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  • Housing Bubble Correction

    Housing Bubble Correction

    Fifteeen Years to Revert to the Mean

    January 20, 2005
    "If there is a real shift downward in housing demand, it would have a dramatic impact across the entire economy," said John Benjamin, a professor of finance and real estate at American University.

    Millions of Americans have become dependent upon rising home values to support home-equity loans and mortgage refinancings, which can be used to pay for cars, remodeling projects, clothes and more.

    "We live in a consumption economy that is financed by debt," which in turn largely rests upon our home foundations, Benjamin said.

    The labor market, too, depends upon feeding the hunger for housing.

    Since the beginning of the economic recovery in November 2001, employment in housing and housing-related industries has accounted for 43% of the increase in private-sector payrolls, according to Asha Bangalore, an economist for Northern Trust Corp.

    - Experts ask: Is there a housing bubble?
    Housing bubbles don't collapse suddenly. They go through a long series of self-reinforcing deflationary stages that typically last five to seven years. Given the extreme and unprecedented nature of the current housing bubble, I expect a ten- to fifteen-year downturn to follow this boom. The government will step in with all manner of supports and bailouts along the way, similar to those that created the bubble in the first place, so the exact trajectory of the decline is impossible to predict. Here I estimate how and over what time period the decline may occur.


    Chart 1: Correlation of Housing Prices to Employment

    Chart 1 above shows that housing prices are strongly correlated to the unemployment rate. Housing prices fall as unemployment rises, and vice versa. Given that 43% of all jobs created since 2001 are housing (bubble)-related, a decline in housing-related payrolls can be expected to reinforce housing price declines in the bust part of the cycle. The rate of home equity extraction is a good proxy for the housing market itself. Home equity extraction tends to rise in line with property values and declines on the way down; no home owner wants to borrow against a deflating asset, and no bank wants to secure a loan against one either.



    Chart 2: Home Equity Extraction - Past and Predicted

    We'll use home equity extraction as our yardstick to project the bust. Thanks to my friend Paul Kasriel at Northern Trust for the original of Chart 2, which shows home equity extraction from 1950 until 2005. I have modified it to show a possible trajectory of home equity extraction decline in seven steps, A through G, from now until 2020. While I'm fairly confident in the length of the entire process, the length and timing of each step is subject to a wide range of error.

    Step A: You are here. Whether the rate of home equity extraction implodes from here (as shown) or decreases more gradually is a matter of debate, although in past boom-bust cycles, the bust rate of decline has been significantly more rapid than the boom rate of growth. What is not debatable is whether the rate of home equity extraction will revert to the mean rate of about zero, from the current rate of more than $250 billion annually. It will.

    In fact, the rate of home equity extraction will tend to overshoot the mean to reach an extreme negative rate of equity extraction (building equity) that's twice the rate of positive extraction that occurred during the boom phase. This relationship occurred in the previous two cycles, which bottomed in 1982 and 1995, respectively. This implies negative equity extraction of minus $500 billion per year at the cycle trough. Chart 2 shows a more optimistic prediction of negative $250 billion occurring between 2015 and 2020. This more prosaic estimate accounts for government efforts to mitigate the impact and minimize the overshoot, by offering specialized loans, making direct purchases of securitized mortgage debt, and so on.

    Step B: As housing prices begin to decline, sales will continue, though more slowly and less frequently. Old habits die slowly. One year into the decline, housing speculators will have left the market, but home owners will generally still believe that prices will either resume their rise or at least flatten out, not continue to decline. Remember the first year of the stock market bubble decline, when most people hung in there until they'd lost all of their money? The first lesson of behavioral finance is that the most common mistake made by market participants is to hang on too long and fail to cut losses.

    While home owners at this stage will borrow less against their houses, and loans will be more difficult to come by, the average home owner will still make frequent trips to Home Depot or hire contractors to make home repairs and improvements, believing they'll "get their money back" in an increase in the value of their home at least equal to the cost of fixing it. Some home owners will put their home up for sale—if they purchased early enough in the boom so that they can still realize a profit, even selling at five to twenty percent below the peak price.

    Step C: After prices have declined for two years, large numbers of buyers who purchased near the top of the market will begin to feel the psychological effects of being underwater on their mortgage. They will be less inclined to borrow money, or to spend money fixing up their home, as home improvement value increases will be swallowed up by general market price declines. There will still be profits to be made by those who bought very early in the previous boom cycle, but fewer people will have this option.

    As transaction volumes continue to fall, demand for housing-related employment will decline too. The first signs of labor market distress will start to show up, as more and more of that 43% of the private sector who found jobs in the housing industry are no longer needed. Coincidentally, major employers—such as the U.S. auto industry—will be going through major restructuring, adding to pressures on housing prices in some areas. Some home owners will need to sell at a loss in order to move to regions of the country where the labor picture is better, and will do this if they have enough equity and are not paying cash out of pocket to cover their remaining mortgage obligations. These sales will further depress home prices.

    Step D: Three years into the decline, marginal home buyers will learn what owning a home really costs, versus renting when housing prices are declining and jobs are more scarce. Rent is a fixed cost, whereas home ownership presents many variable costs, including increased interest payments on ARMs, and rising tax, insurance, and energy costs. Also, upkeep for the average home typically costs five to ten percent of the price of the home, annually. As prices fall, homeowners will have less access to home equity loans. Many will not be able to afford repair and maintenance expenses. Homes in some neighborhoods—and in some cases, entire neighborhoods—will begin to look neglected, further depressing prices.

    Step E: Five years into the downturn, rising unemployment will begin to more seriously affect the market, as indicated in Chart 1. As unemployment rises, homeowners will leave housing bust regions to move to areas where there are more jobs. Many houses will be sold at a loss, or even abandoned, as the market price falls below the loan value. Given the choice between paying cash out of pocket to sell their home or leaving the keys with the bank, many home owners will make the latter choice.

    Step F: Ten years into the downturn, real estate will be widely regarded as a terrible, "can't win" investment. McMansions will be subdivided for rental as multi-family homes.

    Step G: Ten to fifteen years after the start of the decline in housing values, prices will bottom out, setting the stage for the next boom. Time to buy.

    (This article was written by Eric Janszen and originally published on the AlwaysOn Network, January 15, 2005)

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    Last edited by FRED; 08-23-06, 08:34 PM.
    Ed.

  • #2
    Schwab bringing the message to the masses June 26

    "
    * Housing affordability in free-fall.
    * New and existing home inventories surging.
    * Adjustable rate mortgage holders to get pinched.
    * Real estate now a big chunk of household net worth.
    "
    http://www.schwab.com/public/schwab/...ting_ugly.html

    Comment


    • #3
      time nailed the peak

      the peak was nailed by time magazine, with its june 13, 2005 cover:

      Home $weet Home

      Comment


      • #4
        national may foreclosures up 28% yoy

        Irvine, Calif. – June 26, 2006 – RealtyTrac™ (www.realtytrac.com), the leading online marketplace for foreclosure properties, today released its May 2006 U.S. Foreclosure Market Report, showing 92,746 properties nationwide entering some stage of foreclosure during the month, an increase of less than 2 percent from April 2006, but still a 28 percent increase from May 2005.

        Comment


        • #5
          Housing Bubble Correction Update: August 24, 2006

          As the housing market goes through the ten to fifteen year, seven step decline originally predicted January 15, 2005, I'll update this post when I believe we're transitioning from one step to the next.

          At this time most housing markets that experienced bubble growth in the US are exiting Step B and entering Step C.


          Step C: After prices have declined for two years, large numbers of buyers who purchased near the top of the market will begin to feel the psychological effects of being underwater on their mortgage. They will be less inclined to borrow money, or to spend money fixing up their home, as home improvement value increases will be swallowed up by general market price declines. There will still be profits to be made by those who bought very early in the previous boom cycle, but fewer people will have this option.

          As transaction volumes continue to fall, demand for housing-related employment will decline too. The first signs of labor market distress will start to show up, as more and more of that 43% of the private sector who found jobs in the housing industry are no longer needed. Coincidentally, major employers—such as the U.S. auto industry—will be going through major restructuring, adding to pressures on housing prices in some areas. Some home owners will need to sell at a loss in order to move to regions of the country where the labor picture is better, and will do this if they have enough equity and are not paying cash out of pocket to cover their remaining mortgage obligations. These sales will further depress home prices.
          We are now 12 to 18 months into a ten to fifteen year decline. We are starting to see major press stories covering the decline. Not in the Real Estate section, of course, but in the Business section of the newspaper. After prices decline for another year, you will stop seeing stories in the press. Why? Housing price declines won't be "news" anymore. They will be a fact of life that everyone accepts.

          When I was first researching for iTulip.com back in 1997, I'd go to the library and read newspapers on microfilm from the 1930s, looking for stories on The Great Depression during
          The Great Depression. To my surprise, there were none. The Depression wasn't news. The Depression simply "was." More interestingly, as you'd expect there were many ads for inexpensive property in the classified ads section (home prices declined an average of 80% as the banking system imploded), but at the same there were ads for commercial flights to California from New York. "Cross country in only 24 hours!" And for the equivalent of about $10,000 in today's money. This at a few thousand feet, the bumpiest altitude, in a very noisy propeller plane without radar.

          A good number of our readers sold their homes a year ago or more and are now renting. One of these readers who writes in from time to time wrote in last week to tell us he and his wife just renewed the lease on their rented home for another year and are keeping an eye on home prices in the neighborhood with an eye toward buying when the prices appear to be bottoming out. Prices are going down, but the declines appear to be picking up pace, so they'll wait.

          The most common worry expressed by these folks is the continued loss of purchasing power of the money they made as capital gains from selling their home. While the prices of homes are declining, the prices of items on the menus of local restaurants, for example, keep going up. Invest in printing companies?

          I wrote in September 2001 when gold was trading at $270 that I believed gold was a good hedge against the inflation I predicted to occur following government efforts to reflate the economy after the stock market bubble decline. I maintain that a $2000 to $2500 price at the top of the cycle is reasonable, but caution that diversification across precious metals is necessary. I have done well with gold since then, but better with silver and platinum.
          Last edited by FRED; 08-24-06, 12:16 PM.

          Comment


          • #6
            Re: Housing Bubble Correction

            Posted yesterday on Financialsense.com is an article by Kurt Richebacher titled "A Tightening Farce" http://www.financialsense.com/editor...006/0915b.html

            Originally posted by Richebacher
            Present American folklore has it that a protracted slump in house prices is impossible. Let us say for many people it is unthinkable. And that is precisely one reason why this housing bubble could go to such unprecedented excess. The little historical knowledge we have about bursting housing bubbles is from a study published by the International Monetary Fund in its World Economic Outlook of April 2003. It presents past experience in a very different light. Here are some excerpts on decisive points:
            Richebacher lists 4 points he thought pertinent from the above study, the last of which is
            Originally posted by Richebacher
            The authors then give a fourth reason, which was true in the past, but in which the situation in America today radically differs:
            "Housing price busts were associated with tighter monetary policy than equity price busts, reflecting the fact that most housing price busts occurred during either the late 1970s or the late 1980s, when reducing inflation was an important policy objective. The disinflation increased the real burden of debt, which exposed inflation-related overinvestment and associated financial frailty."
            Richebacher argues that credit in the USA has not been seriously tightened so far by the Fed.

            It seems to Richebacher is arguing that the housing bubble may not be over; however, I am not very good in devining the meaning of many things regarding economics. What might anyone else gather from Richebacher's article?
            Jim 69 y/o

            "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

            Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

            Good judgement comes from experience; experience comes from bad judgement. Unknown.

            Comment


            • #7
              Re: Housing Bubble Correction

              NATIONAL FORECLOSURES INCREASE 24 PERCENT IN AUGUST
              By RealtyTrac Staff
              Foreclosures Up Nearly 53 Percent from August 2005, 38 Percent Year-to-Date
              IRVINE, Calif. – Sept. 13, 2006 – RealtyTrac™ (http://www.realtytrac.com/), the leading online marketplace for foreclosure properties, today released its August 2006 U.S. Foreclosure Market Report, which shows 115,292 properties nationwide entered some stage of foreclosure during the month, a 24 percent increase from the previous month and an increase of nearly 53 percent from August 2005. The report also shows a national foreclosure rate of one new foreclosure filing for every 1,003 U.S. households, the second highest monthly foreclosure rate reported year to date. [emphasis added]

              Comment


              • #8
                Re: Housing Bubble Correction

                I found Shedlock's anecdotes on housing bubble collapse informative and scarry if one considers the couple with 3.4million bonars in mortgages.

                http://www.safehaven.com/article-5936.htm
                Jim 69 y/o

                "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                Good judgement comes from experience; experience comes from bad judgement. Unknown.

                Comment


                • #9
                  Re: Housing Bubble Correction

                  Originally posted by Jim Nickerson
                  I found Shedlock's anecdotes on housing bubble collapse informative and scarry if one considers the couple with 3.4million bonars in mortgages.

                  http://www.safehaven.com/article-5936.htm
                  scary indeed. you wonder about how the fed pumping liquidity down the road is going to help the people who worked in the closed restaurants, the mortgage holders going under, etc. i have to say i don't feel sorry for the couple with us$3.4million in mortgages - stupidity i can be understanding about, but stupidity coupled with greed doesn't generate a lot of sympathy from me. there will be a lot of casualties; plenty of deserving objects for sympathy or, perhaps, help.

                  Comment


                  • #10
                    Re: Housing Bubble Correction

                    Originally posted by jk
                    scary indeed. you wonder about how the fed pumping liquidity down the road is going to help the people who worked in the closed restaurants, the mortgage holders going under, etc. i have to say i don't feel sorry for the couple with us $3.4million in mortgages - stupidity i can be understanding about, but stupidity coupled with greed doesn't generate a lot of sympathy from me. there will be a lot of casualties; plenty of deserving objects for sympathy or, perhaps, help.
                    jk, this morning I read my wife the info about the couple who had 3.4million in mortgages and the two words I used to describe them were "stupid" & "greedy." No telling how much of this sort of utter foolishness exists, and who is ultimately going to have to bail out them out? A lot of people who had nothing whatsoever to do with the whole situation. Before all this is over, everyone is going to grow quite sick of reading and hearing about it.

                    Hey, what happen to Thelonius? Becoming accustomed to that cuddly bear is going to take some time. Are we now to believe you are a bear?
                    Jim 69 y/o

                    "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                    Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                    Good judgement comes from experience; experience comes from bad judgement. Unknown.

                    Comment


                    • #11
                      Re: Housing Bubble Correction

                      Originally posted by Jim Nickerson
                      jk, this morning I read my wife the info about the couple who had 3.4million in mortgages and the two words I used to describe them were "stupid" & "greedy." No telling how much of this sort of utter foolishness exists, and who is ultimately going to have to bail out them out? A lot of people who had nothing whatsoever to do with the whole situation. Before all this is over, everyone is going to grow quite sick of reading and hearing about it.

                      Hey, what happen to Thelonius? Becoming accustomed to that cuddly bear is going to take some time. Are we now to believe you are a bear?
                      in the "roubini is eyeore" thread i noted that jim cramer must be tigger, i didn't know who was rabbit, but that when my positions go against me i feel like pooh, "a bear of little brain."

                      Comment


                      • #12
                        Re: Housing Bubble Correction Update: August 24, 2006

                        OVERAGES of: homes + stocks = 1.3 GDP
                        Referring to Real Dow & Real Homes here
                        http://homepage.mac.com/ttsmyf/RDandRJShomes.html
                        I recently reckoned each as ca. 1.85x historical trend.
                        In trillions, for late/end 2005, USA: GDP = $13.0; homes = $21.5 (= 1.65 GDP); stocks = $15. (= 1.15 GDP).
                        The sum of the two above trend overages = 1.3 GDP.
                        (I reckon all the above is a little rough, not a lot.)

                        Comment


                        • #13
                          Re: Housing Bubble Correction Update: August 24, 2006

                          Originally posted by Ed
                          OVERAGES of: homes + stocks = 1.3 GDP
                          Referring to Real Dow & Real Homes here
                          http://homepage.mac.com/ttsmyf/RDandRJShomes.html
                          I recently reckoned each as ca. 1.85x historical trend.
                          In trillions, for late/end 2005, USA: GDP = $13.0; homes = $21.5 (= 1.65 GDP); stocks = $15. (= 1.15 GDP).
                          The sum of the two above trend overages = 1.3 GDP.
                          (I reckon all the above is a little rough, not a lot.)
                          How long to save this much: OVERAGES = 1.3 GDP?
                          I sought to express 1.3 GDP in terms of the US personal savings rate -- of ‘back in the old days’ when it approached 10% of personal income -- I use annual personal savings rate = 8% of GDP = 0.08 GDP per year. 16.25 years times 0.08 GDP per year equals 1.3 GDP. Time-consuming!

                          Comment


                          • #14
                            Re: today's "good" new sales data

                            from a reader at bill fleckenstein's site:

                            This morning's press release announcing a "4.1% increase" in new home sales came as quite a surpise in light of other data points in the housing area. As expected the TV shills were touting this great number and its goldilocks implications.

                            A reading of the actual press release reveals that the 4.1% increase is based on a comparison of the August ESTIMATE of 1,040K to the July REVISED number of 1,009K. The July estimate number was 1,072, thus the REVISED July number is down 5.8% from the estimate and the July reported 4.3% drop from June is now a 9.9% drop from June. Using the apples to apples comparison of August estimate vs. July estimate, new home sales DROPPED 3%.



                            and from another reader:
                            On the residential real estate front, numbers came in for our ABS traunches. Payment shortfalls (delinquencies / defaults) continued at about the same pace as last month (some traunches better others worse), but there WAS one new (and welcome) development: actual foreclosures jumped. Looks like the servicers are getting more aggressive on the foreclosure front (probably due to greater concern about losses now that prices aren't going up). In the past (as prices were rising) the incentive was to be patient (work with the borrower / drag their feet on actual foreclosure) because losses would be lower the longer you waited. NOW, however, the reverse is starting to look possible and that appears to be spooking servicers.

                            Another interesting data point, losses on foreclosures on 2003/2004 loans are coming in at about 20% despite substantial price increases since then...I wonder what they'll look like on 2005/2006 loans? 40-50%?

                            and

                            Here is a link to a Reuters article on MSN titled "Home Loan Demand Falls Despite Rate Plunge."

                            http://news.moneycentral.msn.com/pro...927&ID=6056444
                            Last edited by jk; 09-27-06, 03:42 PM.

                            Comment


                            • #15
                              Re: Housing Bubble Correction

                              http://www.marketwatch.com/News/Stor...o&dist=myyahoo

                              This is a nice article discussing the relationships between the Housing Market Index and the SPX, which suggests the SPX could fall to 530 by Fall of 2007.
                              Jim 69 y/o

                              "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                              Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                              Good judgement comes from experience; experience comes from bad judgement. Unknown.

                              Comment

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