Note: See me discuss this topic live on Bloomberg TV, Monday October 4th, 2010 at 4:30 pm!
As illustrated in the post “Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!“, many mainstream media outlets and investors (retail, institutional and professional included) have become too reliant on the easy to quote, easy to publish and convenient to manipulate Case Shiller home price index. While an econometric marvel, it is not perfect. As a matter of fact, the imperfections that it does have happen to materially and significantly minimize the influence of the factors which actually contribute greatly to the current housing malaise. This, in and of itself, is significant enough of a reason for interested parties to look past the Case Shiller index in to other metrics that can help give a more accurate picture of what is actually happening on the ground.
Another problem that I see as I scan the popularly followed financial rags, TV broadcasts and blogs is the sole (or nearly so) reliance on price data to gauge the health of the market. Prices can be very misleading if viewed in a vacuum, and most view the Case Shiller index which itself is a flawed metric if not used properly, in a vacuum. Often, by the time prices start shifting, it is too late to take advantage of the opportunities, or escape the damage from the lack thereof. At the very least, one can be mislead into a false sense of complacency.
Case in point, is the following of price data when dealing with new, single family houses. On September 2nd, I wrote “More Doom and Gloom: Homebuilders Making Better Money as Hedge Funds than Home Builders” wherein I attempted to illustrate exactly how bad the home building situation looked 4 years after the homebuilder market had tanked. I excerpt:
We looked into Lennar (LEN) to see the impact of the distressed investments group (which is the companies’ Rialto segment) on its operations. Key observations regarding the same are summarized below:
- Rialto segment which the company started reporting (from 1Q10) is described by the company as, “Our Rialto segment provides advisory services, due diligence, workout strategies, ongoing asset management services and acquires and monetizes distressed loans and securities portfolios. In its 3QFY10 transcript with regard to segment’s description the management said,
Simply put, we purchase large and small portfolios of loans and REO at distressed prices and then we work through those assets one at a time to resolve them at retail payoff. It’s all about making money by managing the process of purchasing wholesale and selling retail – purchasing in bulk and selling one at a time. Admittedly, the assets are a little bit more complex, but this is where we excel.
click to enlarge
So, why is Lennar’s most profitable division essentially a hedge fund that buys and sells bad mortgages and REOs? Because the need to build houses is dead and will be so for some time. Meanwhile, the need to deal with excess distressed inventory is strong, and will get significantly stronger as time goes on. See for yourself the difference one’s outlook makes when looking at housing value transactions, as adjusted for inflation as compared to prices (which in the case of Case Shiller, exclude the drags on pricing such as flips, investor properties, vacation/2nd homes, condos, and REOs)…
You should be saying to yourself, “Damn, that’s a big difference. Why are homebuilders still in business?”. That, my dear readers, is a very good question. Of course, they can all just transform into government subsidized hedge funds and trade with no risk, no cost money from the government through the PPIP program.
Even if one were to focus simply on existing home sales, the reality makes the Case Shiller numbers look downright Goldilocks in comparison…
When I said worse, I meant it. July was the worst month on record, while (August was the 2nd worst month). We haven’t seen this in the media, have we?
Currently, we are back to 1995 levels of activity, despite significant population growth. If these numbers were to be normalized for population growth (of which we had a boom in the ’90s) we could very well be back in the ’60’s of ’70’s in terms of activity. I haven’t run the numbers, but one definite conclusion to be drawn is that we are still on a steep decline after considering all of the government efforts and the still increasing foreclosures, distressed and shadow inventory.
Now, let’s put this all together to see what we get…
When quoting the Case Shiller index on a regular basis without taking the whole picture into consideration, you get the equivalent of lipstick on a rhinoceros. Even though it may not look very pretty, it still looks a lot prettier than it actually is, and dangerous too. Notice how the Case Shiller index kept increasing in value as the economic housing activity in this country dropped off sharply. By the time the CS index turned down by a single percentage point, home sales value had already declined by 19%, which meant when you saw prices starting to decline you would already have encountered a problem selling your house. For those that wait to hold out for that best price, their issues are just compounded over time as both price and activity tumult.
Even as the Case Shiller index showed improvement from .gov bubble blowing, the true economic value of housing activity as adjusted for inflation was dropping by 37%. You’re not hearing this in the media, are you?
Subscribers have access to all of the data and analysis used to create these charts, in addition to a more granular application, by state in the SCAP template and by region in housing price and charge off templates – see:
- House price data, 2nd Quarter 2010
- Bank Charge-offs and Recoveries 2Q10
- The very extensive SCAP Assumptions, showing the credit metrics banks needed to submit for the stress tests of 2009, Updated for last quarter on a state by state basis_09082010 Web
More Reggie Middleton on Residential Real Estate:
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