Saturday, May 06, 2006

Is There Really a Housing Bubble?

To many, the housing bubble seems a foregone conclusion. Uncountable blogs devoted to the bubble give the impression that you must be crazy or stupid to not see it. In spite of this, I remain unconvinced. I’m not even sure I know what the “housing bubble” is.

Here is a working definition:
…that housing prices have been pushed well beyond any semblance of reasonableness and the dictates of healthy market fundamentals due to excessive liquidity, extremely relaxed lending standards, a speculative mania, and the increasingly irresponsible "cheerleading" of vested interests.
Endless scary graphs,Click to enlarge like this one, which shows Phoenix appreciation rates over the past 30 years, seem to bear this out. Nonetheless, I am left with questions.

For example, who decides what price is “reasonable”? What standard should we use? Value is entirely subjective. Price, being a function of value plus ability to pay, can seem “unreasonable” to some, but “very reasonable” to others. The only one that matters, though, is the person who actually buys—and who, in so doing, reveals his opinion that the price is “reasonable.”

Where is the evidence of a “speculative mania”? You can’t simply point to the recent rapid appreciation rates and say, “See?”, because that’s assuming what you’re trying to prove. What evidence I’ve seen for this has been sparse and unconvincing, so far. Of course I could be wrong, and we could be on the precipice of the largest housing price decline in history. Unfortunately we’ll only know in retrospect.

The charge of “excessive liquidity” and “relaxed lending standards” also rings hollow to me. Now, it seems certain that the amount of borrowing taking place has increased significantly, but that could be caused by any number of things. Why does this automatically mean that lenders have become “extremely relaxed” with their money—which I presume means they’ve suddenly become willing to lend to any fiscally irresponsible idiot, as long as he has a heartbeat? This seems a testable hypothesis to me. If such an explanation were true, wouldn’t you expect to see foreclosure actions increase over time, as the bad debtors began defaulting on their loans?

When debtors default on their loans, lenders need to provide public notice of the impending sale of the property. These notices get recorded at the county recorders office, usually in the form of a Notice of Trustee’s Sale. In order for a lender to record a Notice of Trustee’s Sale, a borrower has to be at least 90 days late on her mortgage payments. Luckily, Maricopa County makes these records easy to obtain.

This graph shows data I’ve compiled Click to enlargefrom the Maricopa County Recorders office. The blue line is the number of Notices of Trustee’s Sales per month, over the past 11 years. The dotted red line is a 3-month moving average. What does this graph tell us? My first impression is that it’s easy to see evidence of the 2001 tech bubble, but, if anything, Maricopa County seems to have recovered from that, as the average number of notices has returned to 1996ish levels.

Admittedly this one graph is hardly a death-blow to the idea of the bubble, but I believe it’s important to take note of it, if for nothing else, then at least as a caution against our tendency to succumb to Chicken-Littleism and confirmation bias.


Jim Lippard said...

The Economist has been declaring the existence of a housing bubble in the U.S. for several years primarily on the basis of comparisons of monthly mortgage to equivalent rent (a comparison where the Washington Post just reported yesterday that Phoenix isn't particularly out of whack).

The signs of speculation in Phoenix have been investors buying new home contracts and flipping them, which seems to have mostly died out, with a huge growth in inventory, much of which is vacant. I've reported those numbers here. Home builders are reporting slowdowns in purchases as well as an increase in contract breaking due to inability to sell existing homes. They're also offering interesting creative incentives to attempt to sell homes without dropping prices (which would upset holders of existing contracts waiting for their homes to be built).

The percentage of homes sold with option ARMs (and with features like negative amortization options and no documentation of income required) has grown (I believe I saw a statistic that 25% of Phoenix new home purchases have been with option ARMs, with much higher percentages in California), though I think the use of them has declined as interest rates have gone up.

I think you're correct that most of the discussion on blogs seems to be based on anecdote rather than hard evidence, but there are certainly a number of measures that support claims of a housing bubble, at least in particular regions. (BTW, the decline in the stocks of homebuilders could be viewed as another indicator, as well as down-sizing in the mortgage industry.)

Phoenix has the advantage of lots of people moving here, but like California, has the disadvantage of a high percentage of jobs being real-estate related.

Einzige said...

I, of course, grant all that you're saying.

But what if the driver of all of this is, say, a huge expansion in the money supply, instead of some weird mass irrational exuberance? How might we tell the difference?

5 years from now, how are we going to know for sure that this was a "bubble"? Years of doublt-digit negative appreciation rates? A large drop in new construction? Tighter lending policies? Some combination of all those things and more?

What if appreciation rates drop back down to a "normal" 4%-10%, and stay there? What if the number of Trustee's Sale Notices in Maricopa county stay at an average of 800/month for the next several years?

I make no claim to know which is the likelier scenario, but both of them leave me thinking, "What the hell just happened?"

Einzige said...

I should point out that the "increase in the money supply" hypothesis - which undoubtedly raises many questions of its own - at least helps explain the weak dollar, the current high price of gold, and oil at $75/barrel.

Jim Lippard said...

I think that if you don't see price declines and reversion to the mean on some of these measures, then there must not have been a bubble.

Solan said...

Didn't Bernanke get almost famous for saying there was an excess of capital world-wide? You don't need an excess in physical money supply, only in the spendable (loanable) amount, which is a different beast, and international.

Housing prices have been on the rise everywhere else in the West as well, btw. I think Britain's little bubble just got pricked, but I don't pay too much attention to it all these days.

BTW2: I hope it's all a bubble in Norway as well, since I am not among the landed aristocracy these days.

Einzige said...

I feel ya, Solan. Although my 4 investment properties were a huge albatross around my neck, at least when I had them I could say that I had a positive net worth. Now, on the other hand, I'm a veritable pauper by comparison.

Jim, in a purely self-serving way, I do hope that it is a bubble and we do end up seeing some regression, because, as a current non-owner of real estate, the alternative is disconcerting.

Jim Lippard said...

Here's some possible evidence that the underlying issue is a declining dollar: many asset classes that used to move out of sync are now correlated, with the notable exceptions being Treasury bills and bonds.

Solan said...

That should serve to explain why there is a housing bubble (or "price hike") in Europe as well. Does that mean it's going to be permanent?

Einzige said...

If it is, then I hope I get a pay raise soon!

Solan said...

You won't. Those guys overseas working their shirts off will get theirs, though. Or something like that. I am (as always) convinced that times are going to get tough.

Einzige said...

So, you're siding with the guys over at the reckoning, huh?

Solan said...

The Daily Reckoning rubs me the right way, but reading them too often gets tedious. Plus: You have to consider how long they've been wrong. Just like Marx over 150 years ago when he said "The rich are getting richer and the poor are getting poorer" - a mantra that has been repeated by his followers every year for the last 150 years. Wouldn't the world have looked somewhat different if they had been right each of those 150 years? Game: Ask them which years that was, or ask them why not all kids are David Copperfields these days.