Wednesday, August 09, 2006

Thornberg on California Housing

by Calculated Risk on 8/09/2006 06:40:00 PM

UCLA Professor Christopher Thornberg writes for the East Bay Economic Development Alliance: California: Singing the Housing Blues. Here are a few excerpts:

The once loud debate over the existence of the bubble has now been replaced by a debate over how hard a landing it will be, whether home prices will drop, and most importantly what it means for the rest of the economy. What we do know is that we have not come close to the bottom of the market, and it promises to be painful.
On what is a bubble:
... a bubble is when the market price of an asset becomes misaligned with its fundamental value. In the case of housing the fundamental value is the net present value of the rental streams the house offers to its owner over its life. Such mis-valuation is driven by speculators who are betting not on changes in underlying values but simply expected appreciation. This self-fulfilling prophesy can drive the market for a short period of time but must eventually come to an end. What a housing bubble is not, is a period of time when asset prices fall sharply. This may happen at the end of a bubble in stock markets, but the fixed costs of transactions in housing markets causes overall market liquidity, rather than prices, to fall rapidly when the bubble ends. Housing prices fall slowly as a result. This suggests prices will remain overvalued for years.
And on the impact on the economy:
This does not mean the pop will not be harmful to the economy. The real estate and mortgage industries will be hit hard, as will those recent buyers who put themselves in an unsustainable financial position by buying a house far out of their income range hoping for continued appreciation to bail them out of their problems. Consumer spending will take a hit as well, as the home appreciation ATM machine will suddenly run dry.
On California employment (see The Fragile Economy):
The labor markets have been doing fairly well. Unemployment rates remain at very low levels, for the U.S. at about 4.6%, while here in California it has dropped to 5%. But there has been a very distinct slowdown in job creation since the start of the year, both at the national and state levels. At the national level monthly job creation has trended down from the range of 150,000 to 200,000 new jobs per month to 100,000. Here in California the strong pace of job creation in the latter part of 2005 has come to a complete halt, with the total number of jobs barely above where they were at the start of the year. And this time, we don’t have a surge in informal employment making up the difference. Instead, this slowdown is real.
There is much more in the forecast, and especially given the above excerpts, the forecast is actually fairly positive. Here is the entire Quarterly Economic Outlook.