Sunday, January 1, 2017

Housing: Part 199 - More on extreme risk aversion in the early housing bust

One of the late conclusions I have come to in my research on the housing boom and bust is that most of the period during the private securitization boom was a period where investors were risk averse, and this was consistently misinterpreted as risk-seeking behavior.

The most obvious case of this is how, perversely, the intensive demand for AAA securities has been universally taken as a sign of excess, because the institutions that are organized around meeting that demand happen to have financially leveraged business models.  But, most of the owners of that debt aren't leveraged.  In fact, this is acknowledged in parts of the conventional narrative about the period.  The global savings glut wasn't about leveraged savers.  Even domestic money markets were not leveraged.  Remember how it was a big deal that some funds were down by a percentage point or two and "broke the buck"?  There was trillions worth of savings that was not leveraged at all, and this is simply thrown into the memory hole whenever it needs to be ignored in order to keep believing that everything was about excess and recklessness.

As I have pointed out, homeownership peaked in early 2004.  I have tried to demonstrate in various ways how there was a massive outflow of home equity into low risk securities.  The appearance of synthetic CDOs in 2006 and 2007 should have been a stark warning that accommodation was desperately needed.  But, this also was misinterpreted as excess and speculation.

Source

Maybe this is the graph that finally presents the point as I see it.  Here, both the change in home equity and the change in homeownership rate (right scale) are inverted.  From 2005 to 2007, there was a massive outflow of unencumbered and lightly encumbered homeowners from the housing market.  And they piled all of their cash into things like money market funds.

The reason is that risk aversion had become so strong that savers weren't even willing to take on home equity.  New homebuyers tended to be leveraged.  This is partly because lifecycle effects create a natural stable flow of first time homebuyers in all markets.  But, also, because of risk aversion home buying with leverage is basically a form of call options.  And, again, call options can be framed as a tool of speculation or of insurance.  We chose to view it as speculation.  I have come to see it as insurance.

In this graph, we can see the parallel movements out of homeownership (and home equity) and into money markets in 2006 and 2007.  The housing ATM idea has it backwards.  Homeowners weren't using their homes to make withdrawals.  They were using their homes to make deposits.

After 2007, we wiped out homeowners, so since then homeownership has continued to fall, but former homeowners have nothing to show for it.

8 comments:

  1. http://mitsloan.mit.edu/newsroom/articles/rethinking-how-the-housing-crisis-happened/?utm_source=mitsloantwitter&utm_campaign=housingcrisis&utm_medium=social

    These MIT people are nearly as smart as Kevin Erdmann...the story starts weak but stick with it....

    ReplyDelete
  2. http://mitsloan.mit.edu/newsroom/articles/rethinking-how-the-housing-crisis-happened/?utm_source=mitsloantwitter&utm_campaign=housingcrisis&utm_medium=social

    These MIT people are nearly as smart as Kevin Erdmann...the story starts weak but stick with it....

    ReplyDelete
    Replies
    1. They are an important reference in the book.

      Delete
  3. http://scottgrannis.blogspot.com/2016/12/commercial-real-estate-still-booming.html?m=1#comment-form

    Nice charts in link, a reminder there was a parallel plummet in commercial property values 2008.

    So why all the moralizing about housing and not the knaves in the commercial property "bubble"?

    ReplyDelete
    Replies
    1. The confirmation bias is strong on this topic. The parallel you see is frequently used to argue that GSEs, the CRA, and the Fed didn't cause the "bubble" by people who still want to blame subprime and predatory banks, even though the critique applies just as well to that.

      And, note Grannis' reply to you in the comments. He still just presumes that the collapse in residential was inevitable and caused the recession, so the parallel doesn't really do anything to change his perception. Then, he uses the excess inventory idea to explain why commercial RE recovered earlier. Exactly which city had all this excess inventory?

      That's why I decided this had to be in book form. Every false premise is propped up with another false premise. Most people won't be willing to consider it. But, for those who might, all those premises have to be challenged at once, or it's just a game of whack-a-mole.

      Delete
    2. Nice link BC.
      I'd add that one reason the CRE price fall appears delayed is that there are fewer transactions and the sales from July 2007 to June 2008 were mostly voluntary where the sellers could still get an OK value but before there were sales forced by lenders. The realized prices give a falsely high appearance.

      Delete
    3. Bill--that's right ...still the CRE price drop was 40% vs 30% for residential in the chart cited....

      A national series of local markets is a bit of a misfit but obviously very sophisticated borrowers and lenders participated in commercial real estate, without the government housing agencies, and the market took a worse collapse than residential...

      Not sure what this means entirely... but let us blame greedy bankers or left Wingers!

      Delete
  4. Your book will be one of the most important of our era in the world of macroeconomics and monitor policy. Not to put pressure on you….

    ReplyDelete