By Ramsey Su
Real estate bubble, sub-prime mortgages, securitized products and their derivatives were largely responsible for the ultimate collapse, leading us the the economic conditions of today. Policy makers and investors alike were, and still are, basing their actions on a false set of commonly accepted myths.
The first example is provided by the many different House Price Indexes. Borrowing a table from my cyber-friend Calculated Risk, here are the most recent changes in the indexes put together by various different sources:
House price increases according to a variety of sources
Depending on who one prefers to believe, house prices have appreciated between 5.2% to 13.2% year over year. Case-Shiller is probably the most commonly referenced index today. Their fancy model with a nice interactive chart can be found on the S&P/Case Shiller website. Those who want to engage in a bit of intellectual exercise can read the 48 page explanation of the Case Shiller methodology. A much better read however, is this simple one page overview by FNC that debunks all the house price indexes, including their own. I would like to add that no index takes into account the prevailing interest rate and lending practices, and no-one has figured out a method to make appropriate adjustments. For example, how does one compare a house that sold for $100,000 in 2005 utilizing sub-prime financing, vs. the same house that sold for $70,000 cash in 2013, with a few foreclosures and flips in between? Was $100,000 a meaningful indication of value? Did it really depreciate by 30% in 8 years? Here is the well-known Case-Shiller chart:
Case Shiller house price indexes.
Everyone is somewhat familiar with the chart. About the only conclusion I can draw is that easy monetary policy and irresponsible lending practices may lead to a bubble, and bubbles do always burst. It has no predictive value nor does it really tell one much about the past. Gurus may compare today's prices to the sub-prime peak or some imaginary "norm", as if that could offer guidance to policy and investment decisions.
Looking at the Case-Shiller 20 cities composite index simply makes no sense.
The twenty cities disaggregated
These twenty cities all have different demographics that change independently from one another over time. What would be the purpose of contemplating these peaks and troughs, especially when combined in an index?
It is baffling that the FOMC supposedly looks at data such as the various House Price Indexes and somehow decides on that basis that buying agency MBS is a good policy. They even figured out that $600 billion was the right amount for QE1 in 2008, and an additional $600 billion was appropriate for QE2 in 2010. Of course with QE3, the Fed determined that $40 billion per month was good for 2013, but $35 billion is better for 2014.
The wisdom of the Fed escapes me at the moment. Maybe it has other, unrelated objectives in mind. Stay tuned for Debunking Real Estate Myths - Part 2: Overly Stringent Underwriting.
Tables by: Calculated Risk & S&P/Case-Shiller, chart by S&P/Case-Shiller