Friday, August 26, 2005

Fed Indicates Asset Prices Must Come Down

According to this article in Bloomberg, the Fed indicates in their latest remarks that there is an asset price bubble and that asset prices (e.g., housing prices) must come down for the sake of the economy.

Speculators*: be afraid, be very afraid. Why? For many reasons. A big one, as this article points out, is that in past housing busts the majority of owners had traditional fixed-rate loans and we didn't see a flood of houses on the market because many folks could just "wait it out" since mortgages don't get "called" like a put or a call in the stock market. But today "it's different this time", a significant number of people are using ARMs or exotic "name-your-own-payment" type loans; speculators certainly don't take out a fixed-rate mortgage because that just doesn't make sense if you are going to "flip" the property or you plan to sell in less than five or so years. But what is really scary is that in bubble areas like the Bay Area at large, such exotic loans are the majority because they are the only way most people can buy a house these days. These folks will get burned and the buy-up chain reaction will break down.

*I consider a speculator to be (1) anyone who buys a house other than the one they live in -- a vacation house, a house for "investment" reasons, etc., or (2) anyone who buys a property (regardless of whether it is the house they actually live in) with an ARM or exotic loan because these loans by their very nature are short-sighted and only make sense in an increasing asset price environment and are therefore speculative, or (3) anyone who decided to buy a house because "prices only go up, the rate of return on housing is greater than stocks", etc. and who would otherwise not have purchased a house. What do you, the three readers, think is the proper definition of "speculator"?

Some choice quotes:
"The Federal Reserve is paying closer attention to the rising values of assets such as stocks, bonds and homes, as low interest rates encourage more risk-taking, Fed Chairman Alan Greenspan said."

"Investors are accepting ever-lower compensation for risk as economic stability convinces them that their investments are less risky, he said. While that has helped push up asset prices and supported consumer and business spending, Greenspan said the increases ``can readily disappear.''"

"``History has not dealt kindly with the aftermath of protracted periods of low risk premiums,'' Greenspan said. ``Such an increase in market value is too often viewed by market participants as structural and permanent.''"

"``We have a housing valuation issue,'' said Kurt Karl, chief U.S. economist at Swiss Reinsurance in New York, in an interview. ``The time is now for raising interest rates and defuse these problems potentially by slowing down the economy a bit and avoid a big necessary increase later and a consequential recession. The froth here really raises the risk that he'll [Greenspan] continue to raise rates.''"

"``If we can maintain an adequate degree of flexibility, some of American's economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates and exchange rates rather than through more wrenching changes in output, incomes and employment,'' he [Greenspan] said."

"Greenspan's comments come as a growing chorus of economists, including Stephen Roach of Morgan Stanley and David Rosenberg of Merrill Lynch & Co, have criticized the Fed chairman for remaining sanguine in the face of what they say is a dangerous bubble in the U.S. housing market."

"``We have experienced asset bubbles, and we now have an economy that is more highly leveraged than it ever has been in the post-World War II period,'' Kasriel said in an interview before the speech. ``Greenspan has been instrumental in bringing about this high leverage.''"
The rest of the article is about Greenspan defending his economic philosophy and why he did the things that he did. CYA.

4 Comments:

Blogger marin_explorer said...

In a more local sense, how far do you think house prices should drop in Marin to be more in line with the "fundamentals", such as wages, economy, intangibles, etc? Is there a way to reasonably calculate RE value, once we sweep away the effects of the bubble? Certainly time will tell...but in the meantime, I came across something interesting:

Taking current price listings on MLS for Marin (general cross-section of towns/RE segments), I then went to ditech.com and found the price the house sold for last. Then, I selected houses sold prior to the main bubble window (98 and before). Using median pricing stats from the county assessor, I then compared the previous sale price against the median that year, as a percentage of median. Then, I looked at the current price against the '05 median. What I found is that current prices/median are lower than pre-bubble/median. On average, current "values" are 25% lower against median than in pre-bubble years.
Is there a legitimate reason for this? If median prices reflect market fundamentals, then shouldn't current prices be higher? Or, does this suggest current RE is overvalued, throwing the median 'out of whack'?

Aug 26, 2005, 4:36:00 PM  
Blogger Marinite said...

So you calculated the ratio currentPrice/median? Is that a standard, industry based calculation? I do not see how that ratio translates into a measure of "value". Tn my mind, value is some mixture of whatever people are willing to pay plus some measure of how much risk they are willing to take on and how much sacrifice they are willing to take on. But human psychology can turn on a dime and so what is high value today may not be so in the future. Also, value does not translate to fundamentals very well.

Maybe what you observed means that, in terms of house prices, there is less variance of price about the median in Marin. Think of a bell curve distribution with a small variance -- most of the area under the curve buches up around the measure of central tendency. I definately think that is what we have in Marin. There is almost nothing available in Marin for less than $600K now. There is little available above say $1.7 mill or so -- so I think that what we have in Marin is a "bell" curve that starts on the left side at around $600k, peaks at around $950K, then trails off indefinately into the millions.

Think about what $100K buys in one of Marin's local housing markets (e.g. Larkspur, or MV, or Novato); not much. The difference between a $900K house and a $1 mill house is negligible. The same sort of argument could be made for maybe $200K.

It seems to me that less variance in a housing market is not a healthy thing.

Aug 27, 2005, 10:31:00 AM  
Blogger Marinite said...

And you would expect less variance in a bubble market I should think. That is, if prices are being pushed to their absolute maximum by a frenzied buying incentive, those prices will ultimately be limited to people's capacity to pay (these days, people's capacity to pay has been extended by exotic loans but that just pushes the maximum amount able to pay out a little further); even the "low end" houses are being over bidded to higher and higher prices until they are pushed near the limit set by the more expensive houses. So you have a "hard boundary" on the high end where most normal people won't be able to pay past and the "low end" houses getting bid up higher and higher. Pretty soon the prices of most houses in a bubble market bunch up in a relatively narrow range.

In a normal market, people are much less willing to enter into bidding wars, etc. that push prices past so called "market value" and so I would think there would be more variance in house prices.

That's just what I think and what I've observed for myself for the last 30 years or so. But I am no expert or anything and I certainly haven't studied housing statistics over the last 30 years; just "casual observation". So take this for what (little) it's worth.

Aug 27, 2005, 10:42:00 AM  
Blogger marin_explorer said...

So you calculated the ratio currentPrice/median? Is that a standard, industry based calculation? I do not see how that ratio translates into a measure of "value".

No, it's hardly a definitive calculation, just something interesting that turned up (mostly a game for me). And sure--the "bell curve" concept is understood. So, I suppose I'm trying to figure out how the bubble has pushed the curve--and how far. I think it could be interesting to calculate something along that, but in the end, post-bubble demand will drive real prices. Your point of "less variance" is interesting. From my perspective, a lot of "value" is attached to many local properties, which may not be reflected in the long-term.
Thanks for your input.

Aug 27, 2005, 1:16:00 PM  

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