many bubble deniers point to average prices for the country as a whole, which look worrisome but not totally crazy. When it comes to housing, however, the United States is really two countries, Flatland and the Zoned Zone.

In Flatland, which occupies the middle of the country, it's easy to build houses. When the demand for houses rises, Flatland metropolitan areas, which don't really have traditional downtowns, just sprawl some more. As a result, housing prices are basically determined by the cost of construction. In Flatland, a housing bubble can't even get started.

But in the Zoned Zone, which lies along the coasts, a combination of high population density and land-use restrictions - hence "zoned" - makes it hard to build new houses. So when people become willing to spend more on houses, say because of a fall in mortgage rates, some houses get built, but the prices of existing houses also go up. And if people think that prices will continue to rise, they become willing to spend even more, driving prices still higher, and so on. In other words, the Zoned Zone is prone to housing bubbles.

And Zoned Zone housing prices, which have risen much faster than the national average, clearly point to a bubble.

In the nation as a whole, housing prices rose about 50 percent between the first quarter of 2000 and the first quarter of 2005. But that average blends results from Flatland metropolitan areas like Houston and Atlanta, where prices rose 26 and 29 percent respectively, with results from Zoned Zone areas like New York, Miami and San Diego, where prices rose 77, 96 and 118 percent.

Nobody would pay San Diego prices without believing that prices will continue to rise. Rents rose much more slowly than prices: the Bureau of Labor Statistics index of "owners' equivalent rent" rose only 27 percent from late 1999 to late 2004. Business Week reports that by 2004 the cost of renting a house in San Diego was only 40 percent of the cost of owning a similar house - even taking into account low interest rates on mortgages. So it makes sense to buy in San Diego only if you believe that prices will keep rising rapidly, generating big capital gains. That's pretty much the definition of a bubble.

Bubbles end when people stop believing that big capital gains are a sure thing. That's what happened in San Diego at the end of its last housing bubble: after a rapid rise, house prices peaked in 1990. Soon there was a glut of houses on the market, and prices began falling. By 1996, they had declined about 25 percent after adjusting for inflation.

And that's what's happening in San Diego right now, after a rise in house prices that dwarfs the boom of the 1980's. The number of single-family houses and condos on the market has doubled over the past year. "Homes that a year or two ago sold virtually overnight - in many cases triggering bidding wars - are on the market for weeks," reports The Los Angeles Times. The same thing is happening in other formerly hot markets.

Meanwhile, the U.S. economy has become deeply dependent on the housing bubble. The economic recovery since 2001 has been disappointing in many ways, but it wouldn't have happened at all without soaring spending on residential construction, plus a surge in consumer spending largely based on mortgage refinancing. Did I mention that the personal savings rate has fallen to zero?

Now we're starting to hear a hissing sound, as the air begins to leak out of the bubble. And everyone - not just those who own Zoned Zone real estate - should be worried.

__________________
“Socialism is a philosophy of failure, the creed of ignorance, and the gospel of envy, its inherent virtue is the equal sharing of misery.” (Winston Churchill)

Grimm

I don't think it's a bubble, it's a peak for sure, but if it doesn't pop, it wasn't a bubble.

Dave_7

A plateau.



Dave.

brainsmile

more like a plateau ... I don't think it's popping so much as fizzing

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DCM #1 (Founder)





"Nobody beats Vitus Gerulaitis 18 times in a row." - Vitus Gerulaitis on beating Jimmy Connors after 17 failed attempts.

LegendKiller

There are several things that can make a difference in regards to the housing bubble.


1. Personal income raising

2. Personal debt status

3. Cost of living

4. Degree of leverage on the house

5. Appreciation of the house


Now, from all indications personal income is raising *SLOWER* than personal debt and cost of living. Furthermore, people have leveraged their houses to a greater degree, hoping to flip it after two or so years.

ARMs and IO loans add to this since they depend soley on the owner selling before the ARM unlocks or the P kicks in. It also means that the owners have to sell their houses for *MORE* than they paid for in order to make the house worth the interest paid, since they have saved up little or no additional equity.

IO loans are fast becoming a huge portion of loans made. People are also buying houses they cannot truly afford, borrowing more in personal debt than ever before. If this trend continues they will leverage themselves out of their house.

Even if housing prices plateau, you will see the bubble burst in many areas because of the IO and ARM situation combined with personal debt and rampant consumerism.

I am extremely bearish on housing right now. I see all of the apartments going condo, something which Fitch Ratings (could have been S&P or Moody's) have said that 30% of apartment turned condo places will go bankrupt within the next 5 years.

If that is true, then 30% of new condo apartments will lose much of the infrastructure keeping their places going, who knows whether the HOAs will be able to keep the place nice.

It is an extremely bad time to invest in a place in the north. If the boomers head south then prices will decrease even more.

Now, there is another problem. Places like FL, LA, and TX are also in for a worse hurricane season. National Geographic had an article this month regarding hurricanes. According to their data the number of hurricanes has tripled in the last 10 years compared to the previous 10 years. This cycle is predicted to continue for another TWENTY YEARS. Especially as ocean temps rise like they have been doing.

The effects of this is already being felt in Florida since two major home insurance carriers have left the market. The value-at risk of FL is more than 5x as much as it was the last major hurricane cycle (1940-1950 era).

This introduces insurance issues. As more companies flee FL it will be much harder to insure here and more expensive. Eventually people will have to skip insurance, opening themselves up to investment and housing risk.

Old people will not want to go into that situation.

Markets in AZ and other western areas will become inflated as more boomers try to get in there, further inflating. Then we will see boomers paying more and spending less.

This comes at a critical point. The economy is going to need the drive of the oldsters in their "spending" phase of the classical financial cycle. They are supposed to be worrying about doting over children, not paying a mortgage.

This would be a big benefit to younger people in the northern areas, except they have already been burned as their prices fell drastically as a glut of houses from fleeing oldsters has dropped prices. They have defaulted on loans already and won't be able to get cheap mortgages.

Bankruptcies are already on the rise in anticipation of the new law going into effect this fall. My company has seem then rise steadily as more people try to wipe the slate clean before they cannot. This doesn't bode well for people in the future as they will not have a clean slate.

Now, of course, this could be a doomsday scenario. However, I doubt it. We will see something close to this, probably something a little less drastic but bad nonetheless.

I won't be buying a place in the next 5 years, no matter where I live.

sunrisetech

LegendKiller, those are all excellent points. In the region where I live, San Diego, I believe that there will be a plateau and a drop off in housing prices. The prices for homes have risen here steeply in the last few years. And now with all the interest only loans...I believe it's only a matter of time before the housing market here takes a downturn.

After the plunge here (that to me is bound to happen) I hope to take advantage of the market at that time.

johnnymk

I get some feedback on the pulse of Florida from my sister who currently lives in Spring Hill and my close friend who moved to Port Charlotte several years ago. Both have witnessed dramatic price rises in homes in their neighborhoods in just the past two years.

Both of them were trying to influence me to move there because of the low cost of housing, taxes and insurance. However, they no longer recommend Florida for those reasons. I don't like hot weather so it was an easy decision for me not to even consider it.

As to boomers retiring and moving there: what if existing pensions gradually or suddenly were reduced because companies could no longer afford to support them? It's happening in the airline sector and could possibly happen in the automotive manufacturing sector as well. The Federally backed Pension Guarantee Corp. is practically maxxed out, and I doubt will be able to support any additional companies which could renege on their promised payouts.

What would that do to areas like Florida which has little industry and people who depend on pensions and/or investment income? I can't even envision the fallout if this were to occur on a large scale. But I can imagine that the real estate market there could collapse if it happens. That's also a doomday scenario which I hope won't occur.

Merlin

You forgot the most important of all - employment. As long as most people have a job they'll pay their mortgage. Yes, there will be problems as they need to start refinancing them but they'll get through. But if the economic cycle turns down and people start losing their jobs...that would prompt a bursting of the market.

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InfiniteNothing

Unless a good number of those employed are self employed in buying/selling houses.

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As for our common defense, we reject as false the choice between our safety and our ideals.

JackHammer

I hope that bad boy pops. I think we should all focus on San Diego. If San Diego goes, so goes the nation.

__________________
"I'm very sorry for your loss. Your mother was a terribly attractive woman."
-Royal Tenebaum


"Oh yeah. Oh yeah. I would do everything to her, I don't care what she looks like. I would wreck that chick."
-Brian from the Family Guy after Peter asked him whether he would have sex with Lois.

LegendKiller

I was watching cnnfn a few mornings ago and they were discussing CA markets starting to show weakness. LA absorbtion rates is starting to go down, which is alarming since LA is the 3rd most high priced market in the country (behind SD and SF).

Also, they made the point to say that many people think real estate doesn't go down. However, in 1991 period LA/SD/SF prices dropped anywhere from 20-100% and didn't recover until the tech boom. The economy wasn't in such a fuzzy state then as it is now and personal debt wasn't nearly as high, nor was exotic mortgages and speculation.

Cubsfan

How the does a house drop 100% in value? Float out into the ocean?

mcs328

I wonder the same thing....is it the purchase price that you start from? So you buy at 100K. It's worth 200K which is a 100% increase. However if it were to go down by 100K you now have a 50% decrease from the 200K but 100% decrease from the original 100K.

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LegendKiller

Sorry, that shoulda been 50%

mcs328

Well I've seen a 100% decrease quoted in other news stories too so I thought you would know how that could be calculated.

LegendKiller

It is pretty much impossible to have a 100% decrease, that means that it is worthless.

200-100 = 100/200 = 50% decrease

100+100 = 100/100 = 100% increase

LK+no sleep = 200/200 = 100% decrease in brain power

LK = math challenged yesterday.

Butch

Interesting article from the NY Times about the use of homes as investment vehicles . . .

http://www.nytimes.com/2005/08/19/re...te/19real.html

August 19, 2005
In the Long Run, Sleep at Home and Invest in the Stock Market
By MOTOKO RICH and DAVID LEONHARDT
The housing boom of the last five years has made many homeowners feel like very, very smart investors.

As the value of real estate has skyrocketed, owners have become enamored of the wealth their homes are creating, with many concluding that real estate is now a safer and better investment than stocks. It turns out, though, that the last five years - when homes in some hot markets like Manhattan and Las Vegas have outperformed stocks - has been a highly unusual period.

In fact, by a wide margin over time, stock prices have risen more quickly than home values, even on the East and West Coasts, where home values have appreciated most.

When Marti and Ray Jacobs sold the five-bedroom colonial house in Harrington Park, N.J., where they had lived since 1970, they made what looked like a typically impressive profit. They had paid $110,000 to have the house built and sold it in July for $900,000.

But the truth is that much of the gain came from simple price inflation, the same force that has made a gallon of milk more expensive today than it was three decades ago. The Jacobses also invested tens of thousands of dollars in a new master bathroom, with marble floors, a Jacuzzi bathtub and vanity cabinets.

Add it all up, and they ended up making an inflation-adjusted profit of less than 10 percent over the 35 years.

That return does not come close to the gains of the stock market over the same period. The Standard & Poor's 500-stock index has increased almost 200 percent since 1970, even after accounting for inflation.

Yet investment advisers worry that this reality is getting lost in today's enthusiasm for houses, even as some economists say the housing market has peaked. People are buying homes purely on speculation, trading real estate almost as if it were a stock. Surveys show that a large majority of Americans consider real estate to be a safer investment than stocks.

"With how strong the real estate market has performed, there is the urge for people to chase returns," said Jeff A. Weiand, executive vice president of RTD Financial Advisors in Philadelphia. "But it's very difficult to beat the long-term historical record of stocks."

Since 1980, for example, money invested in the Standard & Poor's 500 has delivered a return of 10 percent a year on average. Including dividends, the return on the S.& P. 500 rises to 12 percent a year. Even in New York and San Francisco, homes have risen in value only about 7 percent a year over the same span.

That does not mean real estate is a bad investment. It is often an important source of wealth for families. But its main benefit is what it has always been: you can live in the house you own.

"The biggest value of the house is the shelter it provides," said Thomas Z. Lys, an accounting professor at the Kellogg School of Management at Northwestern University. "Too many people are fixated on speculation whereas most of the benefit really comes from usage."

Despite the fact that home values usually appreciate over time, most of the value of a house actually comes from the ability to use it. In this way, it is more like a car, albeit one that does not become less valuable over time, than it is like a stock. Whenever people sell one house, they must immediately pay to live elsewhere, meaning that they can never wholly cash out of a home's value.

Including the value of living in a house - that is, the rent that a family would have to pay to live in an equivalent house elsewhere - homes in New York have returned more than 15 percent a year since 1980, according to an analysis by Mr. Lys.

But only five percentage points of this return comes from sheer price appreciation, as opposed to the value of shelter. Mr. Lys accounted for property taxes, spending on renovations, interest payments and the tax deductions on those payments, and the fact that most house purchases are made with mortgages.

When the sale of a house brings in a cash windfall, homeowners tend to focus on the fact that they made a down payment that was just a fraction of their house's value, lifting their return. But many forget just how much money they spent on property taxes, a new roof and the mortgage interest.

Add to all these factors the corrosive effect of inflation, and the returns are even lower.

The Jacobses - she is an administrator for a magazine and he a lawyer - were quite pleased with the sale of their house in New Jersey. To them, it was a place to raise their two children more than it was an investment.

When the couple spent about $100,000 to redo their master bathroom, install a walk-in closet and build a deck in the mid-1980's, Mr. Jacobs recalled saying to his wife, "We'll never get the money out that we put into this, but at least we'll enjoy it for 15 years or so."

Told of the comparative returns on his house and the stock market, Mr. Jacobs said, "Of course I couldn't live in the portfolio."

Today, however, he has come to see the advantages of the stock market. The Jacobses now rent an apartment on the Upper West Side for more than $4,000 a month and have invested the proceeds from the house sale in the stock market, making it easier for them to raise cash by selling shares.

"I didn't want to take the money that we pulled out of the house and have all that money tied up in an apartment where I still have expenses of maintenance fees," Mr. Jacobs said.

But many people seem to be going in the opposite direction from the Jacobses. Eighty percent of Americans deemed real estate a safer investment than stocks in an NBC News/Wall Street Journal poll done this spring, while only 13 percent said stocks were safer.

Part of that sentiment is driven by the recent memory of the stock market collapse in 2000. Many homeowners seem to have forgotten that less than 15 years ago house prices in the Northeast and California fell, but the money they lost on technology stocks is still fresh in their minds.

Stocks are also more volatile, and their price changes can be viewed every day. "The news doesn't report to you daily that your house price might have gone up or down," Mr. Lys said. "So you think your house price is more stable than it really is because you don't observe these minute-by-minute gyrations."

Economists caution that any comparison between real estate and stocks is tricky, because real estate is typically a leveraged investment, in which a home buyer makes a down payment equal to only a fraction of a house's value and borrows to finance the rest. While it is possible to borrow money from a brokerage firm to buy stocks, most individual investors simply buy the shares outright.

When home prices are rising, the leverage from a mortgage lifts real estate returns in the short term. Someone putting down $100,000 to buy a $500,000 home can feel as if the investment doubled when told that the house is now worth $600,000.

But the power of leverage vanishes as homeowners pay off the mortgage, as the Jacobses have. Leverage also creates more short-term risk, especially for those who have stretched to afford their house.

"If the home went down by 30 percent, you'd probably be sitting with a bankruptcy attorney," said Jonathan Golub, United States equity strategist at J. P. Morgan Asset Management in New York. "If your I.B.M. stock goes down by 30 percent, no big deal. So you had $100,000, now you have $70,000. You don't declare bankruptcy; you just don't go out to the movies as much, or you retire a year later."

But such risks are hard to imagine when many markets are still enjoying double-digit percentage increases every year. The number of people buying houses they do not plan to live in has surged. There are also Internet exchanges where investors can trade yet-to-be-built condominiums or futures contracts tied to average home prices in big metropolitan areas.

But economists and investment advisers say that most of the value from real estate comes not from anything that can be captured by flipping it, but from the safety net it provides in bad times. Even if the market shifts downward, "you have a roof over your head," said Jonathan Miller, a real estate appraiser in Manhattan.

Beyond the shelter it provides, the biggest advantage of real estate might be that it protects people from their worst investment instincts. Most people do not sell their house out of frustration after a few months of declining values, as they might with a stock. Instead, they are almost forced to be long-run investors who do not try to time the market.

Harlan Larson, a retired manager of car dealerships near Minneapolis, still regrets having bought Northwest Airlines stock at $25 a share a few years ago. It is now trading at less than $5.

By comparison, he views the four-bedroom home he bought for $32,500 in 1965 - or about $200,000 in today's dollars - as a money tree. He and his wife recently listed it for $413,000. That would translate into an annual return of 1.2 percent, taking into account inflation and the cost of two new decks and an extra room.

They plan to move to Texas after it has sold. "I wish I'd bought more real estate," Mr. Larson said.

__________________
I used to be into sadism, necrophilia and beastiality, but then I realized I was just beating a dead horse

Kevster

What caused the downturn in the LA housing market in 1991 was a multi-pronged attack from:

1. Northridge Earthquake
2. The huge local economic impact of the early 90's recession and aerospace relocations/layoffs in Southern California
3. The flight of businesses (and jobs) from Los Angeles thanks to city and county taxation and beneral anti-business attitude that did not change until Richard Riordan came into office as Mayor.

Edit: Unless we have another massive earthquake and another local recession that drives many people away from Los Angeles, the demand is not going to go down necessarily. Los Angeles has had a lingering supply problem and people keep moving here every day (damnit!). The market will likely simmer and stagnate, but I'm not sure how much it could go down like it did in 1991 without some major event(s) happening in conjunction.

__________________
I think over again
My small adventures, my fears.
The small ones that seemed so big,
For all the vital things I had to get and to reach.

And yet there is only one great thing, the only thing:

To live to see the great day that dawns,
And the light that fills the world.

-old Inuit song

zippyjuan

Profits on your own home are an illusion. Yes the neighbors may sell their house for a lot more than you paid, but unless you sell and move to a different area where housing is cheaper, you will spend the extra apreciation in a higher price replacement home. Now you have higher property tax and loan payments than you did berfore. In San Diego you cannot make money by buying a unit and renting it out- rents are lower than what payments would be. The only way you can make money is to buy one in addition to the one you live in and waiting for it to go up in price and then selling it. The best investment in real estate is to have it all paid off when you retire so you do not have to make any mortgage payments at a time when you are on a reduced and fixed income.

__________________
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johnnymk

'Irrational' Housing Exuberance? Greenspan Confidant Thinks So



What does the economics professor who has the ear of Alan Greenspan have to say about bubbles?

He's worried about them - and if history is any indication, homeowners and investors would do well to pay attention.

Robert J. Shiller - the Yale economics professor who fed Greenspan the famous quote in 1996 about the stock market and "irrational exuberance" - is at it again.

This time he has the housing market in his sights.

A recent New York Times profile of Shiller says the author of the best-selling book "Irrational Exuberance" is sounding the same clarion call on housing that he did for stocks nine years ago.

Shiller is predicting that housing prices could fall 40% in inflation-adjusted terms over the next 20 years and that the decline in housing prices will trigger a severe recession during that time span.

"This is the biggest boom we've ever had," said Mr. Shiller, who bought into the boom himself in 2002, when he purchased a vacation home near one of Connecticut's Thimble Islands.

"So a very plausible scenario is that home-price increases continue for a couple more years, and then we might have a recession and they continue down into negative territory and languish for a decade.

"It doesn't even attract that much attention," he continued. "There will be many people thinking it was a soft landing, even though prices may have gone down in real terms by 40%."

In a Recent FIR Interview Sir John Templeton First Warned Housing Prices Could Crash 50%. Find Out What He Said and Learn How to Protect Yourself and Even Profit from the Coming Storm - Go Here Now

While critics don't see it that way, Shiller argues that history is on his side.

With little hard data on real estate pricing trends that goes back farther than the 1970s, when economists began seriously tracking real estate numbers, Shiller created his own map of housing prices dating back to the 1800s, adding prices from foreign markets into the mix, as well.

The numbers, he reports, aren't promising.

In fact, every housing boom of the last few centuries has been followed by decades in which home values fell relative to inflation. Reaching back almost 200 years to the first Dutch row houses, Shiller says that housing cycles tend to crest and then dissipate every 25 years or so.

The end of that cycle is upon us now, he says. But real estate market observers don't see it that way.

They point to continued low interest rates and a growing population that needs housing. Those factors should continue to fuel higher housing prices - just not as high as the United States has seen over the past 20 years.

As for Shiller? Many say he's a wet blanket and self-promoter who can't see the forest for the trees.

"Shiller is predicting the mountain goes into the sea," Robert I. Toll, the chief executive of homebuilder Toll Brothers told the Times. "He's selling himself."

But Shiller shrugs off the critics.

He says that a downward spike in real estate prices would actually provide some strong, much-needed medicine to the U.S. economy. With lower housing prices, he argues, people would have more money to spend on technology, health care - even a night out on the town. Even better, it would get Americans to stop obsessing over the prices of their homes.

"It's very much like studying a disease epidemic. It's a contagion," Mr. Shiller said.

"When it goes in an up direction, it's very impressive. But it can also work in the down direction."

How far down? If the man who coined the term "irrational exuberance" is correct, we'll soon find out.

MikeD

Housing bubble or not, alot of folks have made alot of money. So if the market declines a bit, its no big loss...

You make $300k on a home, it depreciates and you "lose" $50k...you're still up $250. I'll take that.

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LegendKiller

Thats what Enron investors thought.

brainsmile

What you are forgetting is that many are speculators so if they are over leveraged it could get ugly. Those who live in their homes will be generally unaffected. Should help the rental market though.

LegendKiller

Until their ARMs unlock and their IOs turn into Ps, then their 1000/mo payment becomes 2k and they say "ohhh crap, how are we going to pay our uber credit card bills AND our uber mortgage AND our car?!?".

It isn't only speculators who are overleveraged.

ialsohaveadream

I know people who are jumping into interest-only loans just so they can get into a house, and it's only going to bite them in the ass when it comes time to inflate those monthly payments.

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Web log

brainsmile

Well even with rising rates most of the IO won't be affected for a little bit. So that effect will come... I agree LK but it will be delayed.

LegendKiller

According to the interest rate curve rates will increase over 100bps over the next year and a half, that is from what we have already seen which is up from before. Rates have stayed a bit steady as more cash flows into the lending market, but as soon as it dries up after the downturn rates will go up, probabably just in time for ARMS to unlock...oops.

MikeD

I understand your point, but I'm still not concerned. 30 years locked at 5.25%. We're up close to $250k, and don't have a problem making our payment. I don't see where I'm "in trouble"...

ialsohaveadream

To be fair, I don't think LK was referring to you. There are plenty of homeowners and speculators who have jumped into riskier lending schemes to try to turn a profit. Soon, the profit won't be there to make.

Nice rate, by the way.

MikeD

I guess I jumped the gun on this post.



Thanks...wifey is a mortgage broker.