This article has two parts. The first is an analysis of a terribly misleading position presented by Mark Perry and Alan Reynolds. (Links to each will follow.) A position has been has been taken by Reynolds and basically endorsed by Perry. The second part of the article is a presentation of data that has either been ignored by Reynolds or dismissed as irrelevant. The first part is the refutation of the opposition’s arguments; the second part is the presentation of the author’s arguments. Thus another Great Debate© is joined.
Part 1. The Defective Alan Reynolds Argument
Prof. Mark Perry (Carpe Diem) and Alan Reynolds (Investor’s Business Daily) have both argued that falling home prices do not represent a threat to the economy in 2011 because the falling prices will be localized and not represent the whole country. Reynolds wrote:
A dip in the Case-Shiller moving average of home prices in 20 cities for August to October is said to be "troublesome headwind" for the economy in 2011, and "markets such as Sacramento, Las Vegas and parts of Arizona and Florida are at risk of more declines."
Some of those cities may indeed account for a significant share of the Case-Shiller index, because that index covers only 20 cities (and Sacramento, the centerpiece of the story, is not one of them). However, a few troubled cities in a few states do not represent the entire nation.
And he went on to say:
Peter B. Schiff prophesizes that home prices all over the country will fall by somewhere between 24.32% and 28.3% over the next five years.
He imagines home prices must magically revert to some "3.35% annual 100-year trend line," even though no prices of any assets or goods have ever followed such a century-long "trend." This is utter nonsense.
And still further on in the Reynolds discourse:
Falling home prices ultimately help the homebuilding industry because lower prices increase home sales and shrink the excess inventory of existing homes. The stock of existing homes fell to 9.5 months of supply in November from 12.5 months in July. That, not "stalling" prices, is the housing recovery that matters.
There are several problems with Reynolds’ logic. Here are a few points where he is talking nonsense:
1. Reynolds starts out talking about headwinds for “2011” and then magically segues to “ultimately”. Ultimately he is correct. In 2011 he is wrong.
2. He talks about months of inventory of existing homes falling from12.5 months in July to 9.5 months in November. As can be the case, a cherry-picked tidbit of data can be misleading. The following table shows the actually existing home inventory counts for July and November for the past three years.
- Existing home inventories have declined from July to November each year.
- Inventories are larger this November than last.
- The sales rate in July was the lowest on record due to the end of the last tax credit program. (Not shown in table.) This created an artificially larger months of inventory for July.
3. No prices have ever followed a 100-year trend line? Tsk! Tsk! Never say never. The “magical” 3.35% annual slope Peter Schiff quoted for home prices can be compared to the long-term trend lines for such things as:
- Real disposable income per capita (2.4% annually, 1959-2010);
- Industrial Production growth (3.3% annually 1919-2010);
- Real GDP growth (3.3% annually 1929-2009);
- CPI (3.4% annually 1913-2010).
The fact that the items cited above have slowed below their long-term trends in recent decades do prove that such trends see deviations of data in some time periods. But it is certainly not unreasonable to expect some degree of central tendency and I would argue that Peter Schiff is very being very reasonable when he uses the 100-year trend line as a reference.
And if considering trends, Reynold's and company are ignoring a trend reversal in existing home inventory when comparing November data YoY. The following existing home inventory graph posted by Calculated Risk has been marked up to show the reversal in the trend lines by connecting November data YoY.
Click on graph for larger image.
4. Reynolds makes no mention of the supply overhang. Maybe it’s not necessary to mention it because if housing is recovering (as Reynolds implies but is refuted in #2. above) the several million homes in various stages of delinquency, default and foreclosure but not yet on the market will suddenly disappear from the so-called shadow inventory. Of course, ignoring this overhang burden is more nonsense.
5. Reynolds goes to great pains to point out that home value is not as significant a percentage of personal wealth as others have claimed. Here is what he wrote (reference is to a Wall Street Journal article):
The most persistently incorrect argument about the alleged dangers of letting overpriced homes fall to an affordable level is that falling home prices supposedly have a devastating effect on household wealth.
"Homes remain a key part of Americans' wealth," says the Journal article. "Households held $6.4 trillion of home equity at the end of the third quarter, alongside $12.2 trillion in stocks and mutual fund shares. ... For every dollar decline in housing wealth, consumers reduce spending by about a nickel in the subsequent 18 months, Moody's Economy.com chief economist Mark Zandi estimates."
The table alongside shows that the $6.4 trillion of home equity in the third quarter was only 11.9% of estimated household wealth, which was $54.9 trillion. The Journal's reference to "$12.2 trillion in stocks and mutual fund shares" leaves out retirement accounts, bonds, rental property, farmland, precious metals and family-owned businesses, among other things.
Reynolds is imply ignoring the fact that home equity is a disproportionately large part of net worth for those that are not wealthy. Here are the numbers from 2007:
- The bottom 80% of the population has 15.0% of the total net worth.
- The bottom 80% of the population has 7.0% of the total financial wealth.
The major part of that difference (between total net worth and financial assets) is very likely largely home equity. That implies that, for 80% of the population, loss of home equity value is has much more impact on wealth than for the top 20%. The 11.9% for home equity by Reynolds is certainly smaller than that for the top 20% and much larger than that for the bottom 80%.
Mr. Reynolds should stop writing for the wealthy and try writing for everyone.
6. Reynolds writes another circuitous beauty which goes nowhere:
Housing wealth has no more impact on consumer spending than any other sort of wealth. In fact, the $6 trillion increase in overall household wealth since early 2009 was nearly as large as total home equity. The five-year decline in home equity is partly because homeowners took out larger mortgages to cash out equity while home prices were rising.
What pray tell does this mean? He can’t mean to imply the home equity withdrawals simply transferred money from one wealth pocket (home equity) to another asset? It is widely accepted that much of the home equity withdrawals were used to finance consumption. That money has nothing to do with the increase in household wealth since 2009.
And to say housing wealth has no more impact on consumer spending than any other kind of wealth may actually be true today, but it certainly was not true for much of the past decade.
Reynolds could have damaged his arguments less had he simply left out this gratuitous fluff.
This concludes my review of the Reynolds' arguments. Now on to Part 2.
by William C. Wheaton and Gleb Nechayev