Friday, August 14, 2015

CR on Housing in 2005

by Bill McBride on 8/14/2015 10:01:00 AM

Note: CR is on vacation, and I will return on Sunday, August 23rd.

Back in 2005 and 2006, at least every other post was about the housing bubble and the possible impact on the economy. Here are a few examples:

From April 2005: Housing: Speculation is the Key

I have taken to calling the housing market a "bubble". But how do I define a bubble?

A bubble requires both overvaluation based on fundamentals and speculation. It is natural to focus on an asset’s fundamental value, but the real key for detecting a bubble is speculation - the topic of this post. Speculation tends to chase appreciating assets, and then speculation begets more speculation, until finally, for some reason that will become obvious to all in hindsight, the "bubble" bursts.
This is relevant to the current housing situation. Some analysts are arguing prices are forming a new bubble now - based on fundamentals such as price-to-rent and price-to-income - however there is very little of the crazy speculation that was happening in 2005.  And even on a fundamental basis, the current situation is nothing like 2005.

From March 2005: California Real Estate Prices: Boom and Bust
Today I heard someone comment that California Real Estate never goes down. In fact, California RE has declined in the past in both real and nominal terms.
The decline in the '90s lasted 24 quarters from peak to trough. It took 9 years for prices to recover in nominal terms to their early '91 peak. Overall prices declined 12% in nominal terms and 26% in real terms.

Even more important for the economy are the coincident declines in sales volume. Real Estate prices are “sticky downward” since sellers are slow to adjust their prices down, and buyers are reluctant to buy a declining price asset. In this regards, real estate is an imperfect market in that prices adjust slowly to changes in supply and demand (unlike commodities like corn or wheat). Although prices do decline, it’s the decline in volume that leads to declining employment in real estate related occupations like construction, RE sales, mortgages, and more, and impacts the general economy.
And from August 2006: Housing: Inverted Reasoning?
As the housing bubble unwinds, housing related employment will fall; and fall dramatically in areas like the Inland Empire. The more an area is dependent on housing, the larger the negative impact on the local economy will be.

So I think some pundits have it backwards: Instead of a strong local economy keeping housing afloat, I think the bursting housing bubble will significantly impact housing dependent local economies.
CR Note: I do not have a crystal ball, but the housing bubble / bust seemed obvious!