In that regard, I’d again point to my idea of having appraisals not only based on current values, but prior values, such that perhaps FHA wouldn’t loan more than 96.5% of current value, and 90% of value a year prior (or some such numbers). You could do that without involving any tax dollars, and in fact it would have placed fewer tax dollars at risk if done 5 years ago.

RE: patient @ 76 – All that’s saying is you think prices are too high. You disagree with the market. That really doesn’t mean much, other than that you will not be likely buying. Other people drive the market, and they determine value. To come to a different conclusion you have to redefine value.

The U.S. government also disagrees with the market. Otherwise there would be no need for massive tax subsidies, trillions pumped into banks, taking over 80% of the country’s mortgages, and numerous other desperate tactics currently being used to support house prices at artificial levels that a true supply and demand market could never bear.

IOW, all the extra money being pumped in the economy to inflate house prices is the “added value” that doesn’t actually exist in the house itself. So when people buy in todays, market, they are not just buying the house, they are buying all that extra value as well. That makes the deal seem better. But even so, I wouldn’t exactly call the current sales rate a symbol of massive value in the housing market.

I agree with that. With rising incomes comes rising prices as more money chases available goods and services (and vice versa).

If the fixed costs do remain fixed (i.e. if the cost of the “basic needs” remains constant), then your reasoning is sound.

Or if the expansion of money outpaces the increase of the cost of basic needs.

What I’m getting at is, I believe, the sudden availability of easy to get low-down loans increased the amount of money chasing the available assets well beyond the rise in the cost of basic needs or the rise in incomes. This sudden increase caused the multiplier to rise. During this time, a decreasing unemployment rate caused people to feel safe enough to pay a higher percentage of their monthly incomes for housing costs. The decreased interest rate and market exuberance helped push the multiplier over the top of the previous range.

The reverse of this is to remove these loans (and many others) from the supply of money chasing available assets and to increase unemployment. Falling wages would cause a further decrease of the multiplier, even if the cost of basic needs tracked the loss in wages. This is because surplus money would be saved in this fearful environment just as it was spent in the previous greedy environment.

Personally, I don’t believe the multiplier will overshoot the bottom as long as interest rates remain low. But I do believe the multiplier will decrease despite the cheap loans, tax credits, buying of toxic assets, propping up of the banks, etc. And if interest rates go up, all bets are off as to the sustainability of the current multiplier.

I’m not trying to be disagreeable. I’m just trying to express my opinion and work out my thoughts on the issue. It’s something that interest me as a potential home buyer.

There were coal mining towns in the east that went ghost after the federal government required the use of lower sulfur coal. The mines that produced coal with too high sulfur content could no longer sell their product, so total income in the area goes to near zero. All the homes go up for sale at approximately the same time, yet there are few, if any, buyers for the homes located near the former mining operations.

Shelter might have some basic value, but to place it within the context of dollar value, one must go further than to just claim shelter has value. Having a grocery store nearby has value too.

In part this was written especially for David Losh @ 57!

Think it can’t happen to areas as populated as Seattle?

Question:

How far from Ghost is Detroit?

If the fixed costs do remain fixed (i.e. if the cost of the “basic needs” remains constant), then your reasoning is sound.

There are some who suggest that housing should be between X and Y percent of total income. Using this, with some nice assumptions about taxes, interest rates, maintenance, and so on, we could get to a multiplier, and then if the incomes went up, the total value of all the properties in the area should also go up.

Ghost towns, where a mine has dried up, generally have low property values, even if the structures are nice. Total income is near zero.

IMO, inflation is in the greater interest of the puppet masters than deflation.

Actually, I don’t think this is true…

Look at what’s happened in Japan over the last 20 years. The policy makers there did NOT want to see deflation, and did everything they could do to prevent it (including MASSIVE stimulus spending, etc), but they wound up with deflation nonetheless.

When my statement is taken out of context, your statement appears to disagree with me. But in context, you appear to somewhat agree with me.

“IMO, inflation is in the greater interest of the puppet masters than deflation. This does not mean horrific deflation will not occur.”

Financing requirements limit the “market value” decision of the vast majority of home buyers. Most home buyers would pay any amount of money as long as the bank would let them, after all it is not real money just some documents to sign. Hence the bubble.

RE: Jonness @ 64 – I’d answer this in a simpler way.

Let’s say all wages, for the year, are 100 (an index).

When wages go down to 90 (90%), home values will generally follow, as the multiplier remains constant, maybe is even reduced by some other fixed costs.

Of course this can go on and on until a new equilibrium is established.

IMO, the multiplier cannot be thought of as basically constant. It only appears that way because many of the influential factors typically remain fairly constant. I agree that lower wages cause lower home prices because the multiplier is multiplied by wages, but I don’t think this tells the entire story.

I’ll demonstrate with extremes. Let’s say in a given (hypothetical) year, average people can afford to spend $5K extra beyond their basic needs. In the following year, average people can afford to spend $500K beyond their basic needs. This increases the multiplier. Falling incomes have a similar effect that decreases the multiplier. Depending upon how far incomes fall, prices can overshoot the bottom of the multiplier range.

I agree other fixed costs such as interest rate changes do weigh in, but the amount of money people have to spend compared to the amount of assets available also influences the multiplier.

For example, the multiplier was 2.84 in 1989 and 5.92 in 2007. Lax credit helped cause this, as the borrowed money competed with real money to purchase the assets.

RE: Tim @ 56 – You are putting trend analysis, possibly some fundamentals, against the efficient market hypothesis.

An appraisal is a guess, estimate of a final selling price without knowing any one specific buyer’s value.

The only person who knows a given buyer’s value is that buyer. Even if a buyer says what his value is, that number cannot be trusted.

In general lenders do not value the underlying security, except for contingency planning. Clearly signature loans do not require any professional appraisal; it only takes the buyer’s valuation.
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RE: AMS @ 58 –

I’d pit a fair number of analytic techniques againt EMH, given that the latter is demonstrably false. Whether or not we’ve come up with a valid, empirically supported counter-hypothesis, EMH is wrong enough–and has been proved wrong often enough–that I’m surprised you even bother to invoke it.

Anyway, I think a number of prospective first-time buyers–and some long-time appraisers who have been squeezed out by the recent standards–might take issue with your assertion that lenders pay no attention to “the value of the underlying security.” How many deals have been hopscotched because of bad appraisals–either falsely high so the seller holds out for an unrealistic price, or falsely low so the bank/buyer neg the deal because they think the asset is truly worth less? (And I’m talking at the moment of transaction, so no need to beat me up with statistics about how the market is heading downwards.) Hard to gather statistics on this one, I think, but the results would be illuminating.

Let’s say all wages, for the year, are 100 (an index).

When wages go down to 90 (90%), home values will generally follow, as the multiplier remains constant, maybe is even reduced by some other fixed costs.

Of course this can go on and on until a new equilibrium is established.

RE: Jonness @ 30 – No, I am not using probability here, I am asking what happens when wages go down. I am not asking if they will go down, or any probabilities.

I suspect you know the answer to that question better than I do, but here goes:

At the most basic level, when people have less money to chase assets, the asset prices go down. If it goes on long enough, historical valuations are undershot. Seeing that Seattle home prices were 3.52x in 1990, 3.57x in 1998, and 5.13x in 2009, further rises in unemployment and decreases in income wouldn’t fair well for home prices. Considering inflation-adjusted incomes have remained stagnant or decreased for some time, and unemployment is approaching double digits, I would say 5.13x is unsustainable even in light of the massive stimulus being used to artificially prop up prices.

Many people claim now is a great time to buy in Seattle, and I’m left wondering what data they are looking at? If one needs a home, it might be a great decision to buy one for personal reasons. But I just don’t see it being a historically great time to buy for financial reasons as is often claimed in the media.

The question is, will the housing market go the way of the auto industry when the stimulus is removed? IMO, govt stimulus results in less than 1:1 velocity, so it can only be thought of as a temporary measure. At some point, the real problems have to be addressed, and I feel the biggest problem is that the debt has to be unwound. Hiding it can only stoke spirits for so long. Can we really just continue borrowing greater and greater sums for eternity in order to rev up the engine? I suppose it’s possible, but I cannot currently perceive enough of the big picture to understand how it is possible. I understand that money can be locally devalued in a manner relative to local assets, but in our case, that typically means increased oil costs, which can nuke a fragile economy struggling to recover. It all seems to come down on the backs of the American consumer, and as far as I can tell, the consumer is not in good enough shape to lead us back to 7x valuations. This makes me believe the best possible outcome is sideways home prices from here to ? And if that’s the best-case scenario, the worst-case is downright scary.

I never claimed that it is worth what someone is “prepared” to pay, but rather I claim that it has a market value what a willing and able buyer will pay. Generally, as Tim pointed out, the market value of assets is only seen in the rear view mirror, and as you point out, that does not necessarily predict the future market value.

The value someone places on a given asset at a given time is different than market value, as it is usually the case that people are willing to pay more.

This illustrates why airlines have such crazy pricing: The airlines seek to sell high dollar tickets to those who value the air transportation the most while not giving up the customers that don’t have such high value on the air transportation. If an airline sold all tickets at the same price, some customers would not buy and others would have paid much more.

The big issue however is how to value the risk of not being paid, and then the question of the value of the pledged security comes into play.

Signature loans, for example, have no hard asset security, but often these are fairly low risk, and thus are paid back.

With deflation, debts are repaid with ever more valuable dollars, giving bankers additional effective wealth or buying power.

That’s an interesting point I had considered on a personal level but hadn’t applied to the banks. It seems to me the benefits of better debt repayment through deflation are offset by the decline in the value of assets they hold. I suppose if they can hold the declining assets on their books at full value and hide all the shadow inventory long enough, perhaps they can come out the other end. It seems to me to be a risky bet though, considering, as you say, the fed/govt might not have enough power to push the snowball uphill when the appropriate time comes around.

What are your views on the benefits of deflation to banks vs the hit they take on their devaluing assets, and why do you feel deflation in the short-term provides them the better outlook of the 2 paths?

Thanks

This is a pretty good short video from Yahoo Finance that touches on the inflation/deflation possibilities:

http://bit.ly/3ajnma

If only someone had a podcast…

I think we need to get some terminology defined.

Value is the maximum a willing and able purchaser is willing to pay. Each purchaser is going to have a different value, and to make things nice, let’s assume that the value is established independently of other purchasers.

Alpha is the difference between a purchaser’s value and the purchase price.

An appraisal is a guess, estimate of a final selling price without knowing any one specific buyer’s value.

The only person who knows a given buyer’s value is that buyer. Even if a buyer says what his value is, that number cannot be trusted.

In general lenders do not value the underlying security, except for contingency planning. Clearly signature loans do not require any professional appraisal; it only takes the buyer’s valuation.

If the lowest price a seller will accept is above the maximum value, then there will be no sale.

If the lowest price a seller will accept is below a buyer’s maximum value, then a sale may take place. If that buyer needs funding from a third party, and that third party relies on another to appraise the asset, then there may be a problem with the sale, as you are well aware.

In summary, it’s impossible to know how any buyer values a home, as each buyer values items differently. It is possible, however, to get the methodology of an appraiser, which may or may not accurately reflect what buyers are willing and able to pay.

Housing units have the value of housing: shelter, convenience, and amenities.

If you take the cost approach we can see today that the cost of materials is going down, the price of land is going down, and labor costs are way down.

Just because people paid a higher price than actual value, the value of the housing unit, does nothing to change the value.

Let’s take location, location, location. If you build two houses exactly the same, for the same cost, one in Seattle and the other in Ellensburg, will they, or should they, sell for the same price? What about the housing units on the Issaquah Platue; should they sell for the same price as say the units at 85th and Aurora?

Value is different from the price people pay for things. If I buy plywood for $20 a sheet and can sell an end product housing unit for $300K great! If I pay $10 per sheet that’s better, it’s more profit.

If I can only sell an end product housing unit for $250K I really need to have the price of the plywood at $10 per sheet.

So the plywood has a value. It costs $3 per sheet to put in the store. I may tweek the margins, but there are other suppliers. When that same plywood sheet sells for $20 there is a huge profit to some one, probably not all to the supplier. When the sheet sells for $10, it’s less profitable.

The value, the core value, is pretty much set in stone. The profits swirl all around that. We can next talk about the cost of financing the whole mess, but that would take more time.

Value is established by people paying a price for property (raw land or improved). Appraisers, and those who are on this board aspiring to be appraisers, verify that the value a lender is willing to loan money on is valid. As long as I’ve been in housing and many year prior, sold comps are what people use to establish values and find a common ground for asking prices when a home is listed for sale.

Sold prices will be used as the data to justify prices going forward. There can be a mixture of both non-distressed and distressed sales that take place creating a value foundation. To argue that even though a sale takes place at a certain price is nothing more than hot air is nonsense. Can overall values continue to slide. Of course, to a point. Locally, we’ve experienced some very sharp declines from peak bubble prices so the threshold of of values moving sharply lower is now very much up for debate. From a pure data vantage point it is not knowable until it is in the rear view mirror. I work in real time and am very much interested in sharing my views when I think the winds of change are blowing in another direction (as I did in late ‘06) or the flag on the flag pole is idle. When inventory is worked through and sold the building blocks of a foundation for neighborhood values are in place.

Dismissing away the positive signs of some good buys (vs. bubble prices) and solid borrowers (cash, credit and capacity) is just as bad as ignoring the low FICO borrowers and 100% loans as if it those ingredients would have no impact on the market. We are in an interesting place in the market today and with today’s news that the Tax Credit may in fact be phased out I’m going to be curious to see how the markets reacts going forward.

http://bit.ly/3ajnma

Sorry, but you are looking at things from a few years of perspective. The housing bubble started before 2003, it simply stalled in 2001.

There’s no doubt today’s buyers and refinancers will be upset with the continued decline in housing prices and value. The fact is they are stuck with the depreciating asset, they can’t sell it for what they owe.

This is a game changer, but the game is the same. You buy a property with the intent to pay it off as quickly as possible.

Look at it this way: if some one came in with credit card debt of $50K would it be OK because the interest rate was only 5%? No, and if that unsecured debt, because the asset price will not support the value of the Note was $100K, would that be OK if the interest rate was only 5%?

Saying low down or poor credit borrowers are the cause of a global economic melt down is pure hype. The problem is prices far exceeded value. The end user is only a small portion of the over all problem.

Last time I checked Fed numbers the velocity was about one,maybe a bit less.

The key here is to look at the relative size of the numbers involved. There isn’t anywhere near enough cash out there to cover the deficit spending while credit also continues to collapse, so the presses will be ramped up. As a result, the dollar will tank and interest rates will shoot up. Having more of anything makes it worth less, and having more of something when fewer and fewer want to hold/have it makes it worth less still. Ouch.

But look at the relative size of the federal dollar demand verses the other measures of lost wealth, asset values and available credit. The trillions of new dollars won’t even begin to fill that $60 trillion hole (1-2% replacement rate) at least not initially. After several years of printing they may begin to catch up and have an impact- except that the contraction continues. The hole continues to deepen faster than they can fill it up. Deflation and heart-ache all around.

There is currently less than $600 billion of U.S. currency in circulation, the vast majority of which is held outside the U.S.

The U.S. deficit for 2009, counting inter agency transactions, is over $2 trillion dollars. The budget deficit for each of the coming 10 years is currently over $1 trillion, often double that, this time not counting inter agency debt. We are screwed. The government will print, and print heavily. It is the only option they really have.

The questions are: how far, not if, the dollar will fall… and how high will interest rates go? That they still can’t print fast enough to replace the $50-70 trillion in lost asset value and credit is a given, so no hyper inflation. But the combination of falling dollar values, higher interest rates, and a deflationary trend is mind boggling. This is why those who understand get sick in their stomachs.

it’s quite possible that Tim’s buyer are self selected- those on his doorstep, closing deals, are the only ones who could get financing. It may not be the whole story, but I bet it’s a big part of it. As such, it detracts from the credibility of his assertion that recent sales are true building blocks of value. Financial idiots (from ignorance, not inability) with strong moral values will likely have great credit scores, but don’t necessarily have any appreciation for the mess they just wandered into. It’s the old correlation is not causality argument again.

Fantastic post. I have posted in the past that I think this country has a culture problem; not a political problem. In other countries someone eventually comes along and says: “this will be surgery without anesthesia; it will hurt like crap, but it will save us.” No politician here will risk the present and future bribes (sorry, “campaign contributions”) for the country.

MSFT – mind blogging that in the year 2009 they still have anyone doing programming in Redmond. Raj can do the same for 1/4th the salary and live like a king at home in India.

Boeing – is a matter of time. Not too along we only trusted other nations to make things like coat hungers for us; today, it’s everything, and planes are no different. Yes, Chinese toys had high levels of lead; so what was the reaction? Are we making toys here?? Planes are in the way out. Most growth is in ASIA, and planes will be made there. Either by Boeing, Airbus, or “Airboeing” (the Chinese shop that will copy both designs).

If a very large amount were printed in a short enough period, I agree the dollar’s value would plummet. However the amount of printing won’t necessarily come that large or that quick. A large amount of printing spread over a long enough period is much different than a short period of time.

I think the range of possibilities extends beyond the two options presented: As I have suggested in the past, inflation does promote current spending, as assets will cost more in the future.

Unfortunately, I don’t think there is a third (or fourth) option. Just as you can’t be a “little” bit pregnant, you can’t start “printing” money without interest rates going up. The US government would simply lose it’s ability to sell T-bills (for anything less than usurous) rates if it started to print money in any type of serious way.

Thus, the hands of the policy makers are tied. The massive deficits and debts themselves make it impossible for the policy makers to inflate (i.e. since they would be unable to continue rolling debt over and re-financing).

Seattle has historically started a housing bubble at a later time than other major cities, and fallen much harder as a result.

Boeing WILL move some production to South Carolina, and Microsoft India will continue to steal jobs from here.

There are also too many Alt-A mortgages too that will reset in the next two years.

1. Utter destruction of the dollar within a week
2. Prolonged deflation
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As I have suggested in the past, inflation does promote current spending, as assets will cost more in the future.

IMO, inflation is in the greater interest of the puppet masters than deflation.

Actually, I don’t think this is true. It is MORE important for the policy makers to be able to continue financing the national debt than it is to have inflation. Or, to put it another way, when policy makers have to choose between utter destruction of the dollar within a week, and prolonged deflation that keeps dragging the economy down for a long period of time, I believe they will choose deflation.

In short, I believe the policy maker’s hands are tied. if they really start “printing” money in any significant quantity, interest rates will skyrocket, and demand for T-bills will collapse (i.e. which forces up interest rates) which is completely unacceptable to policy makers (i.e. since voters will get rid of them at the earliest possible moment).

Look at what’s happened in Japan over the last 20 years. The policy makers there did NOT want to see deflation, and did everything they could do to prevent it (including MASSIVE stimulus spending, etc), but they wound up with deflation nonetheless.

Can we call not paying one’s taxes a ‘foreclosure?’

When two thirds of the closings coming through our office for purchase transactions were nothing down during the bubble days, it caused me to be alarmed enough to start discussing in late 2006 the idea of a crash, which several people we work directly with did not appreciate. My integrity cannot be sold out to the real estate machine in which I work.

RE: David Losh @ 35disagree about the idea of down payments and credit worthiness being of little consequence. We are experiencing the result of loaning to people with lower FICO’s and no down payments. People with substantial down payments are probably more likely than not to have other areas of their financial lives in order, including other investments/savings that can help them sustain themselves over the long haul. There have been studies done for a long time about an issue: most foreclosures occur with homes that have mortgages. ;>

This poll takes credibility away from your blog. Of course, there will be “adverse selection” here.

Do you mean “self selection,” since there’s no market transactions occurring here from which adverse selection could occur? Either way, I’m not sure how asking people what they think affects a website’s credibility, unless it’s something like a push poll. Please elaborate.

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As for the topic at hand, I’m not sure whether housing is fairly priced today. If you want to say that housing isn’t fairly priced today because there’s a high probability that it will be priced lower in the near future, then I agree. My parlor game guess all along has been that we’ll be off 40%+ in real terms peak-to-trough. If that’s going to come true, we have a ways to go.

In a period of rising interest rates, bonds will continue to go down in value. In fact, they go down in value just enough to bring them to a current market yield. Of course there is often a risk factor, but even risk-free bonds, such as US Treasury Bonds, must be repriced.

There are plenty of bondholders who “hold to maturity,” so these holders do not care what the present value of the bond is, since it will be paid in full anyway. The “held to maturity” issue is what some homeowners suggest is the reason to buy now–lock into a low rate.

If we look at history, housing prices have a long history of rising, even in a period of fluctuating interest rates.

If you purchase something to hold long-term, and then the value falls, and then you sell, clearly it’s not a good deal. I do agree that any home buyer should price the risk of changing life circumstances where a move will happen sooner than anticipated.

Down payment and credit worthiness of the buyer means absolutely nothing in a Real Estate transaction. The only thing that actually matters is the value of the property.

There was a statement in a comment here that said a property is worth what some one will pay for it and that’s just not true. Another myth that builders are promoting is that because they stopped building there will be a shortage of supply in a few years and that’s not true.

The elephant in the living room, one of several at this point, is that builders over built every market place they could get loans in. The point was the loans, that’s where the money was. People buying the finished product was the transfer of the loan. Every body made money and the people who ended up buying those finished products have to pay it back.

Why pay back a mortgage on an over priced asset? In many cases the Note, the mortgage, is $50K to $100K over valued. Now hard working Johnny and Jane need to pay that Note off while huge corporate builders and developers bankrupt an LLC or two, or three.

Banks are making money, builders made money, mortgage, escrow, and title made money, but Johnny and Jane are the ones paying.

Real Estate is a business. You make money by beating the bank. That’s the way it has always been. You don’t make money by paying off a thirty year Note no matter how low the interest rate.People, like Johnny and Jane, need to make hard financial choices that include paying off a mortgage. They can’t sell for what they paid. Prices will continue to decline and the market place is saturated with housing units and many, way too many, are set to go as soon as the permits are applied for.

Over supply of crappy housing units will continue to drag on the market for decades to come.

@1 – Comparing the US bubble to Japan’s is a bit absurd. Things got crazy here, but not nearly as crazy as what happened in Japan. The govt response has also been better this time around despite its flaws.

@12 – Have home sales not outpaced 2008 4 months in a row now?

Have rent ratios not returned to historical levels? (See Tim’s post)

@13 – Does the falling dollar not make US real estate more attractive to foreigners? Last I heard, large bank accounts in China and many other developing nations are still not safe.

It appears to me that current prices have returned to the 2000-2003 trend line set before the MBS ratings fraud took off. (See Tim’s 9/30 post)

There is good reason to think we are not quite at the bottom, but the end of the world scenarios are over the top. Late 2010 is the time to buy if you are just out to maximize your return. Folks who are more interested in their families and careers are already starting to buy.

Oh come on, it’s always favorable to pay a lower price.

Many people claim it’s a great time to buy because interest rates are currently low. Unfortunately, when rates go up, house prices will go down. IOW, most people pay per month as opposed to lump sum. Increasing rates mean less money is available for principle.

Why not pay a lower price at a lower interest rate?

Well, I think we agree this is even better. It is stating the obvious though.

Note how you are playing with the whole “held to maturity” concept. Whenever you change durations, there is added risk, and I have suggested that we discuss duration/interest rate inflection points, which are critical to the banking industry.

I get the feeling you believe my reply was to a post you previously wrote. It is not, as I have not read this thread in its entirety.

Robert Shiller recently stated the housing market is at great risk for not increasing in price over the course of the next 5 years. Since people generally move every 7-9 years, if they choose to pay more for a house in order to get the current low interest rate, they are in great danger of being trapped underwater. This of course is due to paying about 6% to NAR interested parties and 2% or so to Uncle Sam. On top of this, you have holding and maintenance costs. That’s why the general public should stay away from flipping, and anyone considering buying a house to live in right now should probably choose to rent, unless they plan to stay longer than the typical family.