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Readers may have noticed that I don’t make the kinds of sweeping predictions about the housing market that I used to.
There are two reasons for this.
The first is that housing prices are no longer at an extreme. This can be seen in a semi-recent update to my price-to-income and price-to-rent charts, which show local home valuations returning from orbit and heading back to earth over the past several years. It’s pretty easy, when homes are stunningly overpriced, to forecast that they will eventually reach something quite a bit closer to their fundamentally justifiable values. But once the valuations go from “extreme” to “somewhat reasonable,” you just don’t have that same analytical wind at your back.
The second reason for the dearth of forecasts is more specific to this particular time, place, and subject matter. And that is that the real estate “market” is now as much a political entity as it is an economic entity.
The government has gone to amazing levels of effort to prop up the housing market. I described some of these fiscal and monetary undertakings in detail recently, so I won’t cover them again here. But the long and short of it is that huge amounts of money are being borrowed or simply created out of thin air and shunted directly into the housing market through multiple channels. Even as demand is thus boosted, supply is being constrained by foreclosure moratoria and opaque and arbitrary financial industry bailouts.
The net effect is that government intervention is exerting an enormous influence on the housing market. So one can’t just look at fundamentals as in the good old days. Instead, one is forced to practice a sort of real estate Kremlinology in an attempt to figure out how fiscal and monetary policy will affect, or cease to affect, the market.
Just to throw out a few examples on the legislative side: will the home buyer tax credit be extended again? Will Congress find other ways to encourage/bribe people to buy homes? Will moratoria be lifted or lightened? Will there be another round of financial bailouts?
And on the monetary front: will Ben Bernanke, Fed chair and printer of over $1 trillion in support of the mortgage market, be re-appointed? Will the Fed continue to artificially boost demand for mortgage-backed securities and agency bonds by buying them hand over fist, or will they stop early next year as they have suggested? When will the Fed tighten policy or begin raising rates?
It can even extend to foreign governments. If the Fed stops buying mortgage-backed securities, will other central banks step in to fill the breach? And perhaps most important of all these questions: how long will our foreign creditors keep lending us money amidst our frenzy of borrowing and money-printing?
To the extent that we can identify fundamental imbalances, it’s tough to know when or even if they will matter. Let’s take, to cite one frequent Nerd’s Eye View topic, shadow inventory. The shadow inventory problem is so obvious at this point that even USA Today is writing about it. If USA Today knows about it, the folks in Congress and the Fed know about it too. Will they just sit back and watch that train rumbling down the tracks over the next year or two and do nothing? I doubt that very much. So it’s a fundamental factor, to be sure, but it’s just not clear if it will be allowed to matter any time soon.
There is one political prediction I am comfortable making. I have long felt — and the events of the past two years have removed any doubt — that the government will move heaven and earth to prop up housing prices, at least for as long as our creditors are willing to foot the bill. But even if I grant myself that forecast, I have no idea how the housing intervention will play out, over what time frame, and via which policies.
There is also an economic prediction that I can make with confidence. That is that eventually, fundamentals rule. Prices have to get to levels that are commensurate with the realities imposed by the economic underpinnings of the market. But if government intervention causes that process to be slowed or delayed enough, much of the adjustment can be performed by inflation rather than nominal (non-inflation adjusted) price declines. Rather than having home prices fall to market-clearing levels, in other words, inflation could cause rents and incomes to rise up and meet home prices.
Given the challenges posed by a weak economy, shadow inventory, and potentially much higher interest rates, I believe that the fundamentals do justify lower current housing valuations. That is to say, aggregate San Diego home prices ought to be lower in comparison to rents and incomes than they are right now. Clearly, that adjustment is not being allowed to take place. And when it finally does, will it come in the form of lower nominal home prices or higher nominal incomes and rents? I don’t know the answer to that. I don’t believe that anyone truly does.
So you can see how non-extreme valuations within a heavily manipulated non-market render the forecasting of nominal prices a bit of an exercise in futility. And that is why I’ve shied away from the forecasting and shifted my focus more to real-time indicators. When the future is so murky, hopefully we can at least make sense of what’s going on in the present.