Not to say she’s wrong here… but Caroline Baum is a right wing dogmatic freak.
You commented a while ago about how mortgage rates are priced… at Fed Funds plus a risk premium… Technically, for agency a better benchmark is farther out on the yield curve… 5 yr or 10 yr treasuries. Yes, there are weekly and monthly Fed Funds, but normally when people talk about Fed Funds, they mean overnight. But this is not a correct benchmark.
The risk premium you talk about refers to prepayment speeds, default rates, and now home price appreciation rates. Prepay speeds affect duration of the mortgage… some say average life but also it means sensitivity to interest rates (like a stock’s beta measure). But the average life/duration of a mortgage is around 6-8 yrs, so you need a benchmark around this point in the yield curve, which is not overnight Fed Funds.
The Fed is currently influencing the mortgage market directly through its $1.2 - 1.4 trillion program to buy MBS. This is not normal, but it is having a greater impact on the price of mortgages than through the Fed Funds rate. The Fed Funds rate is an overnight rate that the Fed uses to ‘influence’ longer term rates, like mortgages. It can not ‘influence’ long term rates directly through the Fed Funds rate… see Greenspan’s conundrum.
Nevertheless, I agree that prolonged stimulus is inflationary. Ironically, one of the solutions to Japan’s liquidity trap was to raise inflation so that people understood that by buying today it would be cheaper than buying tomorrow… so the idea was that people would realize everything would cost more tomorrow and therefore spend more now rather than save… thereby stimulating the economy.
Oct. 13 (Bloomberg)—Bubble sightings are proliferating by the day, and with interest rates near zero, it’s not hard to understand why. Easy money leads to excess credit creation, which eventually produces inflation in goods and services prices or some type of asset bubble.
Whether these sightings are real or imagined, on the mark or off-base, is another matter.
Current nominees for bubble status include commodities, stocks and bonds: commodities, because a weak dollar stimulates demand for hard assets; stocks, because they’ve come so far so fast and earnings may not justify the prices; and Treasury bonds, because, I imagine, their absolute yields are low.
Those low yields (high prices) represent the antithesis of a bubble. Treasuries manifest none of the bubble zeitgeist. They’re going up in price because of the fear that everything else may go down. And prices are staying up without the support of New-Era prophesies.
Let’s take a look at bonds in the context of typical asset bubbles and see how they stack up.
1. Optimism
Bubbles may be fueled by credit, but they are kept afloat by an overriding sense of optimism about an asset class, the economy or the future in general.
How do bonds measure up on the sentiment scale? Poorly.
No one is buying 10-year Treasuries at a yield of 3.3 percent because the future looks bright. In fact, investors are buying bonds because they aren’t sure stocks and commodities, with their implied rosy outlook, have a lock on the future; because de-leveraging is deflationary in the short run while the Fed’s bloated balance sheet carries future inflation risks; because credit risk is still a concern; because the banks aren’t done with the cycle of writedowns and credit losses now that commercial real estate is facing the same problems as its residential counterpart; and because return of investment is more important than return on investment.
Investors—dollar-recycling foreign central banks notwithstanding—are buying bonds because they’re pessimistic, not optimistic.
2. Belief that prices can’t go down
The recently expired housing bubble is a perfect example of the triumph of faith over reason. Soaring home prices in 2005 represented a little “froth,” not a bubble, according to Alan Greenspan, Federal Reserve chairman at the time.
And who could argue with him? House prices had never fallen on a national average basis since the Great Depression. With history on their side, speculators joined homeowners in the free-for-all (free except for the U.S. taxpayer). Home prices increased by leaps and bounds. Bubble accusations were met with reasons why this time is different.
Buying for Losses
Bonds aren’t part of the ever-rising-prices school. If Treasuries are a bubble, they must be the one where buyers don’t expect huge gains. In fact, it’s just the opposite. Bond buyers know the next big trade is down (yields up). They just aren’t sure about the timing.
Ten-year Treasuries have traded in a post-crisis range of 4 percent to 2 percent and back to 4 percent. Since May, the yield has been slipping, which isn’t a healthy sign. With inflation expectations edging higher—from close to zero at the start of this year to 1.85 percent now—the decline in nominal yields is a result of the drop in the real interest rate, or the real cost of borrowing.
Sure, 10-year yields could go back to 2 percent if the stars line up correctly (if stocks test the March lows). Rather than justify the prices, everyone buying the rally will be looking to get out at the first sign of fatigue.
3. New Era
For investors in Internet and technology stocks in the late 1990s, it wasn’t just a New Era they were touting. It was a New Era for a New Economy. Technological innovation related to the Internet was creating boundless opportunities for productivity growth.
Earnings? Not an issue for the New Economy. Concept was everything, with page hits the new metric and return-on-vision the key ratio.
Rising interest rates? Not a problem. Tech start-ups had unlimited access to venture capital. Interest rates didn’t matter. Borrowing was for sissies.
You can’t fool all of the people all of the time, but if enough of them are delusional for a spell, bubbles can continue to inflate.
Yields on Treasury bills may have gone negative in December, but there’s no New Era talk about note and bond yields falling to zero.
The bull market that started in 1981 with bond yields over 15 percent has nowhere to go. One hears a lot more concern about inflation than deflation, which makes sense when the central bank has an over-active printing press.
For Treasuries, then, the upside is limited while the downside potentially huge. If that’s a bubble, just imagine what a bear market looks like.
Posted by E on 10/13/09 at 05:14 AM
I wonder how Robert Shillers “index” would hold up against his own house and “Zestimate”?
Is it me or does this look like another apartment for sale….?
Posted by winstongator on 10/13/09 at 05:48 AM
People are underestimating the ability for bond yields to fall long-term, and I’m including the value of 30yr fixed & MBS’s based on them also.
Even if the principal is guaranteed and the payment stream secure, getting 4.5% from a mortgage, or 3% from a treasury is much less attractive when new loans are getting 8.5% or 7%.
Can a finance person tell me how much a 30y note’s value changes, note rate 5%, initial risk free rate 3%, risk free rate in 4 years 7%?
Posted by Lee in Irvine on 10/13/09 at 05:54 AM
“because return of investment is more important than return on investment.” LoL ~ Well Said!
We have got ourselves in to one hell of a SNAFU.
Posted by Geotpf on 10/13/09 at 06:16 AM
Pretty much, although isn’t that what a condo is? Although most newer purpose-built condos don’t have neighbors above or below, while this does.
It’s at least bigger than the ~475 sq ft condo featured a few days back. I think this one would rent for the $1,250 mentioned in that post.
Posted by ConsiderAgain on 10/13/09 at 06:16 AM
“Their total property debt was $543,000, and mortgage equity withdrawal was $339,000.”
While I should be use to this by now, I am still amazed at facts like this. $543k against a 728 sq ft apartment in Irvine. Unbelievable.
Posted by mark g on 10/13/09 at 07:48 AM
I’m just wondering how looking at original list price and actual sale price would graph as an average… and add to that the frequency of the sale of a property… we would see a tightening of that ‘gap’ at the low end now and trending tighter in the mid-high end guessing…
I got spam in my inbox today, not for the usual viagra, ambien, or hydrocodone, but for a bank-owned condo in Miami Beach. :-\
Posted by furious sugar on 10/13/09 at 11:09 AM
“Great for individual, new couple or investor.”
What’s a “new couple”? vs. old couple maybe??
Perhaps if you have been married longer than 5 minutes it will seem too small to actually live there?
Posted by Gemina13 on 10/13/09 at 11:24 AM
Of course there’s a Treasury bubble. The Fed wants desperately to keep investors, foreign and domestic, from realizing that the latest rally/Emperor has no clothes. Right now, the only thing we’ve got of any volume to sell is debt. The catch here is, can the Fed manage to sell enough bonds before people catch on that what they’re really attempting to do is devalue all our debt so that, when interest rates are raised, we won’t be swamped?
Posted by newbie2008 on 10/13/09 at 11:42 AM
“The lender is actually losing about $350,000.” Is this true or is that taxpayers losing about $380,000 with the service charge for the FC?
Good write up on creations of bubbles. Questions remain when will the Irvine housing bubble pop and when will the stock market bubble pop?
The mortage rates are more tied to the 30 year and 10 years notes. Under Clinton, Rubin was a genius to finance using shorter-term loans such as 1 and 5 year notes. That drastically lower the rate and cost to maintain the debt. Since the Fed were not selling much 30 year notes, the reduced supply lead to lower home rates. The drawbacks were if general interest rates went up or inflation started the govt would need to finance at much higher rate, the long-term manangement of the Fed debt when out the window and delaying problems so it didn’t blow up on my watch became the SOP for the USA.
Posted by Lb Renter on 10/13/09 at 11:46 AM
Just do Present value in excel to get an approximation. It is more complicated in the real world, but an approximation should work for your purpose.
THE sudden rise in home prices suggests that the psychology of the market has shifted substantially. But what should we expect in the months ahead? Not necessarily that we’re entering a new housing boom. To a large extent, where we’re heading depends on what home buyers are thinking.
Some clues are found in the annual home-buyer surveys that Karl Case, the Wellesley economics professor, and I have run for years. For the surveys, we canvas recent home buyers in four cities — Los Angeles, San Francisco, Milwaukee and Boston; the surveys are now being conducted under the auspices of the Yale School of Management. We have just received the 2009 results, with responses from June and July.
This year’s survey coincides nicely with the upturn in home prices, the sharpest change in direction we have ever seen. The data show that the Standard & Poor’s/Case-Shiller 10-City Composite Home Price Index for the United States rose 3.6 percent between April and July. While that is not a whopping increase, it followed a decline of 4.8 percent in the previous period, between January and April.
The suddenness of this shift surprised me. In my column in June, I wrote that home prices might well continue to decline for years. As of that time, the S.& P./Case-Shiller price index had fallen every month for almost three years. Add to that the prospect of continuing high unemployment and a weak economy for years to come, and the prospects for home prices did not seem rosy.
But the new data are startling. Since the indexes began in 1987, the closest parallel to such a change came at the conclusion of the last housing bust, at the end of the 1990-91 recession. Home prices rose 2.3 percent from April to July 1991 after having fallen 2.1 percent from January to April that year. By July 1996, five years after that “turnaround,” home prices were down 0.6 percent from their July 1991 level, and down 13.8 percent in inflation-adjusted terms.
Could the more extreme recent shift mean that home prices will just keep rising this time? Here is where our new survey results are helpful.
We looked at both the long- and short-term attitudes of home buyers. In our survey, we ask, “On average over the next 10 years, how much do you expect the value of your property to change each year?” The average answer among 311 respondents in 2009 was an increase of 11.2 percent. The median response — with half above, half below — was 5 percent, also high. That sounds rather like bubble thinking.
For a home buyer who borrows 90 percent of the money to acquire a house, an appreciation rate of 11.2 percent offers an investment bonanza. By putting a small amount of money down, investors stand to make a large gain if home prices climb. That is the power of leveraging. Recently, however, home buyers have also experienced the unpleasant consequences of leverage when home prices fall. Investing in a home during the wild past few years has been like gambling in a casino: You can leave with riches or empty pockets.
In our survey data from one year earlier, when prices were falling at an annual rate of nearly 20 percent, buyers were still expressing long-term optimism. Then, the average answer to the question about expected yearly increases in home values was 9.5 percent a year, with a median of 5 percent — high figures indeed for that time. The bubble thinking is not new.
Those long-term expectations may not have changed much in character, but short-term expectations certainly have. In the survey, we also ask, “How much of a change do you expect there to be in the value of your home over the next 12 months?” Here, the average answer for June-July 2009 was a 2.3 percent rise, versus a negative 0.4 percent a year earlier. That was a dramatic change.
Posted by SacBoomer on 10/13/09 at 12:35 PM
I.R.
I had to blink a few times to be sure, and I went to the full article to be positive that they were referring to an annual return not the total return over ten years. 11.2% is frankly delusional. It seems that numbers only register on the way up, not on the way down. There isn’t much you can do in the face of magical thinking, is there?
It’s not the best news reference, but this website is covering the newly-signed regulations for CA mortgages.
Enjoy,
Hard Numbers
Posted by Talyssa on 10/13/09 at 12:59 PM
I assume the realtor mean a YOUNG couple not a new couple. My SO and I lived in a 1br that size and found it quite comfortable for the two of us, provided we didn’t try and entertain more than 2-3 guests.
Of course we’re paying 1500 for a 2br2ba right now, AND i get to do my laundry inside instead of out on the front patio where people walk up.
Seriously, what a lousy design that is. The only thing worse than having to go out on your back patio to do laundry is having to go out on your FRONT patio to do laundry (well that and laundro-mat style). Yuck.
Otherwise, I like it. I’d buy it nad live in it if it was 50k - 60k cheaper (and if it didn’t have the laundry on the front patio, that’s kinda a deal breaker).
I think the FED will be able to sell the debt as long as we still have problems with deflation. The lenders have not written off their commercial loan debts yet. As long as we have deflation, even 3% bond yields have a real interest rate closer to 5%. When we start to have real inflation, it the FED will have a serious problem as you noted.
No, the optimism/delusion among the general population is truly astounding. If houses really did go up in value that fast, you would get rich by buying one… Oh, wait… that is what people really believe.
Posted by Tei on 10/13/09 at 05:37 PM
Hi - I’m trying to catch up on old posts and the links with the pages on the bottom seem to be messed up in case you didn’t notice. It jumps in multiples of 7 and ends up with a page not found.
Posted by mav on 10/13/09 at 07:00 PM
There is a feed back loop in place. A sudden spike in interest rates would lead to massive defaults and another round of deflation in asset values. Deflation is a very powerful force to reckon with… can you imagine what would happen if a catastrophic spike in 10 year t-bills from 3 to 6 % happened tomorrow? Asset value deflation and debt defaults would send rates back down… the global economy can not detach itself from the US without a catastrophic impact on the global supply chain…
Posted by Gemina13 on 10/13/09 at 09:51 PM
This is an excellent reason why financial fundamentals need to be taught in schools, starting as soon as kids learn about decimals and fractions.
Posted by mike23w on 10/14/09 at 03:47 AM
My coworker just bought a second house as an investment in the hopes of renting it out. I asked him if he ran the numbers to see if it made financial sense and he said “No, I’m not like you”. He just jumped in because the house had a big discount from the peak price. Idiot.
The bubble mentality is alive and strong.
Many people I know are heavily in favor of real estate as a low risk, high return investment.
Surprising, the majority of people don’t realize an asset(eg. Real Estate or stock) that is expensive will generally result in a lower return than an asset that is inexpensive.
What I can say with a good amount of certainty is that house prices will not appreciate anywhere near 10%/year over the next decade. Sadly, only a handful of us clustered on these blogs share the same sentiment. The general public is still delusion with greed - may they lose their money.
Posted by DirkDigler on 10/13/09 at 06:02 AM
Not to say she’s wrong here… but Caroline Baum is a right wing dogmatic freak.
You commented a while ago about how mortgage rates are priced… at Fed Funds plus a risk premium… Technically, for agency a better benchmark is farther out on the yield curve… 5 yr or 10 yr treasuries. Yes, there are weekly and monthly Fed Funds, but normally when people talk about Fed Funds, they mean overnight. But this is not a correct benchmark.
The risk premium you talk about refers to prepayment speeds, default rates, and now home price appreciation rates. Prepay speeds affect duration of the mortgage… some say average life but also it means sensitivity to interest rates (like a stock’s beta measure). But the average life/duration of a mortgage is around 6-8 yrs, so you need a benchmark around this point in the yield curve, which is not overnight Fed Funds.
The Fed is currently influencing the mortgage market directly through its $1.2 - 1.4 trillion program to buy MBS. This is not normal, but it is having a greater impact on the price of mortgages than through the Fed Funds rate. The Fed Funds rate is an overnight rate that the Fed uses to ‘influence’ longer term rates, like mortgages. It can not ‘influence’ long term rates directly through the Fed Funds rate… see Greenspan’s conundrum.
Nevertheless, I agree that prolonged stimulus is inflationary. Ironically, one of the solutions to Japan’s liquidity trap was to raise inflation so that people understood that by buying today it would be cheaper than buying tomorrow… so the idea was that people would realize everything would cost more tomorrow and therefore spend more now rather than save… thereby stimulating the economy.
Posted by IrvineRenter on 10/13/09 at 05:13 AM
Treasury Bond Rally Fails the Asset-Bubble Test: Caroline Baum
Oct. 13 (Bloomberg)—Bubble sightings are proliferating by the day, and with interest rates near zero, it’s not hard to understand why. Easy money leads to excess credit creation, which eventually produces inflation in goods and services prices or some type of asset bubble.
Whether these sightings are real or imagined, on the mark or off-base, is another matter.
Current nominees for bubble status include commodities, stocks and bonds: commodities, because a weak dollar stimulates demand for hard assets; stocks, because they’ve come so far so fast and earnings may not justify the prices; and Treasury bonds, because, I imagine, their absolute yields are low.
Those low yields (high prices) represent the antithesis of a bubble. Treasuries manifest none of the bubble zeitgeist. They’re going up in price because of the fear that everything else may go down. And prices are staying up without the support of New-Era prophesies.
Let’s take a look at bonds in the context of typical asset bubbles and see how they stack up.
1. Optimism
Bubbles may be fueled by credit, but they are kept afloat by an overriding sense of optimism about an asset class, the economy or the future in general.
How do bonds measure up on the sentiment scale? Poorly.
No one is buying 10-year Treasuries at a yield of 3.3 percent because the future looks bright. In fact, investors are buying bonds because they aren’t sure stocks and commodities, with their implied rosy outlook, have a lock on the future; because de-leveraging is deflationary in the short run while the Fed’s bloated balance sheet carries future inflation risks; because credit risk is still a concern; because the banks aren’t done with the cycle of writedowns and credit losses now that commercial real estate is facing the same problems as its residential counterpart; and because return of investment is more important than return on investment.
Investors—dollar-recycling foreign central banks notwithstanding—are buying bonds because they’re pessimistic, not optimistic.
2. Belief that prices can’t go down
The recently expired housing bubble is a perfect example of the triumph of faith over reason. Soaring home prices in 2005 represented a little “froth,” not a bubble, according to Alan Greenspan, Federal Reserve chairman at the time.
And who could argue with him? House prices had never fallen on a national average basis since the Great Depression. With history on their side, speculators joined homeowners in the free-for-all (free except for the U.S. taxpayer). Home prices increased by leaps and bounds. Bubble accusations were met with reasons why this time is different.
Buying for Losses
Bonds aren’t part of the ever-rising-prices school. If Treasuries are a bubble, they must be the one where buyers don’t expect huge gains. In fact, it’s just the opposite. Bond buyers know the next big trade is down (yields up). They just aren’t sure about the timing.
Ten-year Treasuries have traded in a post-crisis range of 4 percent to 2 percent and back to 4 percent. Since May, the yield has been slipping, which isn’t a healthy sign. With inflation expectations edging higher—from close to zero at the start of this year to 1.85 percent now—the decline in nominal yields is a result of the drop in the real interest rate, or the real cost of borrowing.
Sure, 10-year yields could go back to 2 percent if the stars line up correctly (if stocks test the March lows). Rather than justify the prices, everyone buying the rally will be looking to get out at the first sign of fatigue.
3. New Era
For investors in Internet and technology stocks in the late 1990s, it wasn’t just a New Era they were touting. It was a New Era for a New Economy. Technological innovation related to the Internet was creating boundless opportunities for productivity growth.
Earnings? Not an issue for the New Economy. Concept was everything, with page hits the new metric and return-on-vision the key ratio.
Rising interest rates? Not a problem. Tech start-ups had unlimited access to venture capital. Interest rates didn’t matter. Borrowing was for sissies.
You can’t fool all of the people all of the time, but if enough of them are delusional for a spell, bubbles can continue to inflate.
Yields on Treasury bills may have gone negative in December, but there’s no New Era talk about note and bond yields falling to zero.
The bull market that started in 1981 with bond yields over 15 percent has nowhere to go. One hears a lot more concern about inflation than deflation, which makes sense when the central bank has an over-active printing press.
For Treasuries, then, the upside is limited while the downside potentially huge. If that’s a bubble, just imagine what a bear market looks like.
Posted by E on 10/13/09 at 05:14 AM
I wonder how Robert Shillers “index” would hold up against his own house and “Zestimate”?
http://www.zillow.com/homedetails/201-Everit-St-New-Haven-CT-06511/57964201_zpid/
Posted by WorkingInIrvine on 10/13/09 at 05:44 AM
Is it me or does this look like another apartment for sale….?
Posted by winstongator on 10/13/09 at 05:48 AM
People are underestimating the ability for bond yields to fall long-term, and I’m including the value of 30yr fixed & MBS’s based on them also.
Even if the principal is guaranteed and the payment stream secure, getting 4.5% from a mortgage, or 3% from a treasury is much less attractive when new loans are getting 8.5% or 7%.
Can a finance person tell me how much a 30y note’s value changes, note rate 5%, initial risk free rate 3%, risk free rate in 4 years 7%?
Posted by Lee in Irvine on 10/13/09 at 05:54 AM
“because return of investment is more important than return on investment.” LoL ~ Well Said!
We have got ourselves in to one hell of a SNAFU.
Posted by Geotpf on 10/13/09 at 06:16 AM
Pretty much, although isn’t that what a condo is? Although most newer purpose-built condos don’t have neighbors above or below, while this does.
It’s at least bigger than the ~475 sq ft condo featured a few days back. I think this one would rent for the $1,250 mentioned in that post.
Posted by ConsiderAgain on 10/13/09 at 06:16 AM
“Their total property debt was $543,000, and mortgage equity withdrawal was $339,000.”
While I should be use to this by now, I am still amazed at facts like this. $543k against a 728 sq ft apartment in Irvine. Unbelievable.
Posted by mark g on 10/13/09 at 07:48 AM
I’m just wondering how looking at original list price and actual sale price would graph as an average… and add to that the frequency of the sale of a property… we would see a tightening of that ‘gap’ at the low end now and trending tighter in the mid-high end guessing…
Posted by Conan on 10/13/09 at 09:30 AM
I got spam in my inbox today, not for the usual viagra, ambien, or hydrocodone, but for a bank-owned condo in Miami Beach. :-\
Posted by furious sugar on 10/13/09 at 11:09 AM
“Great for individual, new couple or investor.”
What’s a “new couple”? vs. old couple maybe??
Perhaps if you have been married longer than 5 minutes it will seem too small to actually live there?
Posted by Gemina13 on 10/13/09 at 11:24 AM
Of course there’s a Treasury bubble. The Fed wants desperately to keep investors, foreign and domestic, from realizing that the latest rally/Emperor has no clothes. Right now, the only thing we’ve got of any volume to sell is debt. The catch here is, can the Fed manage to sell enough bonds before people catch on that what they’re really attempting to do is devalue all our debt so that, when interest rates are raised, we won’t be swamped?
Posted by newbie2008 on 10/13/09 at 11:42 AM
“The lender is actually losing about $350,000.” Is this true or is that taxpayers losing about $380,000 with the service charge for the FC?
Good write up on creations of bubbles. Questions remain when will the Irvine housing bubble pop and when will the stock market bubble pop?
The mortage rates are more tied to the 30 year and 10 years notes. Under Clinton, Rubin was a genius to finance using shorter-term loans such as 1 and 5 year notes. That drastically lower the rate and cost to maintain the debt. Since the Fed were not selling much 30 year notes, the reduced supply lead to lower home rates. The drawbacks were if general interest rates went up or inflation started the govt would need to finance at much higher rate, the long-term manangement of the Fed debt when out the window and delaying problems so it didn’t blow up on my watch became the SOP for the USA.
Posted by Lb Renter on 10/13/09 at 11:46 AM
Just do Present value in excel to get an approximation. It is more complicated in the real world, but an approximation should work for your purpose.
PV (rate,nper,pmt,FV)
Initial rate .05/2= .025
Initial nper 30*2=60
initial pmt 2.50
initial fv 100
in your example if 30 year bonds 4 years from now are yielding 7% change the following.
PV (rate,nper,pmt,FV)
rate .07/2= .035
nper 28*2=56
initial pmt 2.50
initial fv 100
Posted by IrvineRenter on 10/13/09 at 11:48 AM
A Bounce? Indeed. A Boom? Not Yet.
THE sudden rise in home prices suggests that the psychology of the market has shifted substantially. But what should we expect in the months ahead? Not necessarily that we’re entering a new housing boom. To a large extent, where we’re heading depends on what home buyers are thinking.
Some clues are found in the annual home-buyer surveys that Karl Case, the Wellesley economics professor, and I have run for years. For the surveys, we canvas recent home buyers in four cities — Los Angeles, San Francisco, Milwaukee and Boston; the surveys are now being conducted under the auspices of the Yale School of Management. We have just received the 2009 results, with responses from June and July.
This year’s survey coincides nicely with the upturn in home prices, the sharpest change in direction we have ever seen. The data show that the Standard & Poor’s/Case-Shiller 10-City Composite Home Price Index for the United States rose 3.6 percent between April and July. While that is not a whopping increase, it followed a decline of 4.8 percent in the previous period, between January and April.
The suddenness of this shift surprised me. In my column in June, I wrote that home prices might well continue to decline for years. As of that time, the S.& P./Case-Shiller price index had fallen every month for almost three years. Add to that the prospect of continuing high unemployment and a weak economy for years to come, and the prospects for home prices did not seem rosy.
But the new data are startling. Since the indexes began in 1987, the closest parallel to such a change came at the conclusion of the last housing bust, at the end of the 1990-91 recession. Home prices rose 2.3 percent from April to July 1991 after having fallen 2.1 percent from January to April that year. By July 1996, five years after that “turnaround,” home prices were down 0.6 percent from their July 1991 level, and down 13.8 percent in inflation-adjusted terms.
Could the more extreme recent shift mean that home prices will just keep rising this time? Here is where our new survey results are helpful.
We looked at both the long- and short-term attitudes of home buyers. In our survey, we ask, “On average over the next 10 years, how much do you expect the value of your property to change each year?” The average answer among 311 respondents in 2009 was an increase of 11.2 percent. The median response — with half above, half below — was 5 percent, also high. That sounds rather like bubble thinking.
For a home buyer who borrows 90 percent of the money to acquire a house, an appreciation rate of 11.2 percent offers an investment bonanza. By putting a small amount of money down, investors stand to make a large gain if home prices climb. That is the power of leveraging. Recently, however, home buyers have also experienced the unpleasant consequences of leverage when home prices fall. Investing in a home during the wild past few years has been like gambling in a casino: You can leave with riches or empty pockets.
In our survey data from one year earlier, when prices were falling at an annual rate of nearly 20 percent, buyers were still expressing long-term optimism. Then, the average answer to the question about expected yearly increases in home values was 9.5 percent a year, with a median of 5 percent — high figures indeed for that time. The bubble thinking is not new.
Those long-term expectations may not have changed much in character, but short-term expectations certainly have. In the survey, we also ask, “How much of a change do you expect there to be in the value of your home over the next 12 months?” Here, the average answer for June-July 2009 was a 2.3 percent rise, versus a negative 0.4 percent a year earlier. That was a dramatic change.
Posted by SacBoomer on 10/13/09 at 12:35 PM
I.R.
I had to blink a few times to be sure, and I went to the full article to be positive that they were referring to an annual return not the total return over ten years. 11.2% is frankly delusional. It seems that numbers only register on the way up, not on the way down. There isn’t much you can do in the face of magical thinking, is there?
Posted by Hard Numbers on 10/13/09 at 12:57 PM
New CA Laws:
http://business.theatlantic.com/2009/10/californias_sensible_mortgage_restraints.php
It’s not the best news reference, but this website is covering the newly-signed regulations for CA mortgages.
Enjoy,
Hard Numbers
Posted by Talyssa on 10/13/09 at 12:59 PM
I assume the realtor mean a YOUNG couple not a new couple. My SO and I lived in a 1br that size and found it quite comfortable for the two of us, provided we didn’t try and entertain more than 2-3 guests.
Of course we’re paying 1500 for a 2br2ba right now, AND i get to do my laundry inside instead of out on the front patio where people walk up.
Seriously, what a lousy design that is. The only thing worse than having to go out on your back patio to do laundry is having to go out on your FRONT patio to do laundry (well that and laundro-mat style). Yuck.
Otherwise, I like it. I’d buy it nad live in it if it was 50k - 60k cheaper (and if it didn’t have the laundry on the front patio, that’s kinda a deal breaker).
Posted by IrvineRenter on 10/13/09 at 02:54 PM
I think the FED will be able to sell the debt as long as we still have problems with deflation. The lenders have not written off their commercial loan debts yet. As long as we have deflation, even 3% bond yields have a real interest rate closer to 5%. When we start to have real inflation, it the FED will have a serious problem as you noted.
Posted by IrvineRenter on 10/13/09 at 04:01 PM
No, the optimism/delusion among the general population is truly astounding. If houses really did go up in value that fast, you would get rich by buying one… Oh, wait… that is what people really believe.
Posted by Tei on 10/13/09 at 05:37 PM
Hi - I’m trying to catch up on old posts and the links with the pages on the bottom seem to be messed up in case you didn’t notice. It jumps in multiples of 7 and ends up with a page not found.
Posted by mav on 10/13/09 at 07:00 PM
There is a feed back loop in place. A sudden spike in interest rates would lead to massive defaults and another round of deflation in asset values. Deflation is a very powerful force to reckon with… can you imagine what would happen if a catastrophic spike in 10 year t-bills from 3 to 6 % happened tomorrow? Asset value deflation and debt defaults would send rates back down… the global economy can not detach itself from the US without a catastrophic impact on the global supply chain…
Posted by Gemina13 on 10/13/09 at 09:51 PM
This is an excellent reason why financial fundamentals need to be taught in schools, starting as soon as kids learn about decimals and fractions.
Posted by mike23w on 10/14/09 at 03:47 AM
My coworker just bought a second house as an investment in the hopes of renting it out. I asked him if he ran the numbers to see if it made financial sense and he said “No, I’m not like you”. He just jumped in because the house had a big discount from the peak price. Idiot.
The bubble mentality is alive and strong.
Many people I know are heavily in favor of real estate as a low risk, high return investment.
Surprising, the majority of people don’t realize an asset(eg. Real Estate or stock) that is expensive will generally result in a lower return than an asset that is inexpensive.
What I can say with a good amount of certainty is that house prices will not appreciate anywhere near 10%/year over the next decade. Sadly, only a handful of us clustered on these blogs share the same sentiment. The general public is still delusion with greed - may they lose their money.