A snapshot of home-prices
posted by Realist Theorist @ 1:06 PM
How high are house prices? News reports often focus on the short-term: "prices fell last month". In this post, I summarize the medium-to-long-term history of house prices. I hope this will provide the reader with context necessary to integrate those news stories into a longer-term perspective.
In this post, I look at prices alone. There are other important metrics: for instance, "were people taking larger loans even for the same underlying house?" I hope to address those another day.
The blue line is a 10-region average. (The red line is a newer, broader version that covers 20 regions.)
Notice the initial spurt in 1987-88, followed by prices staying almost flat for a decade. Then, they began to rise in 1998. They "made up" for the flat years, rising for about 8 years. Then, around 2006, they began to drop and have fallen 35% up to Dec 2008.
What would be normal though? Should we expect home prices to stay flat forever? The two straight green lines on the graph show what steady 3% and 6% annual increases would look like. I chose 3% because the official CPI rose 3% per annum for the period 1987-2008. I drew the 6% line, because I've heard many people suggest that the government understates CPI; so, I wanted to depict where a slightly higher rate would lead.
House prices were flat, then rose sharply. Nevertheless, even with the housing bubble, prices did not go beyond above where a steady 6% per year rise since 1987 would imply. If they were to revert all the way to a 3% yearly level (the CPI average), they still have 25% to fall.
The graph shows where we've been and where we are. Also, it gives a sense of the scale of the increase, compared to the rising CPI. This graph does not give us enough to judge whether prices are really "too high", or not high enough.
OFHEO index: Another index (this time from the government) shows the same pattern of acceleration (albeit slower than Case-Schiller), and the same downturn (though in 2007 rather than 2006). (1)
In this, we basically have confirmation of the Case-Schiller index.
Regional variations: One last thing... do not apply the above to your own house or city. The U.S. index "hides" the great deal of regional variation.
Here's the Case-Schiller (blue line same as the first graph in this post).
Notice how Miami and Washington D.C. rose much higher than the average index. In contrast, notice how Chicago rose much less than the index. As for the Detroit area, the index is already at levels last seen in 1998!
Evaluation: Are home prices "too high" today? For starters consider these two quotes, from 2005. First, Alan Greenspan, (using the royal "we") speaking in May 2005: "... we don't perceive that there is a national bubble... ... but it's hard not to see...that there are a lot of local bubbles". And, now one from "American Banker" (May 23, 2005): "... history is definitive... the national average price of a house may remain relatively flat for a number of years, but it doesn't fall" (2)
It is easy to laugh at them in hind-sight, asking "how could they not have seen it?" However, the real problem is that one cannot simply look at prices going rising off norms and conclude they are too high. If Greenspan and that journal ought to have seen the problem, it is other things they ought to have been watching (for instance, how much risk were people taking and whether incomes were growing too).
Similarly, it is difficult to predict if prices will go lower from here. If you are buying a house, you must look at various factors to decide if you think the price is right.
Government policy: It is wrong for any bureaucrat to decide whether today's prices are too high or too low. The only way we will know is as individuals across the economy make decisions, based on their new expectations. A bureaucrat might get it right, but only by pure chance; in principle, such a calculation is impossible.(3)
When prices fall, houses become more affordable. Any government action to nudge prices this way or that is simply more intervention -- a form of redistribution.
Falling prices are "natural". They will fall until the market reaches equilibrium. Lower prices entice buyers; they help "clear" the market. It won't happen overnight with housing; but, it will happen... unless prevented by bad law.
Notes:
(1) Case-Schiller is higher that the OFHEO index because of three factors that are equally important: OFHEO includes refinancings, which (it turns out) have used valuations lower than actual sales; OFHEO does not look at "exotic" lower-end mortgages that Fannie/Freddie won't take; and, third, a technical difference in weighting different data,
(2) Quotes for Greenspan and "American Banker" from James Grant's book "Mr. Market Miscalculates".
(3) Economist Ludwig von Mises called this "the impossibility of calculation" that a central planner faces.
In this post, I look at prices alone. There are other important metrics: for instance, "were people taking larger loans even for the same underlying house?" I hope to address those another day.
Prices: The most well-known index of house-prices is the "Case-Schiller Index". It tries to measure how much people are paying for the same underlying "real house" across the years. Look at the blue line in this graph:
Notice the initial spurt in 1987-88, followed by prices staying almost flat for a decade. Then, they began to rise in 1998. They "made up" for the flat years, rising for about 8 years. Then, around 2006, they began to drop and have fallen 35% up to Dec 2008.
What would be normal though? Should we expect home prices to stay flat forever? The two straight green lines on the graph show what steady 3% and 6% annual increases would look like. I chose 3% because the official CPI rose 3% per annum for the period 1987-2008. I drew the 6% line, because I've heard many people suggest that the government understates CPI; so, I wanted to depict where a slightly higher rate would lead.
House prices were flat, then rose sharply. Nevertheless, even with the housing bubble, prices did not go beyond above where a steady 6% per year rise since 1987 would imply. If they were to revert all the way to a 3% yearly level (the CPI average), they still have 25% to fall.
The graph shows where we've been and where we are. Also, it gives a sense of the scale of the increase, compared to the rising CPI. This graph does not give us enough to judge whether prices are really "too high", or not high enough.
OFHEO index: Another index (this time from the government) shows the same pattern of acceleration (albeit slower than Case-Schiller), and the same downturn (though in 2007 rather than 2006). (1)In this, we basically have confirmation of the Case-Schiller index.
Regional variations: One last thing... do not apply the above to your own house or city. The U.S. index "hides" the great deal of regional variation.
Here's the Case-Schiller (blue line same as the first graph in this post).
Notice how Miami and Washington D.C. rose much higher than the average index. In contrast, notice how Chicago rose much less than the index. As for the Detroit area, the index is already at levels last seen in 1998!
Evaluation: Are home prices "too high" today? For starters consider these two quotes, from 2005. First, Alan Greenspan, (using the royal "we") speaking in May 2005: "... we don't perceive that there is a national bubble... ... but it's hard not to see...that there are a lot of local bubbles". And, now one from "American Banker" (May 23, 2005): "... history is definitive... the national average price of a house may remain relatively flat for a number of years, but it doesn't fall" (2)
It is easy to laugh at them in hind-sight, asking "how could they not have seen it?" However, the real problem is that one cannot simply look at prices going rising off norms and conclude they are too high. If Greenspan and that journal ought to have seen the problem, it is other things they ought to have been watching (for instance, how much risk were people taking and whether incomes were growing too).
Similarly, it is difficult to predict if prices will go lower from here. If you are buying a house, you must look at various factors to decide if you think the price is right.
Government policy: It is wrong for any bureaucrat to decide whether today's prices are too high or too low. The only way we will know is as individuals across the economy make decisions, based on their new expectations. A bureaucrat might get it right, but only by pure chance; in principle, such a calculation is impossible.(3)
When prices fall, houses become more affordable. Any government action to nudge prices this way or that is simply more intervention -- a form of redistribution.
Falling prices are "natural". They will fall until the market reaches equilibrium. Lower prices entice buyers; they help "clear" the market. It won't happen overnight with housing; but, it will happen... unless prevented by bad law.
Update (Mar 04, '09): Removed poor example.
Notes:
(1) Case-Schiller is higher that the OFHEO index because of three factors that are equally important: OFHEO includes refinancings, which (it turns out) have used valuations lower than actual sales; OFHEO does not look at "exotic" lower-end mortgages that Fannie/Freddie won't take; and, third, a technical difference in weighting different data,
(2) Quotes for Greenspan and "American Banker" from James Grant's book "Mr. Market Miscalculates".
(3) Economist Ludwig von Mises called this "the impossibility of calculation" that a central planner faces.
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"Falling prices are 'natural'. They will fall until the market reaches equilibrium. Lower prices entice buyers; they help 'clear' the market. It won't happen overnight with housing; but, it will happen... unless prevented by bad law."
Absolutely true. It is counter-productive to ameliorate this process, for example, by having the government provide a targeted 10% tax credit, or by buying homes, lots, and partially completed homes, or through any other scheme. The market for homes will clear, despite these efforts, which will only prolong the decline. More importantly, the market for homes *should* clear so that new, financially stable owners acquire them. That requires that prices fall.
Absolutely true. It is counter-productive to ameliorate this process, for example, by having the government provide a targeted 10% tax credit, or by buying homes, lots, and partially completed homes, or through any other scheme. The market for homes will clear, despite these efforts, which will only prolong the decline. More importantly, the market for homes *should* clear so that new, financially stable owners acquire them. That requires that prices fall.
The unfortunate part is that the government will continue to distort this market, either through the coercive power of TARP, or though the tax system. The biggest flaw in Frank 'n' Dodd's excellent housing adventure, is the failure to acknowledge that a good percentage of the population should be renters.
Another funny part of it is to pull up a NASDAQ chart from 1985-present, and crude oil 1985-present and put them side to side with the the Case-Shiller. You'll notice the NASDAQ bubble dovetails into the housing bubble which dovetailed into the oil bubble. What do all of these have in common - all caused by the easy money policies of the Federal Reserve. This excess money found its way into financial assets, causing the tech bubble, then sought safety in real property, then jumped to oil and other commodities. I did this little exercise a while ago and found it rather interesting.
Interesting Mitch. Makes sense too.
I think economists needs to work on a new measure of price-rise that takes into account asset-prices. The CPI and so on were made for a different purpose. Even to the extent that they are computed in good faith, they don't even try measure the increase in *all* nominal expenditures as a ratio to *all* real expenditures. Instead, they have more of an accounting bent: with a focus on current expenses rather than on expenditure.
I think economists needs to work on a new measure of price-rise that takes into account asset-prices. The CPI and so on were made for a different purpose. Even to the extent that they are computed in good faith, they don't even try measure the increase in *all* nominal expenditures as a ratio to *all* real expenditures. Instead, they have more of an accounting bent: with a focus on current expenses rather than on expenditure.
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