PARALLEL UNIVERSE: In 2006, Fed Scoffed at Signs of Housing Bubble; In 2012 They Admitted There Was a Bubble

By David M. Kinchen
The New York Times reported on Jan. 13 (Link) http://www.nytimes.com/2012/01/13/business/transcripts-show-an-unfazed-fed-in-2006.html?nl=todaysheadlines&emc=tha25 that Federal Reserve officials in 2006 “maveled at the desperate antics of home builders” seeking buyers, but “meeting every six weeks to discuss the health of the nation’s economy, gave little credence to the possibility that the faltering housing market would weigh on the broader economy, according to transcripts that the Fed released Thursday, Jan. 12. Instead they continued to tell one another throughout 2006 that the greatest danger was inflation — the possibility that the economy would grow too fast.”
“We think the fundamentals of the expansion going forward still look good,” Timothy F. Geithner, then president of the Federal Reserve Bank of New York, told his colleagues when they gathered in Washington in December 2006.

Yeah, that Tim Geithner, who’s now Obama’s treasury secretary!

Meanwhile, the Times story noted “by the end of 2006, the economy already was shrinking by at least one important measure, total income. And by the end of the next year, the Fed had started its desperate struggle to prevent the collapse of the financial system and to avert the onset of what could have been the nation’s first full-fledged depression in about 70 years.”

Fast forward to Jan. 4, 2012, when the Federal Reserve issued a White Paper (link: http://www.federalreserve.gov/publications/other-reports/files/housing-white-paper-20120104.pdf ) virtually admitting that they were wrong, that the bubble resulted in a massive foreclosure crisis that continues today and that the bubble resulted in house prices that “for the nation as a whole declined sharply from 2007 to 2009 and remain about 33 percent below their early 2006 peak….For the United States as a whole, declines on this scale are unprecedented since the Great Depression.”

The Fed White Paper adds that this means that more than “$7 trillion in home equity (the  difference between aggregate home values and mortgage debt owed by homeowners) — more than half of the aggregate home equity that existed in early 2006 — has been lost.”

The Fed White Paper deals with many issues, including what Realtors and builders call “excessively restrictive” lending standards and what to do about foreclosed houses (one suggestion in the White Paper is for the banks to rent them out) and is worth reading in its entirety. I’ve read it and it doesn’t have a lot of economic mumbo jumbo talk.

I hate to say “I told you so” (actually I like it!) but way back in 2005 I warned against the housing bubble, at a time when builders were offering free cars for anyone buying their overpriced houses (according to the Jan. 13 Times story), when I reviewed a book by David Lereah, then the chief economist of the National Association Realtors (NAR).

Here is my Feb. 21, 2005 review:

BOOK REVIEW: Economist Says There’s No Danger of Housing Melt-Down; Says Media Exaggerates ‘Bubble’ in ‘Are You Missing the Real Estate Boom?’

Reviewed by David M. Kinchen
Huntington News Network Book Critic

You would expect David Lereah to be a cheerleader for the housing industry: After all, he’s the chief economist for the National Association of Realtors in Washington, D.C.

In his new book “Are You Missing the Real Estate Boom?: Why Home Values and Other Real Estate Investments Will Climb Through the End of the Decade – and How to Profit from Them” (Currency/Doubleday, 288 pages, $19.95) he body-slams the news media for a stream of stories suggesting that double-digit annual price appreciation of single-family houses in select markets portends a crash in housing prices like the one in 1989-91.

In fact, he says that buying a house – or two or three or even more – will continue to be a better investment than buying stocks and bonds for the foreseeable future. I hope the folks who are tinkering with Social Security don’t hear about that! Lereah is a fine Ph D economist who writes about housing in a way a lay person – or even a veteran housing journalist like this reviewer – can understand. I receive his regular reports as a member – and as a past president (1984) of the National Association of Real Estate Editors.

As a reporter who covered housing steadily from 1970 to 1990 and off and off and on since then, I’ve made a few conjectures about housing appreciation, or inflation, if you will. I’ve been a homeowner since 1977 and believe in homeownership for those who meet the requirements. It’s not for everybody, as many recent college graduates who’ve moved back with their parents have discovered.

I’m sure Lereah, who distinguishes between residential housing and commercial real estate in which pros like Donald Trump get burned, has his heart in the right place. One problem, which he readily concedes, is that only a few markets have substantial housing price appreciation, and he lives in one: Fairfax County, Va., outside Washington, D.C. West Virginia is notably lacking in areas with substantially housing price appreciation, with the possible exceptions of Putnam County and some areas of the Eastern Panhandle. If you don’t live in the choice areas, you’re out of luck as far as many of his investment tips are concerned. He discusses ways, such as REITs, that those in lower appreciation areas can benefit. They can also buy investment houses in hot growth areas – and experience the dubious joys of long-distance property management.

In the interests of journalistic fairness, I discovered a report from RISMedia in which housing economist Richard DeKaser, chief economist of Cleveland-based National City Corp., studied 99 U.S. real estate markets and found housing “bubblettes” in one-fifth of the U.S. housing stock.

“Bubblettes” are defined by DeKaser as areas with “home premiums in excess of 20 percent, a metric that may indicate future price corrections.” Potential “bubblettes” include a city most people have never heard of, Chico, Calif, where a buyer will pay the highest premium at 43 percent. (Chico is a college town more than 100 miles north of Sacramento). Premiums above 20 percent can be found in San Francisco, Los Angeles and Miami. New York is at 16 percent and Chicago is at 11 percent. Chicago is the home town of both my parents, the first city I worked in after graduating from college in 1961 and a place where buying a house makes great sense. Boom and bust cycles like those in California are anathema to Chicagoans.

DeKaser examined what home prices should be, “controlling for differences in population density, relative income levels, interest rates, and historically observed market premiums or discounts,” according to the RIS article by Beth Bresnahan.

Among DeKaser’s undervalued markets are Salt Lake City, with a 23 percent discount; Memphis at -20 percent; Macon, Ga. at -17 percent; New Orleans at -14 percent and Houston (America’s most affordable big city) -11 percent. Dallas, another overbuilt metro area, is also at -11 percent.

Lereah and DeKaser agree on a couple of points, including the fact that residential housing has driven whatever economic recovery the nation has had since the stock market bust of 2000-2001. They also agree that housing appreciation substantially beyond the underlying inflation rate is limited to a relatively few areas – listed in Lereah’s book on Page 240. Among the “haves” – areas with substantial housing appreciation – are Las Vegas at 52 percent (that scares me in a city with a lot of low-wage service workers); Anaheim (Orange County); Riverside/San Bernardino; San Diego; Los Angeles; West Palm Beach, Fla.; Miami, Washington, D.C. and a surprise, Portland, Maine, at 23 percent. I would have guessed the other (Oregon) Portland, but Lereah also includes the Maine metropolis in a list (Page 242) of metro areas experiencing boom times – a list that almost exactly coincides with the “haves” list on Page 240.

Lereah’s list of “have-nots” includes: Dallas, Austin, New Orleans, Columbus, Ohio, Detroit (which includes some of the nation’s wealthiest suburbs); Syracuse and Atlanta.

Fully 75 percent of the houses sold by members of Lereah’s trade association are existing houses, so there’s no arguing the importance of this market segment. I believe he underestimates (misunderestimates in Bush-Speak!) the stagnation of income for many workers since the 1970s. He doesn’t address downsizing, which has thrown many people who should be in their peak earning years (ages 50-60) into the tender mercies of today’s job market. The lackluster growth in jobs over the past five years is not something a cabal of journalists is making up (we’re not that smart!) On Page 230 he deals frankly and concisely with such bread-and-butter issues as income, savings rates, consumer confidence, job security and “stored wealth.” He also downplays the rapid escalation in property taxes in high-appreciation areas. I know that property taxes are deductible, but you have to pay them first, along with mortgage payments, hazard insurance, skyrocketing gas and electric rates, car payments, skyrocketing college tuition and a host of other costs not included in the deceptive definitions of inflation handed out by government economists.

Maybe I take a Max Weber “Iron Cage” pessimistic outlook at the future, but I have serious doubts about the sustainability of the economy in the light of massive U.S. budget and trade deficits and the rapidly declining dollar vis-à-vis the Euro and other currencies.

Advising people to invest in vacation houses and rental properties – as Lereah does repeatedly and forcefully in his book is easier said than done. The scandals at Fannie Mae and Freddie Mac – major sources of housing finance in the nation – will, in my opinion, make it more difficult for even fairly affluent people to make such investments. Why? Because lenders are tightening up their standards and making it more difficult to buy housing that isn’t primary housing. While Lereah discusses the problems of dealing with tenants, I wonder if he has had hands-on experience – as my wife and I have had – in dealing with tenants on a daily basis. It’s rough!

If all these discouraging words haven’t turned you off, or if you’re looking for a readable look at housing today, I recommend “Are You Missing the Real Estate Boom?” 
* * *

OK, enough already: I won’t beat the dead horse — or the PhD economists who got everything wrong — anymore, but I suggest that one of the root causes of the housing bubble was the constant refrain about the “ownership” society, that everybody should be a homeowner. Not everybody should be a homeowner, and many people should consider renting as an option and put the downpayment money into secure investments (don’t buy Eastman Kodak stock!)

Pushing the “ownership society” led to the subprime mortgage crisis, when people who had no business buying a house drove the market, along with the “smartest guys in the room” on Wall Street who securitized these toxic assets.

Now, at the start of 2012, both the Realtors and the NAHB are praising the Fed white paper for  calling for an easing of “excessively restrictive lending standards” that are “impeding a housing and economic recovery.” Both trade groups applaud the white paper’s recommendations — increased lending to creditworthy home buyers and more loan modifications, mortgage refinancings, and short sales to reduce the rising inventory of foreclosed homes and help stabilize and revitalize the housing industry — to reanimate the housing market.

My view is that we ought to act like the grown-ups to the north of us, our neighbors in Canada, who never had a housing bubble, housing meltdown or a foreclosure crisis and who have very stringent lending standards. Homeownership is not a fair-haired boy in Canada, where there is no mortgage interest deduction on income taxes. Despite this, Canada’s homeownership rate is higher than ours (68 percent in canada, 66 percent in the U.S.). For an analysis of what Canada did right, click: http://www.aei.org/article/economics/financial-services/why-canada-avoided-a-mortgage-meltdown/) The story was published almost two years ago — in  March 2010 — but the facts are still true.

The article points out:

1) Canada has no Fannie Mae or Freddie Mac, two GSEs (government sponsored entities) that in my opinion contributed to the housing bubble

2) Canada has no 30-year fixed rate, freely prepayable mortgage loans; Canadian fixed-rate mortgages typically have prepayment penalties to protect the lender and the interest rate on the loan is fixed for up to five years

3) Mortgage lending is more conservative “and more creditor-friendly”

4) Canadian mortgage lenders have full recourse to the mortgage borrower’s other assets and income — in addition to having the house as collateral.

5) The absence of a tax deduction in Canada for mortgage interest “probably increases the incentive to pay down debt”

6) Most Canadian mortgage payments are made through automatic debit of the borrower’s checking account

The Canadian comparison report’s conclusion: “This relative creditor conservatism has meant that Canada and Canadian banks have so far come through the international financial crisis in much better shape than their U.S. counterparts.”   The classic definition of insanity is doing the same thing over and over expecting a different result. Let’s stop the insanity and grow up when it comes to housing. Home ownership shouldn’t be any more favored by government policy than, say, car ownership. That’s my view from covering real estate in all its forms since 1970.   If you want to watch an excellent documentary on the financial meltdown, get your hands on Charles Ferguson’s “Inside Job” (2010), which won an Academy Award. It’s narrated by Matt Damon and is very watchable and very accurate.

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