98. Rant: Big Bubble of the housing market
Save This Post as PDFThis post is the next one in the series devoted to the study of the global financial crisis, its origins and possible consequences. Last time I’ve tried to argue that one of the main reasons for market bubbles to take off is the exceedingly large amount of reserve currency in circulation. Today I would like to discuss a one particular bubble – the one on the housing market.
As European Guy has indicated in the comment to my post about switchers, LHC and global crisis, the turmoil on the US housing market was actually the first sign of the newborn global financial crisis and maybe it has actually led to it. Let us try to determine whether it is so, what is the origin of this particular bubble and what we might expect.
1. Technical introduction into the turmoil: S&P indicators
So what is the current situation on the housing market that people who bought a house in US around 2006-07 are currently enjoying? Let us take a quick look though the recently published (October 28) S&P data:
- 20-City Composite S&P/Case-Shiller Home Price Index is 16.6% down compared to its value a year ago,
- 10-City Composite is 17.7% down,
- Existing Home Sales Median Sales Price is 8.6% down,
- Existing Home Sales grew 3.8%
- New Home Sales decreased 33.1 % (!)
- Real Residential Construction is down 21.7 % (!)
- Single Family Residential Construction is down 31.7% (!!)
To my layman’s eye it looks like there are lots of secondhand houses on the market, and prices got down quite a bit (3). Some people see this as the Opportunity, but their confidence is not yet terribly high (i.e., much more potential buyers remain cautious) (4). On the other hand, virtually nobody wants to buy freshly built houses (5) and construction dropped (6), (7) as a result.
If you scroll the S&P data list down, you will see two interesting quantities in the end: Consumer Confidence Index and Consumer Sentiment Index. These are slightly high, which may be an indication that the market has finally hit the bottom. Below I shall try to argue that this is not so, and the reason for CCI/CSI to grow is exactly that one: many people see such a market fall as the opportunity of their lifetime.
Case-Shiller composite indices take all the factors above into account and are therefore sufficiently good quantities to analyze. And that is what we see without any technical analysis (via bubblemeter) -
the older bubble’s blow off around 1988, the trend stabilisation in 1990-1998, the takeoff of the current bubble around 1998 and its blow off in 2004-2006.
It is immediately clear to me that a) during the blow off of the present bubble the composite indices fell way below the quasi-trend line of 1990-98 and b) this bubble is probably just the next one in the sequence of older bubbles. As I would like to conclude from (a), the fundamental issue that has led to takeoff of initial bubbles is yet to be resolved and therefore the housing market has not reached its bottom yet (we will talk about it more in the end of the post).
2. Why is the housing market bubble so dangerous?
In this section, I am going to write down a long list of banalities. The goal I am pursuing is not to disappoint US readers, who know this staff all too well, but to construct a firm cognitive model of the housing market bubble in my head.
As BusinessWeek wrote in January,
According to an analysis conducted for BusinessWeek by Zillow.com, the real estate Web site, a further 20% decline in prices nationwide would mean that two-thirds of people who bought in the past year would owe more than their homes would be worth, meaning they couldn’t take out cash if they wanted to.
Well, that is, to my understanding, exactly what happened. While so many people have used their homes as the source of cash through refinancing mortgages back in 2005, they’ve got a painful hit back in 2008 – cash is gone long ago, and their mortgage debt grew higher than the market value of their homes. The latter statement is the key one explaining why housing bubbles are to burst.
While a house bubble is trivially dangerous for public (people loose their houses, their valuable time spent on work to repay mortgages and their opportunities), it is also extremely dangerous for institutional investors and banks. The latter get seriously weakened by mortgage losses and the loss in value of mortgage backed securities and derivatives. Basically, instead of mortgages repaid in full banks get back houses they physically own until the mortgage is repaid. Since the market value of houses has changed, it is impossible for banks to sell these houses even asking for prices they were initially bought at.
Second thing why a housing market bubble is so dangerous is that the housing market is huge in value. In US only its potential depth is probably as high as 40 million houses (based on the estimation of the US population, that is about 400 million people now – every family may want to leave in its own house), and this number is going to grow nearly exponentially (since the population grows nearly exponentially). with Starting prices for houses and apartments are at the level of 100000 US (for a bachelor apartment), and not so many bachelors can actually afford it. As a result, they go to a bank and apply for a mortgage. Taking into account that the most popular mortgage is 25 year one and the average percentage is (substitute here your favorite number, mine is 5%), you finally really get the idea. It means that institutional investors cannot help (well, cannot actually afford not to) entering this market, and they are the ones who is going to feel the real pain (measured in US dollars, of course, the public gets the real reals one) from the market bailout.
Interestingly, the first signs of coming bailout came already in 2001 (see the plot above). I don’t really think it was Osama who hit the American economy at that time.
3. Pulling the trigger of the global financial crisis
So, why do I think the housing market turmoil has initiated the global financial crisis? Since my theory is that this crisis is the one of liquidity, I would say that the housing market (its bubble, in particular) absorbed too much free cash. Since FED wanted to keep the economy warmed up, they have started to print even more priceless green pieces of paper; the latter has led to a resonance instability 
, since money were again absorbed by the housing market, etc. etc.
4. Some conclusions. Where is the bottom?
Housing decline of 1925-32 has seriously affected banks and strongly contributed into the Great Depression of 1932. The housing market crisis was finally resolved with the end of War and the Great Depression itself (note that the resolution of the turmoil at that time required complex measures strongly influencing the situation beoynd the housing market) – by postwar housing boom of 1950. Does the current situation remind me the one of the Great Depression? You bet it does: residential construction has reached a much higher peak in 2005 than the peak of 1950 – it was necessary to house all the baby boom generation. Did it stop the development of the housing market turmoil or maybe has slowed it down? You know the answer. Another illustration comes from the last December – Fannie Mae and Freddie Mac, private companies with implicit government backing at that time, had 87% of mortgage securitizations. You know in what situation both companies are currently. This actually allows me to think that the current sutuation may be actually more serious than the one of 1930s. I strongly hope this is not so… In the mean time, I shall prepare to see the bottom near 2010-2012. By the way, house price growth is slowing and reversing everywhere (well, with the exception of Moscow, I think ): Europe and UK foremost.
So, in conclusion, I have an impression that the bottom is still very far, since the fundamental reason for this financial crisis, this housing bubble and previous series of bubbles is still to be identified and resolved by authorities. Your humble correspondent has indentified this reason ias a) the FED policy regarding the support and total amount of reserve currency in the world (I think, I have already discussed this issue extensively) and b) the generally accepted policy of credit expansion followed from (a).
But about this – in the next time.
Some more or less relevant references
- S & P key housing indicators
- Bubblemeter – the guy writes really nicely
- BusinessWeek – Housing meltdown, Jan 2008 issue
- Wikipedia – US housing bubble and references therein, that’s quite a study
- The housing crisis: how we got there – azcentral.com
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