Wednesday, November 2, 2016

Housing: Part 185 - the phases of the bust

 I want to look at the graph from yesterday's post some more, because I think that graph highlights the turning points of the housing bust well.

We can roughly divide the period into 6 sections:

1) Normal market, with Closed Access supply problem.

2) GSEs and FHA in decline while private securitizations rise.  Since the GSEs and FHA tend to serve first time buyers, this exchange of market share coincided with a decline in homeownership.  But, private securitizations, probably helped by both a loosening of regulations regarding marginal lending and by the decline in the public conduits, grew to take their place.  The less stringent limits on terms for the private securitizations allowed home prices in credit constrained markets of the Closed Access cities and Contagion cities to rise, though these loans were generally to households with high incomes.  The change during this time was in the terms, not in buyer incomes.  So, even though homeownership was beginning to decline, price increases during this time were at their strongest.  First time buyers were as strong as ever here, so we can presume that tactical selling out of ownership was strong.  During this time, there was strong out-migration from the Closed Access cities - weighted toward low income households, but not necessarily weighted toward renters.  During this period, there was probably some profit taking among existing homeowners in the Closed Access cities, who, because the private securitization boom was pushing their home prices up, were incentivized to take capital gains, even where they had been enjoying artificially low property taxes.

Researchers like Mian & Sufi write about a transfer from high wealth to low wealth households, but in a lot of ways, wealth is a proxy for age.  If we think in terms of income, migration data from this period suggests that there might have been some profit-taking among low income households.  I suspect there was a bimodal distribution of migrants - poor renters forced out and low income owners taking profits - both induced by an expansion of housing consumption among young, educated, high income workers in the Closed Access cities, which was made possible by the lenient terms of the private securitization market.

3) In the spring of 2006, the Federal Reserve intentionally pushed the Federal Funds Rate high enough to slow real housing growth.  And they succeeded royally.  Mortgages held on banks' balance sheets had been strong, helping to counteract the relative decline in GSE and FHA lending, but banks predictably reduce lending in the face of an inverted yield curve.  We can see the effects of this policy choice.  So, at the margin of the market - new home sales - we see a sharp drop.  New home buyers were still relatively strong, however.  The continued entry of first time buyers begins to cause leverage to rise during this time, as the wave of tactical selling builds from existing homeowners exiting the market.

4) By 2007, the number of first time buyers begins to drop, but the exit from ownership continues.  This causes new home sales to fall even farther, and home ownership rates really begin to fall.  But, intrinsic value rules.  Rent inflation was rising sharply, and home prices remained near their peaks, because intrinsic value dominates supply and demand in asset markets that are not in disequilibrium.

5) In late 2007, disequilibrium hits.  Both buying and selling dry up.  Notice that the homeownership rate levelled off somewhat in 2008 despite the drop in first time buyers.  Tactical selling was strongest when prices were high.  That stopped after prices began to drop.

6) In late 2008, the GSEs were taken into conservatorship and the banks were in disarray.  The GSEs severely tightened credit standards, to widespread approval.  The Fed finally fully committed to stability.  So, prices and sales finally bottomed out and stabilized.  But, because the stabilization was targeted at the high end and left the low end out, the apparent stabilization of the housing market was a bit of a mirage.  This period was the worst period for the bottom half of the housing market.  And the continuing drop in homeownership was concentrated at middle incomes and the bottom.

Keep in mind that homeownership to begin with was already 80% to 90% for the top 40% of households, by income, so the rise in ownership among those groups, as a proportion of existing non-owners, was much stronger than in lower income groups.  And, today, compared to 1995, ownership rates are lower for the low income groups and higher for the high income groups.  We gave low income households a bust when they never had a bubble.

These last charts are annual changes in median home prices, by zip code (from Zillow Data).  Zip codes are arranged by price on the x-axis, on a natural log scale.

Across many cities, the same pattern developed in 2008 and 2009.  The aggregate market appeared to have stabilized, but we removed liquidity from the bottom half of the market.  The number of defaults that happened during this period is many, many times the number of defaults that had happened before the subprime market collapsed in 2007.


  1. And, today, compared to 1995, ownership rates are lower for the low income groups and higher for the high income groups.--Kevin E.


    I am a free-market kind of guy, ran my own business for decades.

    And yet, over and over again, I see the results of policies that appear to favor the upper-class. Such policies just become buried, non-issues.

    You can see editorials against rent control---but without mention of property zoning, and the artificially constrained supply, embraced by property owners. Oh, that?

    The minimum wage is good for a thumping every day or the week. Property zoning rarely, if ever. And only lulus talk about regulations against push-cart and truck-vending, or the zoning of retail space.

    Yes, the globalists want open borders for the US, and lots of immigrants---but not open property markets. Lots of demand for housing, but limited supply.

    The home mortgage interest tax deduction--who does that favor?

    I do not think there is a conspiracy.It just yes like this: Policies that hurt upper-inome people are eventually corrected or evaded (think offshore tax havens).

    Policies that benefit upper-income people become non-issues.

    1. And everybody's pissed off. But who are they pissed off at? The Fed for being loose, even though it was too tight. The banks for making loans to poor people, even though they made loans to high income people. The GSEs for feeding the housing frenzy, even though the GSEs were countercyclical.

  2. Kevin E---they say knowledge is power...but sometimes knowledge is just really irritating


    the above is a youtube of Lord Adair, who despite his name is a great economist and thinker.

    He makes some interesting points that may dovetail with your thinking. Regrettably the topic of property zoning and scarcity (which encourages bank-lending on property) is not addressed. Indirectly, perhaps.

    I think he is onto something, with his observation that bank lending has largely become real-estate lending, and most of that is on existing properties. Appreciation validates more lending, and scarcity validates price.

    I think his point of view is this process leads to bust. He points out many recent recessions started out as real estate depreciations.

    But of course, he ignores Canada and Australia which have not had property depreciations.

    Still, a thought-provoking presentation.

    1. I have come to the conclusion that focusing on lending is problematic. I think there is a natural tendency for an inflation targeting central bank to apply monetary offset to lending growth, just as they would to fiscal spending. And, in both cases, I'm not so sure that monetary offset doesn't frequently overshoot, especially when the topic is salient. That may be one reason why deep recessions tend to follow real estate "bubbles". It certainly seems to have been the case this time.

      If that is the case, it's funny how empirically this would lead people to the disastrously wrong conclusion - that what we need is even tighter monetary and credit policy.

  4. I think that is Lord Adair's conclusion too. He is fan of money-financed fiscal programs, aka helicopter drops.

    I sense he leans to solutions on real estate I might not like, such as "macorprudential" regulations, which might be some sort of tax or disincentive on property lending, or even mere heavy-handed regulations.

    It is interesting how much zoning keeps stikcingitsnose into the situation. You have written that without zoning, there would have been more housing production on the West Coast, yet likely the property would be worth less in aggregate.

    Five units are worth $1 million each, but 10 units are worth $400k each.

    My own view that without zoning there would be a forest of middle-class condos along the SoCal waterfront, surely many luxury units, and the middle lower class would live inland by a few miles. There would be no Inland Empire.

    There would be no real estate bubbles, and no busts, and monetary policy could encourage growth.

    In many ways I wish I had never started reading Idiosyncratic Whisk. Once one starts thinking about property, property lending (now the bulk of bank landing) and zoning…it ties into monetary policy and global malaise.

    I am taking up gardening.

  5. Ben and Kevin,
    I think you'll "like" this article. Like, in this case, means find it very irritating.

    1. Good comments Ben.

      Interesting article, bill. Thanks.