by Mike Kimel

Home Values: Delusional Buyers, Bank Squeezers and Zillow

Via Barry Ritholtz, a link to a post at Time Moneyland post which led to a post at the Zillow blog:

Zillow recently compared the asking price of 1 million for-sale homes with those homes’ previous purchase price, then factored in the change in the Zillow Home Value Index at the ZIP code level to determine the home’s current market value.

We found sellers who bought after the housing bubble burst, in 2007 or later, price their homes 14 percent above market value. Those who bought before the housing run-up, prior to 2002, overprice by nearly 12 percent. Somewhat surprisingly, sellers who bought during the run-up, from 2002-2006, seems to be the most realistic, pricing their homes 9 percent over market value.

The Moneyland post goes on:

How to explain this pattern? We suspect that homeowners who bought around the market peak are painfully aware of having bought at the height of the market and have no real hope of getting back what they paid upon re-sale. Homeowners who bought after the market peak, on the other hand, may be patting themselves on the back a bit too much for having bought after prices began to correct — not realizing just how much prices have continued to fall even after their purchase.

It also states:

Two underlying impulses appear to lead sellers who purchased after 2006 to over-price their homes. First, there’s classic loss aversion: Sellers who purchased more recently are loath to sell for a loss. Second, they may be unaware that home values have declined further since their home purchase – a mistake that leads them to view their purchase price as a useful criterion in setting their selling price.

Zillow has a lot of data, but I suspect they are missing something because their categories are too broad. (This is something I’m keenly interested in because, being on the job market and living in a relatively small city, I expect we will be moving in the foreseeable future… which means I expect we will be selling our house, and we bought ours in December of 2009. We also expect (and hope) it would sell for quite a bit more than we paid for it, and more than the Z-estimate of the price based on the sales of comparables since that time.)

I think what Zillow is missing is that by late 2009 and early 2010, in some markets, home sales in many markets had dried up. I can’t prove it – I don’t know where one can find data on this – but my experience is that many banks started accepting a lot of short sales at this time. It also seems to me that many banks seemed not to have much of an idea of what their inventory was worth. I can tell you from my own two eyes that at that time you could see two otherwise very similar homes on the same block owned by the same bank, and the one with the enormous crack in the foundation that ran all the way up the living room wall was priced twenty five percent higher than the other. We made a few offers on homes at the time that our real estate agent considered ludicrous, and she didn’t even want to turn in the offer to her counterpart. The ludicrous offer that got accepted was the one we bought.

On the other hand, I noticed that houses that weren’t short sales or REOs were selling for prices that assumed a steady upward trajectory. That is to say, among those buying at the time were many who weren’t aware of the process for buying short sales or REOs, or who didn’t have the willingness (in many cases, the patience) to go through process. And plenty of homeowners were willing to oblige by trying to sell their homes at prices that were higher than 2007 and 2008.

I remember commenting to our real estate agent that there were two categories of home sales going on at the time: those involving people unaware of the downturn in prices and sales and who thought was the same as it always was, and those involving people squeezing banks. I suspect the buyers in former group is in trouble now, and buyers in the latter group are not. Now, there are two dynamics at play. First, the delusional buyers from the time bought less house for the buck than the bank-squeezers. But, perversely, the Z-estimate price of the homes bought by the delusional buyers is, today, higher than the Z-estimate price of the home bought by the bank-squeezers. After all, the Z-estimate price of the home depends a lot on the previous sales prices of the home; if two similarly situated homes (same number of bedrooms and bathrooms, same square footage, etc.) sell for very different prices in December 2009, I assume Zillow’s algorithm is going to assume that the one that if one sold for a better price, it was in a better state of repair or otherwise had better features that aren’t measurable by Zillow’s data (e.g., it is more aesthetically pleasing or has a better view), and that the differences carry on today.

So the question is… what should Zillow do? Is it possible to determine if a home sold for way below Zillow’s Z-estimate because it was trashed v. because someone squeezed the bank on a short sale? Theoretically, property taxes would take care of the problem – homeowners who acquired a trashed home, in theory, would have an easier time getting their property taxes reduced. In practice, I suspect bank squeezers are more likely to go through the effort and successfully argue for a a reduction in their property taxes. Regardless, that clearly isn’t the solution to the problem.

Because foreclosures (and people requiring a short sale) are contagious, I imagine Zillow must track how many homes on a block or within a given radius have gone into foreclosure or are otherwise sold for well below Z-estimates at a given time. I imagine having information about the home owners (which I assume Zillow does) must help. A former flipper who found himself with eight homes in 2010, and unloaded most of them for well below Z-estimates is clearly someone who worked out a deal with the bank. And perhaps it is possible to correlate unemployment rolls with home ownership – I don’t know.

What would you do if you worked for Zillow?

Anyone who was in the MBS market and not working for a primary originator can tell you that the MBS securitization market ended around Halloween 2006. (Those of us who were at places with origination go a few more months, but had no flow by February.)

Only economists were fooled by what I’ve been calling a Xmas Miracle, and even they (via Mark Thoma) are starting to wise up:

The blue line is the usual measure of GDP, which is obtained by adding up total spending. When you read the newspapers, this is the number they report. But the Fed’s Jeremy Nailewaik has convincingly shown that red line—which is the sum of all income—is the more reliable measure. In theory the two lines should be identical—one person’s spending is another’s income—but in practice, the measurements differ. I’ve also plotted the peak, trough, and latest reading of each measure.
Focus on the red line, and you’ll see that the recession began in the final quarter of 2006, not the end of 2007.

You can sustain a bubble as long as more funds are coming into the system. Sell the 1BR on the West Side, reinvest the profits on the 2BR in Park Slope while that seller reinvests in 2,600 square feet in Summit or Hasting-on-Hudson who…

Until the incomes stop moving—transaction costs slow the margin, generally just after a few of the easier lenders demonstrate the flaws of their “business model” and the infrastructures have been built up at other firms based on those chimeric profits, when fixed costs and narrowing margins make better and better firms look worse and worse.

Economics has caught up with finance. What will they think of next?

Note: Subtitle added as I realized this may become a series. – klh, 10 June 2011

The NYT moves deeply into delusion:

The rolling real estate crash that ravaged Florida and the Southwest is delivering a new wave of distress to communities once thought to be immune— economically diversified cities where the boom was relatively restrained.

In the last year, home prices in Seattle had a bigger decline than in Las Vegas. Minneapolis dropped more than Miami, and Atlanta fared worse than Phoenix. [emphasis mine]

Putting it politely, that is h*rs*sh*t. Anyone who was paying attention in the Atlanta area—or who has been paying attention to Georgia Bank Failures—has described the Greater Metro Area’s housing prices (let alone Atlanta itself) as a bubble. (As I noted at the link above, one of our commenters, Nancy Ortiz, was all over this in June of 2009; and the old Business Week covered it in an article published in October of that year. Does the NYT believe that local banks fail for no reason? As Peter Carbonara wrote in the BusinessWeek piece:

One Material Loss Review released today, for example, describes the death throes of FirstCity Bank, which had $297 million in assets and was based in Stockbridge, Georgia, a town not far southeast of Atlanta. FirstCity, like many other banks in the metro Atlanta area, partook of the state’s late, lamented enormous real estate boom, making a large number of loans to local builders. When the boom turned into a crash in 2007, those loans turned bad. The bank failed on March 20. [emphasis mine]

Minneapolis is another clear case where the locals were talking about a bubble back in late 2006/early 2007. Commenter TrickStar was all over Minneapolis at Barry Ritholtz’s place it in November of 2008. (Indeed, by March of 2010, the S&P/Case-Shiller Index was claiming a “recovery” for Minneapolis [link is PDF]. Talk about “green shoots.”)

That same PDF&again, from 11 months ago, using January 2010 data—discusses Seattle, which had the fifth-largest drop in housing prices during 2009. And that was over a year ago. As the Seattle Bubble blog noted, things only got worse last year.

SEATTLE UPDATE: Even David Leonhardt piles on. Hint to the NYT: Institutional Memory is an Asset only when used. If you need someone to run your Knowledge Management division, give me a call and we’ll talk.

In short, anyone who was paying attention knew that all three cities were prime examples of housing bubbles. The idea that the NYT’s best economics writer doesn’t is frightening at best.

To riff on a phrase from Brad DeLong, Why Can’t We Have a Better-Informed Press Corps?

UPDATE: CR appears to agree with me, even as he raises another point:

Bernanke used data from other countries to suggest monetary policy was not a huge contributor to the bubble … however, Bernanke didn’t discuss if non-traditional mortgage products contributed to housing bubbles in other countries. This would seem like a key missing part of the speech.

I’m willing to believe that my interpretation of this speech is inaccurate, but here’s the evidence:

Some observers have assigned monetary policy a central role in the crisis. Specifically, they claim that excessively easy monetary policy by the Federal Reserve in the first half of the decade helped cause a bubble in house prices in the United States, a bubble whose inevitable collapse proved a major source of the financial and economic stresses of the past two years. Proponents of this view typically argue for a substantially greater role for monetary policy in preventing and controlling bubbles in the prices of housing and other assets. In contrast, others have taken the position that policy was appropriate for the macroeconomic conditions that prevailed, and that it was neither a principal cause of the housing bubble nor the right tool for controlling the increase in house prices. Obviously, in light of the economic damage inflicted by the collapses of two asset price bubbles over the past decade, a great deal more than historical accuracy rides on the resolution of this debate.

If I have to pick, I’ll take the latter group. Easy money alone doesn’t cause a crisis. So when he says:

Can accommodative monetary policies during this period reasonably account for the magnitude of the increase in house prices that we observed? If not, what does account for it?

The first answer is clearly “No.” And the second answer is important. Eventually, he answers it:

I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases.

The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble. [emphases mine]

As Albert Brooks once noted, he “buried the lede.” Bernanke notes that the “nontraditional” products constituted around 1/3 of the market by 2003. (As many others have noted, those mortgages were not passed through/to FHA/Fannie/Freddie, either.) Two years later, guidelines were being developed.

An institution that did not attempt to regulate claiming that it should be given more regulatory power is an invitation to disaster. Or am I missing something?

The WSJ collects reactions to the release of the latest Case-Shiller index. Let’s look at two, just for fun:

One in four mortgages are currently underwater. Foreclosure and delinquency rates, which hit a record high at the end of the third quarter of 2009, are therefore likely to continue to rise, perhaps sharply. In addition to this, the inventory of homes for sale remains near record highs. … Despite the recent positive reports on housing prices, we believe that prices have further to fall—about another 5%-10%. — Patrick Newport, IHS Global Insight….

When the Case-Shiller index began increasing in the summer, there were concerns that exaggerated seasonal patterns were an important driver, as trends had briefly improved in the summer of 2008 as well. However, while some seasonality does appear to have been present, the fact that the Case-Shiller home price index is continuing to increase is good news. We still believe that home prices could fall a bit over the course of 2010, but the majority of the price adjustment has probably already occurred. — Abiel Reinhart, J.P. Morgan Chase

I’m not cherry-picking here. I could make fun of the excluded “the long-awaited U.S. housing market recovery is well upon us” all day, but I’ll leave that one to CR (who, I now see, has already done a Variation on the Theme).

But let’s look at pieces of the two points, and see why I’m not sanguine (besides being long housing, that is):

1. One in four mortgages are currently underwater. One in four = 25%.
2. “[W]e believe that prices have further to fall—about another 5%-10%.”
3. “[T]he Case-Shiller home price index is continuing to increase”
4. “Home prices could fall a bit over the course of 2010, but the majority of the price adjustment has probably already occurred.”

Even if you take all of those at face value, you have to combine Bad Economics and Bad Policy to assume the worst is near over.

Details below the fold.

Bad Economics: If 25% of households are underwater right now, it would be foolish to assume that those people would or should stay in their house. (Steve Randy Waldman made this point a while back.)

This doesn’t mean that all 25% of those householders should move. There are major transaction costs in moving, not the least of which is the cost of moving itself. Renting will not be a better deal for everyone, but more and more people are going to realize that not walking away will be A Bad Idea, damaging the future of their child and themselves long after any credit report impact will have dissipated.

And if prices are still 5-10% above where they will be, the decision will become that much more inevitable, especially in areas where employment is lagging.

Looking at the “bright spot”—the counterintuitive rise in the Case-Shiller Index—which looks less firm than one might gather from the commenters—we see that this is another Second Derivative Problem: the pace of the decline has slowed (7.3% YOY) and the gain (“a seasonally adjusted 0.4%”) comes primarily from two areas (Phoenix, which has the largest YOY decline in the Index, and SF), with only five other positive gains over the month, none greater than 0.4% (SD; New York City is flat).

There are green shoots there, but they are on rather fallow ground.

Bad Policy is made clear in the last point: “the majority of the price adjustment has probably already occurred.”

Let’s assume that statement is true. We are, therefore, slightly away from equilibrium, but probably close enough.

But 25% of householders are underwater. And probably 80% of those—one in five “homeowners”—would have their economic situation improved by walking away and renting.

The term that comes to mind is “deadweight loss.” And let’s look at that in the next post.

Dr. Black had a link to foreclosures in Irvine, California. This one especially caught my eye:

5031 Alcorn Lane, Turtle Rock
Amount owed: $298,876.14
Last sale: July 2001, $485,000
Auction date & time: Nov. 5 at 10 a.m.
Location: In front of the flagpoles at Placentia Civic Center, 401-411 E. Chapman Ave.
Trustee sale #: JPM-580
Information: 714-573-1965 [emphasis mine]

I assume the JPM means JPMorganChase, though that’s not the important thing.

If you look at the other houses, the “last sale” and “amount owed” values are fairly close, or the Amount Owed is higher. Which is what you would expect.

But not only is this one not higher, it’s not even close. It’s almost a 40% decline from the last sale date—and more than a $185,000 difference. And 2001 wasn’t exactly top of the bubble anywhere, especially not in Irvine.

Why does a house get foreclosed? Because it can’t be sold to cover costs adequately. But in this case, we’re not even talking about needing a short sale.

No one was willing and able to bid enough on the property to keep it from being foreclosed.

Nearly 40% below 2001 levels would be severe. The Shiller Real Home Price Index indicates that prices are just about even with (maybe 2% below) their 2001 level.

Either this is a real outlier, or the housing crisis is much worse than even the most pessimistic predictions.

by Rebecca

Yesterday’s post on the Australian economy sparked some discussion of its housing market. I agree – Australia’s bubble is large relative to that in the US (interestingly enough) and Canada.

The chart illustrates the price to rent ratio in Australia, Canada, France, Ireland, the UK, and the US, which measures the trade-off between owning and renting. Across country, the housing indices are not perfectly comparable – for example, Statistics Canada measures the value of new homes, while the S&P/Case-Shiller index measures repeat sales of existing homes. Furthermore, countries often measure the owner-equivalent rents differently. Nevertheless, the trends are meaningful.

Australia’s bubble was (is) big, and relative to rents, home values recently turned upward. According to Steve Keen (thank you reader VtCodger for the link), government subsidies provided households the incentive to leverage up their balance sheets while the private business sector deleveraged. Basically, the crash is yet to come.

The recent uptick in the Australian price-rent ratio, i.e., jump in housing prices relative to rents, is interesting. Notice the same is happening in the UK and Ireland; however in their cases, seriously weak economic conditions are dragging down the CPI housing index (the denominator). (In the UK, prices are likewise rising, but rents are falling faster.) As rents slide, so too will the relative attractiveness of home ownership.

I expect that the same will happen in the US. In Q2 2009, the S&P/Case-Shiller home price index grew 1.4%, faster than did the owner-occupied rents index in the CPI. Owner-occupied housing (see CPI table here) inflation slowed dramatically in Q2; and given the long lag on core price fluctuations, there is a very good chance that it turns negative.

Rebecca Wilder

by Rebecca Wilder

Actually, murky is something of a good thing when referring to business cycle dynamics. It usually means that a bottom is forming.

In some sense, the key to recovery is the stabilization of home values. If home values would just “stop” declining – I understand that there is a market mechanism going on here that is pushing home values to (or even below) an equilibrium – then the banking system can get on with its solvency issues. (Naked Capitalism has a nice piece today on banks not foreclosing in order to avoid further writedowns.) Let’s see what’s going on in the US from the perspective of several indicators.

The S&P/Case-Shiller and the Federal Housing Finance Agency (FHFA) reported their quarterly house price indexes today. Interestingly enough, the two (Q2 2009)reports diverge.

The S&P/Case-Shiller marked a quarterly gain of about 1.4%, while the FHFA reported a quarterly loss of about 0.7%. Is this the start of an interesting story on the downside? On the upside, the Case-Shiller index showed a much larger bubble in home values relative to imputed rents. Will the FHFA show a deeper trough than the Case-Shiller?

The chart illustrates the price to imputed rent ratio for the two measures of national real estate values. This can be thought as the tangible asset equivalent to a corporate stock price to earnings, or price to dividend, ratio. It measures the value relative to the flow of ownership gains, as represented by the imputed rent series measured by the BLS (owner occupied rent in the CPI table).

It is unlikely that the quarterly FHFA index will depart from the positive trend for too much longer (if indeed, it has stabilized), as the monthly index is showing more consistent gains over the last three months.

This is kind of interesting – the Case-Shiller, which includes foreclosures, is likely catching the upswing in foreclosure demand, while the FHFA is grabbing more of the downward trend in the “average” mortgage. But the LoanPerformance home price index likewise includes subprime loans and foreclosures, and it is showing some life (see chart below). Below is the 3-month annualized growth rate over the last two years for a cross-section of home value indicators. (In most cases, the monthly indexes are a subset of the national index.)

One indicator to note is the LoanPerformance house price index (LPHPI), which is used by the Fed to estimate the value of real estate in the flow of funds accounts, and is growing at a 9.1% annualized rate. States seeing at least a 4% 3-month gain include Ohio, Wisconsin, New York, Virginia, South Carolina, Georgia.

Likewise, the median existing home price and new home values are reported. These series are not seasonally adjusted; and therefore, are not extremely helpful in this context. But the 3-month existing home values remain in positive territory, although at a slowing rate of improvement. It should be noted that the median home prices is a cruder measure of home values – the Case Shiller and FHFA were developed in order to overcome the limitations of thinking in terms of the “median”.

So it looks like there is a chance that home values stabilize before 2010. We will see, as a 1 quarter increase by the Case Shiller index, although positive, is far from a trend.

Rebecca Wilder

(Edited slightly for readability….rdan)

but it doesn’t do that much for the rest of us. Via The Ambrosini Critique, Scott Sumner discovers there was no housing crash:

The BLS claims that housing prices are up 2.1% in the last 12 months….According to the BLS, housing makes up nearly 40% of the core basket of goods and services.

Further reading gets us to the base of the claim: Owner-Equivalent Rents went up 2.7% in the past year. CR was all over this in April and May. Take a gander at this chart–from the CR posting in May:

So while the ratio has gone from 1.4 to 1.1 (which would be more than a 21% decline), almost a whole 10% of that change has been because the base (rent) has gone up. The other 19% of decline doesn’t matter for BLS in(de)flation calculation purposes.

No one better tell David Malpass or his investors at Encima Global (motto: “Failing Up is Always an Option”; see the Forbes article link at the left side of the Encima page).

McGill University Macroeconomics Comprehension Exam, May 2003, Question 10 (Essay):

The stock market bubble burst in the spring of 2000. The popular pres now talks about a housing bubble, referring to ever rising prices of houses in North America (and elsewhere). They say that if the housing bubble bursts it will have a much more severe effect on the economy. Do you agree? Sketch a model that would capture your argument.