Friday, November 23, 2007

Rational Expectations and the Housing Bubble

"More than 70% of U.S. consumers believe a national housing bubble will burst and home prices will collapse within the next year, although 56% believe it's unlikely to happen in the area where they live, according a new survey."




Morrissey, Janet. 2006. "Consumers Expect Housing Bubble to Burst." Wall Street Journal (20 April): p. D 3.

16 comments:

rosserjb@jmu.edu said...

Michael, I am a bit mystified by the point of this. Is the contradiction between what people say in general versus what they say about their local situation supposed to be evidence of problems with ratex?

BTW, folks, I continue to be unable to post due to bizarre technical difficulties that the managers and I have not been able to resolve. Somehow, when I go to post, I am told that my invitation to post has expired. However, when the managers go in to try to invite me again, they are told that I am already invited and are unable to do so. Anybody with any suggestions on this would be most welcome. Thanks.

Barkley

Michael Perelman said...

I find the story doubly interesting. First, the "it can't happen here" mentality among the masses. Second, that the financial markets appear to have had the same short sighted view.

Myrtle Blackwood said...

Sorry to hear about your inadvertent censorship, Barkley.

Michael P, speaking of "it can't happen here" and "short-sighted views" how many economists who are watching the financial markets are presently also referring to the frightening and now-bursting 'water bubble'?

I refer to the fact that we have been, on the whole, drawing on the reserves of groundwater in many countries and that this vital resource is about to run out very quickly. (This is quite apart from climate change which is, itself, already causing historic droughts globally).

I read that Atlanta city, for example, could be without water in two months time.

The structured finance and housing situation pales in comparison.

'As the World Turns ... and Bakes and Burns'
http://www.motherjones.com/commentary/tomdispatch/2007/11/as-the-world-turns.html

And, of course, there are the bursting bubbles of oil (peak oil now), coal (20-30 years), minerals (some appearing now), topsoil (now), forest (10 years), fisheries (now) food (now) 'bubbles'.

'Global food crisis looms as climate change and fuel shortages bite'
http://www.guardian.co.uk/environment/2007/nov/03/food.climatechange

Michael Perelman said...

Where I live, farmers have organized a water district. They are getting the county to let them "sell" water, but of course the water is not just under their farms, but homes (including mine) as well. So, we will have to drill deeper, use more energy ....
I think that the water crisis is more serious than the petroleum problem.

Bruce Webb said...

Michael what does the cost of housing in LA have to do with the cost of housing in Aberdeen, South Dakota? Some certainly, since financing is by and large now national and no longer local (except maybe in small town America).

There is nothing irrational in believing that a meltdown in a selected number of bubble markets combined with some predatory lending in distressed markets in the Mid West will in aggregate equate to national "meltdown" while still believing "it won't happen here".

I live in a market that shows some signs of reaching a price peak, our economy is strong and if the delivery schedule of the 787 Dreamliner doesn't slip any more than it has (the test models were supposed to be in the air by now) will continue to be so. Now it is true that average sales prices in King County (Seattle and eastern suburbs) are beginning to go down some that seems to be an artifact of a continuing transitions from Single Family Residences to Condominiums, the towers are going up everywhere and can be had for prices under Jumbo rates (whereas it is difficult to be able to secure loans for $600,000 houses no matter what your credit and assets).

People I respect a lot insist there will be a contagion effect even into markets that never appreciated much to start with or which like here have strong fundamentals. But I have a problem seeing it from where I am sitting.

What does a dollar crisis mean in Northwest Washington? It means Dubai and Singapore able to buy a few dozen more jumbo jets than the collective hundreds they already have on order. Ka Ching! We also make heavy trucks (Kenilworth and Peterbilt) and have a huge agricultural sector much of which is exported to Asia. Ka Ching, Ka Ching!! And a big domestic lumber industry that in recent years was pressured by Canada. Try that with a Loony at $1.05.

Bad news for the East Coast and for the Sun Belt can be good news for people in Flyover Country and the Pacific Northwest. Those people may not be irrational at all. They may just be better situated.

rosserjb@jmu.edu said...

Brenda,

Congratulations on getting rid of Howard down under there!

Barkley

Anonymous said...

Would it be rational to assume that credit conditions being generated by the bust will impact those towns and cities which didn't experience such large price inflations.

Real estate may be local but the bundled, sliced, diced, leveraged, securitized alphabet soup of claims and counterparties became global, reaching from Beijing to London and Europe where the signs grow more dire with U.S. interbank rates running away from target, covered bond trading (roughly €2,000bn market) suspended as spreads began to blow out...

See - http://www.nakedcapitalism.com/
(which includes: Are U.S. Investors Still in Denial? )

Anonymous said...

I have to laugh about the "Seattle is special" argument. I live on Queen Anne, which is close to downtown and a pretty desirable area. Half of my street has been flipped in the last couple of years and prices have tripled in the last eight years. Meanwhile wages have been fairly stagnant and until recently the county had negative population migration. Speculation has been rampant, time on market has been running up, etc. Percentage of mortgages that are ARMs or interest only is significant. Seattle seems to be most special in that its residents have greater depths of denial to tap.

Bruce Webb said...

Anon we will see. Queen Anne ain't Seattle in toto. You can see the same thing in micro-markets as you do nationally: Queen Anne, Magnolia and Montlake can be vastly over-valued leaving Belltown, the Central District, and indeed suburban locations like Downtown Everett holding up strong. The distance between Queen Anne Hill and Belltown is basically nothing, advising someone to avoid buying a Victorian in QA would not by that fact alone keep me from advising someone to buy a new condo downtown. You have to know your markets to the neighborhood level.

Michael Perelman said...

Bruce, of course some neighborhoods can be immune, but the article suggested that people in general thought that they were safe.

How much does Seattle depend on Boeing with the headquarters gone and outsourcing? Is that enough to keep your city afloat?

Myrtle Blackwood said...

Michael P: "Where I live, farmers have organized a water district. They are getting the county to let them "sell" water, but of course the water is not just under their farms, but homes (including mine) as well. So, we will have to drill deeper, use more energy ....I think that the water crisis is more serious than the petroleum problem.

It looks like the wheeler-dealers ( or are they our new feudal lords?) JP Morgan, Macquarie and Goldman Sachs agree with you on that last point. In the absence of water creation the next best thing to do with a massively dwindling resource is to control it, monopolise it and then sell it at higher prices.

RBS Sells Southern Water for £4.2bn
Published: October 9 2007 02:54 | Last updated: October 9 2007 06:15
http://www.ft.com/cms/s/0/255b56a8-7609-11dc-b7cb-0000779fd2ac.html

Where I live in Tasmania (in the temperate forest rainshadow) the water from the dams have virtually failed to overflow for 3 consecutive years . Also, the rainy season has shifted from Autum and Winter to Winter and Spring instead. The Labor state Government is demanding that the locally-owned-and-paid-for municipal water be handed over to the government in preparation privatisation.

Barkley said: "Congratulations on getting rid of Howard down under there!

Well my advice to Australians was to refuse to distribute preferences to either of the two major parties.
They didn't listen, Barkley!

The Australia Labor party is 'labour' in name only. Although they gained a lot of traction by opposing the Howard Government's 'WorkChoices' legislation they have repeatedly provided a reassuring wink to big business here. The incoming PM, Kevin Rudd, learnt a lot of new tricks from John Howard. He refused to be interviewed by reporters that kept raising a question until they received an answer. (Two in total.) I was not witness to any Rudd challenges from the media at all. They let him off the hook with the now usual "I don't answer hypothetical questions" line. And it was obvious that the Murdoch and Fairfax media wanted Howard out, after eleven and a half painful years.

The new Government has identical policies to the outgoing Libs except for an agreement to sign onto the Kyoto Protocol and (as mentioned) expected minor adjustments to WorkChoices. The troops will stay in Iraq, there'll be escalated forest rape in Tasmania with the establishment of a gigantic pulp mill, both support the atrocious Northern Territory intervention in aboriginal communities, big-business private-public partnerships in infrastructure development, both claim to be fiscal and economic conservatives committed to 'economic growth' and 'higher productivity'.

Oh hummm. This is the time to stick the Desiderata poster back on the wall.

You are a child of the universe; no less than the trees and the stars, you have a right to be here. And whether or not it is clear to you, no doubt the universe is unfolding as it should...

Bruce Webb said...

Well Michael we also have Microsoft and much of Google. And a lot of bio-tech plus Paul Allen funding a bunch of venture capital. Plus a very large container handling port which may not have the volume of Long Beach but still transships a lot of the product we get from China.

The loss of corporate Boeing was a blow to civic pride but economically did not mean much, a few hundred execs and their secretaries moved to a place closer to their airline customers and more convenient to Washington, they didn't take the manufacturing with them.

Certainly every distressed market is likely to have some bright spots. Anon was trying to make the opposite argument, that because a few neighborhoods were overpriced that it argued that the market as a whole was vulnerable. That doesn't appear to be the case around here.

The fatal flaw of the case of the housing doom and gloomers is that of mechanism. If your stock portfolio goes south you have lost that value outright, if the stock does not recover you get nothing. Housing is a little different, prices can go up or down and yet every month you get a discount for rent. You sum up your mortgage payment and property tax and then subtract out tax savings and equivalent rent (because you would have to be living somewhere). It doesn't take a lot of appreciation to make this a winning investment, and even in a flat to slightly declining market the extra-financial aspects make homeownership worthwhile. You control your own front door (no 24 hour notice of entry by the landlord), more often than not you have access to better schools than the typical renter, crime rates tend to be lower, and the neighborhood generally is better maintained. Are these petty measures? Well not if you are shelling out big bucks to send your kid to private school because the local public school is somewhat dysfunctional.

Etymologically 'yard' and 'guard' are cognates, there is a psychological component to 'having a house with its own back yard' that doesn't get captured by Case-Schiller. If your job is secure and you like your house and like your neighborhood on a month to month basis the precise amount of your equity is rather meaningless, particularly if your market never got over-heated to start with.

Anonymous said...

Brenda,

back in the late 1990s 'oilman' T. Boone Pickens or 'T-Bone' as I affectionately call him, took a hankering to water, formed another company and, due to his strong environmental concerns, began taking control of 'the 174,000-square-mile Ogallala Aquifer, North America's biggest underground water reservoir and among the most pure.'

With 'peak oil' at hand, or so says T-Bone, you can surely see the necessity of combining an energy hedge fund, BP Capital LLC, with the tender mercies of commodified water. What better way to advance the general well being than taking from the water rich to supply the water poor?

Which makes it all the more confusing when you hear a rancher claim that there may have been shenanigans involved -
"He's obtained the right of eminent domain like he was a big city. [Water's] supposed to be for the public good, not a private company.' ...
John Spearman Jr., a Roberts County rancher and chairman of the Panhandle Groundwater Conservation District, is one of many local critics who contend that Pickens' water play could upset conservation efforts and seeks to profit from shortages of a vital resource."


Bruce,

most of 'the housing doom and gloomers' I've been aware of see 'the mechanism' as an interacting of real estate and finance with the latter having helped drive the former in a vicious dynamic of asset price inflation, increasing unaffordability, greater creativity in lending and offloading risk, build out of not just structures but ponzi-like financing in which the home buyer began to become secondary to the financial... In short, a bubble, the deflating of which would necessarily impact credit conditions in general, whether in Seattle or Keokuck or Youngstown... Uneven and borderless.

Myrtle Blackwood said...

Juan, it figures a Texas oilman would be piping the new liquid gold. I suppose he's got the pipes already, just needs to relocate them a little.
No need this time to figure a way to get us all hooked on the stuff.

Bruce, you said: "The fatal flaw of the case of the housing doom and gloomers is that of mechanism...

But

"The Center for Responsible Lending estimates that 2.2 million American homeowners will likely lose their homes via foreclosure. Default rates are terrible in many regions of the nation, not confined in any way since a systemic problem. One in five subprime mortgage customers who purchased homes in the last two years is likely to enter foreclosure, amounting to 1.1 million people. The most alarming conclusion made from the study, after analysis of more than six million mortgages since 1998, is that the risk of default is independent of the credit score of the borrower. The failures are occurring regardless of income and past credit history..."

and
"The most dangerous bank system risk might not be the failures so much as the skewed internal underwriter risk controls, and policy for loan loss reserves. Piggyback loans are insane since they directly enabled loans which would not have been approved. They are called “silent seconds” since their loan-to-value lenders only report the first mortgage. Mortgage industry data is thus skewed and biased. Shocks are next.

From: the Economic Views by Timothy von Fuelling Straus. 27th February 2007
www.eastonspointcapital.com/Straus%20peices/forever.pdf

Bruce Webb said...

Juan certainly. But if you have a fixed fifteen year mortgage at 5% that you took out five years ago and have a secure civil service job with a defined benefit pension then the question becomes "Who cares". Which was my position a couple of years back. Due to a lawsuit the value of my condo unit dropped 40% in a year. Did I panic and hide away all the sharp objects in my house? No for me the only practical effect was a large drop in my property tax, I was reasonably confident the value would come back on settlement of the lawsuit and removal of the market uncertainty and so it proved.

Now a few years later I got pressured out of that 'secure' job and am looking to sell my unit next Spring in a market where prices are holding up strong but where time on market is lengthening somewhat. Well that is the difference between Bruce 'Then' and Bruce 'Now'. I suggest there are a lot more Bruce 'Then's out there than current reporting takes into account. And Case-Schiller does us no favors here, it tends to exclude markets where prices remained more stable and mortgage balances lower.

From what I see rapid swings in prices on McMansions in markets like LA and Phoenix where base prices were higher to start with are acting as a very vigorous tail shaking the perceptual dog and attracting a lot of attention on Wall Street and around the world. It doesn't have a lot of effect on a Boeing retiree living in the house he bought for $30,000 in 1974.

I got this all the time back when I worked for the Assessor's office. These people didn't care that their house could sell for $300,000 or if it was sitting on an acre in town for $1,000,000. They didn't want to move and could see no reason why they were paying more in property taxes on a monthly basis than they were paying on their now paid off mortgage. For a very large but mostly invisible group a massive collapse in house prices is simply a tax break. Obviously this would come as an odd concept to the typical Angeleno who bought their house counting on 20% appreciation forever. C-S is just not capturing this everyday reality.

Anonymous said...

Bruce, certainly there are many 'Bruce Thens' but these as well as most all others will not be spared the more difficult econ & credit conditions generated by the breaking mortgage finance bubble.