Concerning the Case Shiller Housing Index

The National Association of Realtors released results stating sales actually rose .04% (statistically significant?), but were down 20% from last year with prices down across the board. The Times Online is reporting Shiller Says America could plunge into Japan-Style Recession.

Losses arising from America's housing recession could triple over the next few years and they represent the greatest threat to growth in the United States, one of the world's leading economists has told The Times.

Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years.

Professor Shiller, co-founder of the respected S&P Case/Shiller house-price index, said: "American real estate values have already lost around $1 trillion [£503 billion]. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars' worth of losses."
He said that US futures markets had priced in further declines in house prices in the short term, with contracts on the S&P Shiller index pointing to decreases of up to 14 per cent.

"Over the next five years, the futures contracts are pointing to losses of around 35 per cent in some areas, such as Florida, California and Las Vegas. There is a good chance that this housing recession will go on for years," he said.

My take: I believe that my blog's readers are considerably above average in financial acumen and common sense. The NAR is simply not an entity to be taken too seriously, due to the obvious conflict of interest exemplified by their ex-economist, David Lereah, who published some of the most absurd BS I have ever seen come from a nationally reknown organization. Examples of his work from Wikipedia: Are You Missing the Real Estate Boom?: Why Home Values and Other Real Estate Investments Will Climb Through The End of The Decade� And How to Profit From Them was published in February 2005 at just about the tippy top of the bubble (that takes some talent). One year later in February 2006, as the market is already on it's way down, Lereah retitled his book Why the Real Estate Boom Will Not Bust and How You Can Profit from It. Lereah's previous book The Rules for Growing Rich: Making Money in the New Information Economy touting investment in technology company equities was published in June 2000 at the onset of the collapse of the dot-com bubble. This extreme cheerleading has died down substantially, but the overly optimistic spin is still evident with their new economist, Lawrence Yun.

Mr. Shiller, is a different story, though. He is to be taken seriously and has no such conflicts that I can see. BUT (there always is a but, isn't there?), you should know what it is you are looking at when you stare at his numbers. In September of last year (Happy New Year, everybody) I cautioned about misreading the numbers from the Case-Shiller index (see The Real Trend in US Housing Prices... )

The Case Shiller index, although an econometric marvel (it is uncannily accurate for what it intends to do), does not capture the true essence of the housing downturn. It uses something called the "repeat sales methodology" for detached/semi-detached single family, owner occupied homes. This means that to be included in the index, the house would have had to be sold in an arm's length transaction more than once. It also takes pains to only include owner occupied detached/semi-detached homes. That excludes:

• new construction - hence all of the homebuilder's heavily discounted inventory sold is not counted,
• it excludes condos (where the biggest drops in price are to be found),
• it excluded multi-family units (those that thought rental income would save them),
• and it excludes investment properties and flips (again, where much of the damage is done).

Trust me, the Shiller index actually makes things look pretty compared to what is actualy going on out there. I use a proprietary guage that starts with the Shiller-based futures but adds back all of the stuff above (with a slight tweak for futures markets tend to overshoot the mark), and it has proven to be much more realistic. This is how I forecast values for the homebuilders and banks, see Ryland Group Summary Update for a summary example.

Comments

[User 134115]

Hi, Shiller quotes the implied price declines from futures prices on his indexes but these futures are not liquid. for example, the Miami Future has 1 contract OpenInterest combined for all contracts beyond in 2009, 2010, 2011 and 2011 (6 of 7 contracts have -0- open interest). who is setting these futures levels if they are not trading and are they reliable if noone is trading them?

[Rocktex]

Very good post! You mention the rosy picture the Index is painting, at least. But.... (as you said), not good enough.

As an investor, I have been questioning if Case Shiller price index is a piece of junk for a long time. Please see my article at activerain.com/blogsvi...

I would like to write an article to pinpoint the uselessness of the Index. I've check how the Shiller Index collect its data as you did and roughly had the same position as you have. But, there is one thing stop me from writing. I have to make it very sure that what Dr. Shiller means when he use the term "arm-length" transaction. Also, I have to clarify what a "transaction of sale" means since so many real estate websites such as Zillow.com, Realty Trac or Trulia.com have different criterias to include a "sale."
Can you be kind enough to tell me that NAR considers a forced "foreclosure"... as a "sale" transaction as Zillow.com did?
Thank you very much.

[Randall B.]

Great article.

I've read Robert Schiller's "Irrational Exuberance" from cover to cover. Although not a page turner, it was the single most insightful guide that I have read to rationally consider what lies ahead. I greatly respect his work, which appears to be motivated by his personal desire to minimize the downside effects of capitalism - primarily by increasing market transparency to properly align expectations.

Although the index may be flawed, it is the best tool so far to provide a timely and widely respected window to observe the changing state of house prices.

However, the best picture that Schiller provides to the public (in my opinion) is that found at his irrationalexuberance.c... website (irrationalexuberance.c...). I believe his inflation adjusted historical graph of home prices speaks volumes. The limited fuel (credit bubble and over exuberance) which launched the prices into the air has run dry. Now, the plane can no longer defy gravity and will settle back to earth - the only question is how long.

More specifically, my stance is as follows:

Markets often behave irrationally and tend to return to fundamentally supported levels over time. The housing market is no different.
- It is reasonable to expect that U.S. national REAL housing prices could fall by about 50% from their December 2005 peak back to their historically normal level.
- It is reasonable that national NOMINAL prices could also fall significantly (10%-45%) over the next eight years or so unless the U.S. experiences a greatly increased rate of inflation (6-11% for the next 4-8 years).
- Because deflation is often considered to be a greater evil than inflation, the Fed will likely pursue an inflationary policy.

(Inflation/housing numbers created from projecting the data from the "irrational exuberance" graph located at irrationalexuberance.c...

[jaybee]

While Schillers Index may have some flaws in it, as amply indicated in other blog comments, it's pretty useful for overall trends. However, as most real estate is fairly localized, it doesn't really reflect actual market conditions. For example, having recently returned from Florida, specifically Miami where the condo market is in a free fall and will probably get worse as the huge oversupply of condos come on stream. One recently completed building I visited had over 20% of the units either in foreclosure who heading that way. How are those kind of statistics included in the Shiller Index?

My own experience is nothing beats "kicking the tires" or counting the lights at night in a recently completed condo project.

[dano]

There's a chart I just keep coming back to, over and over. It's the one that shows the resets of mortgages on a monthly basis over several years starting in January 2007. You can find it at:

www.recharts.com/repor...

@chart 42.

What bothers me about so many forecasters who claim "soft landings" and that real estate will turn up in "08" is their obvious
lack of this info.

In the simplest terms, $25B/mo in sub-slime resets every month
(avge) for over two yrs. Then, we get a break, and for about
1.5 years roughly $16B/mo in OptionaRMS resets every month.

At present, we are looking at:

1) falling home prices
2) rising rates
3) RISING CREDIT STANDARDS TO QUALIFY
4) a far smaller pool of buyers (the 20% that were flippers are gone)
5) increasing inventory
6) increasing foreclosures
7) tapped out consumers
8) (potentially) slowing economy
9) reluctant buyers waiting for better prices

So when one looks around, I have to wonder -- WHO is going
to turn housing around? WHERE are thebuyers going to come
from? HOW will they come up with the down payments and
ability to finance if so many couldn't in the past unless it was
thrust at them on a silver platter? WHAT can replace all the
liar loans, ARMS, etc that are disappearing from the option
pool of financing?

and most importantly...

WHY would anyone even think they could predict a turnaround
in housing so soon in the face of all these opstacles?

Shiller (and Roubini) have been on the 'bleeding edge' of calling
for significant bloodletting in housing and the economy. I don't
see where the optimism to counter them is going to come from.

NOT from Banks. NOT from the FED (slow to respond). NOT
from buyers.

I share that chart with people and ask them, in the face of all
that is happening, where is the good news? No one knows.

[dano]

sorry, I left off the last part above...

Given all our bad news, and the fact that many will be unable to
make their reset payments, thus feeding even more into the
foreclosure and jingle mail mill, I have to wonder...

are we headed for a feedback loop?

if so, housing could feed on itself going down just as it went up.

In the end, Shiller's potential prognosis could be dead on.

[gone2pot]

Hey dano, my comments have little to do with Case Shiller (although we've used it recently to our advantage) but thanks to people like you, patrick.net, seekingalpha and several others, I am a home buyer. I'm a very smart home buyer and I'm not located on the east or west coast, but in the midwest (St Louis area). I'm an extreme rookie wrt housing and have only been studying what's been going on since I sold a historic home in Clarksville, MO last July. My wife and I made a VERY nice profit after six years (doing all the restoration and remodel work myself). Since we've moved closer to civilization, we've seen a LOT of homes for sale that were on the market for a long time (1 year or more) as well as near empty new housing developments going bankrupt. Because of you guys, I found out why and am now a whole lot smarter. Armed with knowledge, I'm in the throes of buying a very high end preforeclosure home in a well established and desirable neighborhood 35 miles west of downtown St Louis for 17% less than what it sold for three years ago and only 5.9% more than what it sold for new in 1997. I know we're few and far between but if more folks get smarter via you guys, some of us will benefit. You may still think we're stupid to buy now, but without the information you all made available, we'd have taken a REAL stupid plunge last August. I agree with you wrt Case Shiller regarding the house we're buying. CS (using Chicago's trend line) would value the house we're buying 26% higher than our offer and 30% more than what it sold for new. There are several auctions, foreclosures and unsold new homes(being discounted up to 200,000) within a ten mile radius that CS does not take into account. Perhaps this housing deal will cause some of you smart guys to develop a more accurate index.