The Emperor's New Clothes


Dec 2009 FHFA Housing Prices – Is the recession over?
April 30, 2010, 3:21 pm
Filed under: Housing Prices | Tags: , , , , , , , , ,

The assertion that the recession is over reminds me of Bill Clinton’s defense of his assignations with Monica Lewinsky … he simply defined the word “sex” rather narrowly.  Likewise, the economists’ definition of “recession” is fairly narrow.  It is “two down quarters of GDP”.  By that definition, the recession is over.  However, for the 9.7% of our workforce that are unemployed, and the 49% of homeowners with mortgages that are underwater, it sure doesn’t feel like it has ended.

We might reasonably expect that our high unemployement rates and housing markets will return to their respective norms.  I believe this to be true.  The major caveat, however, is that real estate prices have already done this. We are at the norm!  The 2005/2006 real estate prices were an aberration that we will not see again.  We have not experienced a temporary declination in values, but rather a permanent correction.

As is well known, real estate prices have fallen off the cliff in many markets.  From peak-to-trough the Miami CBSA has fallen 44%; Oakland 41%; and Phoenix 42% (to mention just a few).  Interestingly, however, other markets such as Dallas have shown modest but consistent growth in real estate values over the past twenty years.  In fact Dallas is currently at its twenty year peak.  The difference between the bubble and the non-bubble markets lies in one very important statistic; namely, real estate value as a multiple of per capita income.

It goes without saying that there is a relationship between home prices and mortgagors’ income.  For example, if you buy a $300,000 home with 10% down, your principal and interest payments would approximate $1,500/month.   Throw in another $250 for taxes & insurance and you have a housing cost of $1,750/month.  At a 28% housing ratio, this translates to an income requirement of $75,000 per year.  Thus, in this example, the mortgagor could afford a house equal in value to 4 times annual income.

Actual value/income went through the roof in the bubble years.  CBSAs such as Oakland had value/income ratios in excess of 9, while Dallas was only 4 .  While a nine multiple may be supported short term by home owners trading amongst themselves, it precludes buyers from moving from a low ratio area into a high ratio one.  In the long term it is unsustainable.  Real estate prices have essentially declined to sustainable levels over the last couple of years.

Accordingly, government attempts to support real estate values are akin to Sisyphus continuously trying to roll a rock uphill.  The best we can do is to mimic Captain Sullenberger in his crash landing of Flight 1549 in the Hudson River.  We may be able to control the descent, but there is no way in the world we can artificially inflate the real estate markets above their sustainable levels.

So, is the recession over?  It depends on how you define “recession”.

NB … data used in this blog were obtained from www.PredictiveData.Info.  The author is the owner of this data research firm.


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