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Home Publications Blogs Beat the Press Wild and Crazy Times at the Low End of the Housing Market

Wild and Crazy Times at the Low End of the Housing Market

Sunday, 06 July 2014 13:38

Floyd Norris had an interesting piece on the impact of investor purchased homes on prices at the lower end of the housing market. His takeaway is that investor purchased homes have made housing less affordable for many low and moderate income households.

While this is partly true, by focusing only on the last couple of years the piece misses much of the picture. While investor purchases have pushed prices to unusual levels in many markets, in some cases they essentially put a floor on the market, helping to stabilize prices at levels that are consistent with longer term trends. The chart below shows house prices in the Case-Shiller indices for the bottom third of the market for five cities. (This is the same series used for the charts in the article.) 


There are several features of this chart worth noting. First, it is possible to see a rise in house prices (most pronounced in Minneapolis) in the middle of 2009. This was the result of the first-time homebuyers tax credit. This policy currently ranks #1 as most boneheaded policy of the century. It encouraged millions of people to buy into a market that was still inflated by the housing bubble.

As soon as the credit ended, prices began to plummet again, surprise, surprise. Many of these first-time homebuyers suddenly found themselves underwater. Of course the flip side is that many homeowners were able to dump their homes before they went underwater. And, many holders of mortgages were able to get them paid off either through a sale or refinancing. The new mortgages almost always sat with the government, either at Fannie Mae or Freddie Mac or were guaranteed by the Federal Housing Authority. In fairness, prices have mostly recovered, but those who were forced to sell in 2011 or 2012 would have taken large losses.

The other noteworthy point not fully picked up in Norris' discussion is that the house price rise had moderated in most markets. This is an unheralded result of Bernanke's famous "taper talk" in June of 2013. This press conference, at which Bernanke first suggested that the Fed would soon start cutting back its quantitative easing program, sent interest rates soaring. As a huge and possibly unintended plus, it took the air out of the bubble in many of these markets. 

In many cities, house prices in the bottom tier had been rising at extraordinary rates. For example, in Phoenix house prices in the bottom tier had risen 44.6 percent between May of 2012 and October of 2013, a 29.8 percent annual rate. (October is used because there is a lag between when the market weakens and its appearance in the index.) The rise in prices over the same period for the bottom tier of the market in Las Vegas and Atlanta was 57.9 percent and 80.3 percent, respectively. In the six months since October for which we have data the annual rate of price increase for the bottom tier in Phoenix has been 4.5 percent, in Las Vegas it was 7.6 percent, and in Atlanta it was 17.7 percent.

In these markets prices had been badly beaten up, so a bounce back was good news. However, when prices are rising at a 50 percent annual rate, as was the case in the bottom tier in Atlanta, they will soon be in bubble territory regardless of how low they started. Bernanke's taper talk broke this bubble momentum. That may not have been his intention, but he deserves some serious credit on this one.

This brings us to the final point, we may indeed have some new bubbles to worry about. Inflation-adjusted house prices for homes in the bottom tier in Los Angeles are 64.7 percent above their level at the turn of the century. The price increase for the bottom tier in San Francisco would be even larger. While these are clearly desirable cities in which to live, there has been no comparable increase in rents. In the case of Los Angeles, the rental index has risen by just 13.8 percent in real terms over the same period.

This discrepancy should give homebuyers in Los Angeles and other cities with sharply rising house prices something to worry about. While rents and house prices may not rise at exactly the same rate, this is an extraordinary discrepancy. The past history indicates that it is more likely that house prices will adjust to bring the two into balance. A plunge in house prices in Los Angeles, San Francisco and other cities with inflated house prices will not crash the economy, as did the bursting of a nationwide housing bubble, but it will not be pretty for those directly affected. 

Comments (14)Add Comment
Finally! Somebody is pointing out the good here!
written by Dave, July 06, 2014 4:16
Dean comes through again! I believe Bernanke did this intentionally. I also believe he knew the original housing bubble had to be stopped, despite the negative consequences. It could have done more harm had it been allowed to continue longer.

It was investor's purchases that were causing the rise in prices. Sure, it put a floor in in some places a floor was needed, but it was definitely bubbling out in a different way than the first bubble.

Investors learned from the first bubble. They learned the effect of the Fed's actions upon mortgage rates. This time they anticipated it. Last time it was only known to some of the hedge funds and more savvy, top investors, but this time I think smaller investors had caught on too. Thus the market learned, and it thus undercut what the Fed was able to do without causing a bubble.
written by djb, July 06, 2014 4:25
I am sure that it would have been much more of a price stabilzer if the banks had modified peoples loans to let people keep their houses

I am sure that banks would have lost less money too.... instead of foreclosing and then selling to wall streeters

Wonder why the did that

Also bubbles occurring again sounds more like wall street than people buying homes to live there
djb, the answer is slicing and dicing
written by ifthethunderdontgetya™³²®©, July 06, 2014 5:16
I am sure that banks would have lost less money too.... instead of foreclosing and then selling to wall streeters

Wonder why the did that

It is because in the modern age of securitizing mortgages, the banks in charge of deciding whether a homeowner got kicked out or had a modified mortgage wre not the people who owned the mortgages.

Special servicers had incentives to kick homeowners out, and so it has been done. Even when illegal. Even when they had the wrong home.

@djb and copyrighted name
written by Dave, July 06, 2014 6:14
I seem to remember Geithner pushing an agreement in the neighborhood of a measly 30 billion dollars because we all had an incentive to allow the fraud to take people's homes.

But I can remember knowing nobody that had that incentive. Nobody normal anyway.
Predatory Arbitrage is Not a Bargain
written by Last Mover, July 06, 2014 7:17

It's pretty bad when we have to give credit to predatory investors for buying up cheap housing that puts a floor on prices to stabilize the market. Like they're really effective at offsetting swings in business cycles when it counts aren't they.

What few crumbs are available to low end buyers on the market downside are snatched away by the predators that "protect" everyone from an unstable market over the longer run.

That's like praising the predators for snatching up all the generators before a hurricane to resell them at three times the price in a stabilized generator market to prevent a shortage.
Is the Bay Area and LA entering a bubble?
written by Victor, July 06, 2014 11:17
From out here in California, it seems like rents are rising very fast along with the cost of buying houses. Are they out of whack? I don't have the figures in front of me, but I know San Francisco, Oakland, and San Jose all saw big jumps in rents over the last year--on the order of 10-12%. It may be that in SF it is slower because rents were already thru the roof sending potential renters out of the city to the surrounding areas. The problem has been at the root of the recent demonstrations against the Google Buses in San Francisco and the enactment of new limitations on the amounts rent can rise in Oakland. Rent increases in the last year are matching the increase in house prices--at least in the central city areas. How this compares over the last 15 years, I don't know. LA is a different story--I seem to recall that rents rose in the LA region during the crash as people foreclosed out of their homes flooded local rental markets trying to stay in the same area they had previously owned in. So it may be that Like san Francisco, it had hit a peak for the rental market. But even there rents are up by double digits over a year ago.

On the other hand, this doesn't mean it isn't a bubble economy, but it may not be housing that is the bubble, but the tech industry.
written by Rastro, July 06, 2014 11:47
Isn't the investor class now looking into securitizing rentals just like the securitized, sliced and diced mortgages? If so, that would truly be a grand unifying theory - change bankruptcy laws then artificially inflate the housing market with predatory loans, then foreclose and sell the properties at a huge discount to investors who buy up all the inventory thus increasing number of renters, then securitize rents and voila! Profits once again rise like a phoenix from the ashes.
There is more to the story
written by EMichael, July 07, 2014 7:25
Just looking at the rising prices alone gives an imperfect view.

Much of the increases in prices were due to foreclosure resales, and no attention is paid at all to the cost of rehab of those houses.

Anyone who has been remotely involved in real estate in the bubble areas(as I have been since 2002 in Phoenix) knows these sale prices totally understate the real cost due to the rehab costs necessary to make the properties ready for market and/or rentals.

written by Peter K., July 07, 2014 9:42
Maybe it deflated a bubble but didn't it hurt the economy overall as well?

Could there have been other ways to deflate the bubble in those areas?
fed should target the interest rate which discourages bubbles?
written by Peter K., July 07, 2014 9:47
It seems as if Dean is agreeing with the BIS here.

Krugman on the subject:


"No, what the BIS is arguing is that there is some other appropriate rate, defined as a rate sufficiently high to discourage bubbles, and that central banks should target this rate even though it is above the Wicksellian natural rate – or, equivalently, that the economy should be kept permanently depressed in order to curb the irrational exuberance of investors.

It’s true that they don’t put it that way – probably because the policy recommendation sounds outrageous when you do. We can’t regulate finance effectively, so we have to accept a permanent slump instead? Really? But that’s what it amounts to."

I'm sure Dean and others who agree with him would rather the government employed currency policy and fiscal policy while the BIS doesn't care. But those policies to prevent a slump are off the table for the moment.
written by LSTB, July 07, 2014 12:07
Dean, what rental price index are you using for Los Angeles? I ask because when I use the BLS's "rent of primary residence" for the Los Angeles statistical area, I get 24.5% growth in real rental costs since 2000, not 13.8%.

Regulatory Power and Talk can stop bubbles
written by Dean, July 07, 2014 1:25
I would not use interest rates to stop bubbles except as a last resort. The Fed has much regulatory power to crack down on the loans that fuel bubbles (or at least housing bubbles).

They also have the power of talk. I know economists dismiss this (unless we call it "forward guidance"), but I think if the Fed chair said that she though house prices are over-valued and was prepared to take steps to bring them in line with fundamentals, that it would have a large impact on prices. I know it would make me more reluctant to buy a house. In any case, what would be the downside of trying?

To LSTB's question, I looked the owner's equivalent rent index for primary residence. This is a more appropriate comparison with house sale prices because it excludes utilities.
RE: Krugman
written by Dave, July 07, 2014 1:30
It is not called delusion, it is called denial. And a lot of people have this problem including Krugman himself.

The monetary system doesn't function they way people believe it should. Hardly any economist is actually in touch really on that subject.

Unfortunately, the one that seems in touch most with it publicly is John Cochrane. It is a strange change of events.

discount rates
written by J.R., July 07, 2014 11:48
if property prices rise but rents are flat it means expectations of future interest rate have fallen. that's just the dividend-discount model. given how CBs are behaving, that's not such a wild and crazy idea after all.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.