Shiller at BAAS: Housing Will Continue to Fall

I want to thank one of my former students from Boston College, Harry Markopolos, for sending me his notes from a talk delivered last month by Robert Shiller to members of the Boston Security Analyts Society. Shiller, who is a member of the faculty at Yale University, is also the man who closely tracks housing prices. He was instrumental in developing the now famous S&P/Case-Shiller Home Price Index. I had the pleasure of interviewing him a couple of years ago shortly after he released the second edition of his prescient book, "Irrational Exuberance." I call the book prescient because the first edition correctly called the top of the stock market in 2000; and the second edition correctly called the top in housing.

As everyone knows, housing prices are still falling. Shiller expects them to keep falling for quite some time since the monthly year-over-year declines are still accelerating. Actions taken by government officials may slow these price declines, but eventually the market will have to find its equilibrium. In fact, it would probably be better for our economy if the government did not intervene and allowed this process to proceed as quickly as possible.

Shiller pointed out that the price gains seen in recent years were historically unusual. From 1890 to 1990, housing prices appreciated at about the same rate as inflation. Starting in 1990, however, prices took off as home buyers began to view a house more as an investment rather than just a place to live.

Shiller pointed out that for many home owners, their house is their most valuable asset. Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. Shiller believes the existence of such instruments make it much less likely that a housing bubble will develop again in the future.

Interestingly, Shiller said that in every market he examined, lower-priced homes exhibited the greatest price increases during the recent housing bubble. He attributes this to the widespread availability of sub-prime mortgages, which sometimes did not even require a down payment or the verification of income. This made it possible for individuals, who would not have otherwise qualified for mortgages, to buy homes. As a result, lower-priced homes saw the biggest increase in demand, and therefore, the biggest percentage increase in price. But now, this is also where most of the pain is being felt. Unfortunately, other segments of the housing market and the wider economy are not entirely immune. They, too, are feeling some pain.

Comments

[lindlou:]

Some pain, maybe--but not quite as much as the little guy. And they will assuredly get much more help than the little guy. Just go on Bankrate.com's mortgage calculator and after you run your amounts, a helpful hint pops up at the top that says: "If you are seeking a mortgage in excess of $417,000, recent legislation may enable lenders in certain locations to provide rates that are different from those shown in the table below. We recommend that you contact your lender directly to determine what rates may be available to you." I would presume that the "different" rate they are talking about would be much lower than the rate the average person would receive. Why is congress setting up programs to help people with mortgages in excess of $417,000 get better rates?

2008 Apr 13 09:58 AM

[Rhett:]

I don't know your parameters of "lower-priced" homes, but those in the $500,000 range are feeling a lot of pain on the downside, too.

2008 Apr 13 10:48 AM

[romorris:]

Same here regarding pain, $850K is now 550. I guess that is a lower-price home *here* in So. Cal. Nationwide, certainly not. The home started at $350K in 2000. It's a nice enough looking but very poorly built track house of 1500 sf.

2008 Apr 13 12:38 PM

[sorgmot:]

The decline in USA Dollar interest rates lasting from 1980 to 2000 made that period one in which unit prices on houses, cars, aircraft, farm equipment, commercial real estate, and other assets like stocks and bonds to rise relative to the yearly dividends they paid without causing inflation. That is to say, the price to earnings ratios on stocks, bonds, and other assets rose as interest rates declined.

The USA had a bull market in asset values from 1980 to 2000. Then after 2000, interest rates stopped going lower and began rising for the first time since the end of the 1970's. It was hard to take interest rates below 2%. As interest rates moved higher, assets which could not earn more immediately suffered price declines due to lower price to earning ratios (P/E's). In order to maintain a set price your assets have to earn more as interest rates go up. Houses save their owners rent. If the rent saved stays constant or falls and the price to earnings ratio falls, the house price takes a big step down.

2008 Apr 13 01:05 PM

[cynic69:]

As the price of gasoline increases I expect that houses that are sprawled farther from work centers are going to have some pretty dramatic price reductions.

2008 Apr 13 01:24 PM

[brokerbila:]

"Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. " In reference to this part of the artilce...

Why not have fannie mae , freddie mac mandate that borrowers pay for this hedge insurance referenced to the Shiller index. Borrowers must currently protect the lender with PMI private mortgage insurance, why not have them protect themselves aagainst a fall in prices too. This could help put in a bottom in the housing market and create stability for the future. Buyers could begin to buy with confidence knowing that their value was protected against decline.

2008 Apr 13 02:22 PM

[Mr Pasadena:]

I'm still waiting for prices to fall back to earth. The areas I am looking at still think prices have no gravity. Many Arcadia sellers are still listing their homes at bubble prices with the help of their brokers. I just saw a list where the owner purchased in 2003 for $400K and now wants $900K. It has been remodeled but this is an average income neighborhood but they want nearly a million dollars.

2008 Apr 14 09:14 AM

[jhnnny:]

I have been watching a home in the city of Cerritos where I once lived in go from 1998 sale price of 415,000 to a recent sale last year , May 2007 of 1,290,000. It recently dropped 65,000 in value. Absolutly insane what with property taxes and HOA dues. This home was originally built in 1978 and sold for 179,000 brand new! Average home price in Cerritos is 600,000. Beautiful city to live in, totally unafordable!

2008 Apr 14 11:35 PM