Flashback 2005: Margaret Hwang Smith and Gary Smith said "there is no bubble"

Margaret Hwang Smith and Gary Smith, economics professors at Pomona College in Claremont, California, argued in a paper titled "Bubble, Bubble, Where’s the Housing Bubble?" that "there is no bubble in the prices of single-family homes in 2005."

In a bubble, market prices are far above fundamental values calculated with reasonable assumptions about the future cash flow. By this definition, there is no bubble in the prices of single-family homes in 2005. ... The observation that real estate prices are higher than they used to be or higher than the values predicted by models using historical prices does not prove that current prices are above fundamental values. ... The relevant question, however, is not how much prices have increased in the past or how fast people expect them to increase in the future, but whether, at current prices, a house is still a fundamentally sound investment. Our answer is generally yes, if the owner plans to stay in the area for many years to come.

If housing was "still a fundamentally sound investment" near the peak of the market, then why is the federal government today trying to rescue homeowners from foreclosure? Why is the Smiths' home state of California in such an economic mess?

Congratulations, Margaret Hwang Smith and Gary Smith! I hereby award you the James K. Glassman and Kevin A. Hassett Award for being completely unable to recognize an asset bubble.

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Quote of the day

This quote from Dean Baker—one of the first economists to notice the housing bubble (about a year-and-a-half after I noticed it, but I digress)—actually comes from two weeks ago. I just found it and I like it, even if it is an exaggeration:

The Fed Is Responsible for 10.2 Percent Unemployment in the Same Way That Al Queda Was Responsible for September 11th

An elaboration:

There may well be an anti-elitist strain to the anger against the Fed and Bernanke, but serious people do not dispute their responsibility for the economic crisis. There was an enormous housing bubble that was easy for competent economists to recognize. It was inevitable that it would collapse and that its collapse would lead to a serious downturn. Bernanke and the Fed allowed the bubble to just continue to expand until it collapsed of its own weight instead of using the powers of the Fed to rein it in before it grew to dangerous levels. All of this is entirely clear to those who know the history.

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Federal housing subsidies are insane

Federal housing subsidies are insane.

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GDP revised downward

From The Wall Street Journal:

What last month had appeared to be third-quarter growth of 3.5% in gross domestic product turns out to have been a more modest 2.8%. Consumer spending was pared back to 2.9% from 3.4%. The cash-for-clunkers subsidy produced fewer new-vehicle purchases than first estimated. In short, we aren't getting much bang for our $787 billion stimulus bucks.

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Cato on the housing crisis

The Cato Institute's view of the housing bubble and resulting financial crisis:

The housing bubble and its aftermath arose from market distortions created by the Federal Reserve, the government backing of Fannie Mae and Freddie Mac, and the Department of Housing and Urban Development and its Federal Housing Administration. Americans suffered through a severe recession in 2008 and 2009, a downturn unfortunately precipitated by perverse government policies.

Regarding bad decisions made by the private sector, the traditional remedy for severely mistaken investment policies was to shut and dismantle those firms making mistakes to stop the bleeding, to free their assets and personnel to go where they can add value, and to make room for firms with better entrepreneurial ideas. That sort of market restructuring should have been allowed to happen in the U.S. financial sector.

A financial market in which failed enterprises like Freddie Mac or AIG are never shut down is like an American Idol contest in which the poorest singers never go home. The closure of Lehman Brothers (and the near-closure of Merrill Lynch), by raising the interest rate that the market charges to highly leveraged investment banks, forced Goldman Sachs and Morgan Stanley to change their business models drastically. The most effective and appropriate form of business regulation is regulation by profit and loss.

The long-term remedy for the severely mistaken government monetary and regulatory policies that have produced the current financial train wreck is similar. We need to identify and undo policies that distort housing and financial markets, and dismantle failed agencies and departments, such as HUD, whose missions require them to distort markets. We should be guided by recognizing the two chief errors that have been made. First, cheap-money policies by the Federal Reserve do not produce sustainable prosperity. Second, delivering mortgage subsidies by imposing affordable housing mandates on banks and by providing federal support to Fannie Mae and Freddie Mac bonds can backfire in a tragic way that damages the broader economy.

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Almost one-quarter of mortgage borrowers are underwater

From The Wall Street Journal:

The proportion of U.S. homeowners who owe more on their mortgages than the properties are worth has swelled to about 23%, threatening prospects for a sustained housing recovery.

Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic, a real-estate information company based in Santa Ana, Calif.

These so-called underwater mortgages pose a roadblock to a housing recovery because the properties are more likely to fall into bank foreclosure and get dumped into an already saturated market. Economists from J.P. Morgan Chase & Co. said Monday they didn't expect U.S. home prices to hit bottom until early 2011, citing the prospect of oversupply.

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Existing home sales up 23.5% year-over-year

The month-over-month change was 10.1%:

Existing home sales surged in October to the highest level in more than 2-1/2 years, according to a real estate industry report issued Monday.

The National Association of Realtors reported that existing home sales rose 10.1% last month to a seasonally adjusted annual rate of 6.1 million units, up from the downwardly revised rate of 5.54 million in September. ...

The gain was likely due to an influx of buyers looking to take advantage of an $8,000 tax credit that the Obama administration made available for qualified first-time home buyers, the report said.

The tax credit was scheduled to expire at the end of November, but it has been extended to April 30 and expanded to include more home buyers.

"Many buyers have been rushing to beat the deadline ... and similarly robust sales may be occurring in November," NAR chief economist Lawrence Yun said in a statement.
Make money in 2010: Your home

But such a spike means December and early 2010 will probably see a "measurable decline before another surge in spring and early summer," Yun said.

Adam York, economist at Wells Fargo, agreed that "it's really a story of the tax credit, and a payback is inevitable." ...

The median price of homes sold in October was $173,100, a 7.1% year-over-year drop. Distressed properties comprised 30% of the houses sold during the month.

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Housing starts fell significantly in October

Month-over-month housing starts fell in October:

In a blow to the optimism that had surrounded the U.S. housing sector in recent months, housing starts fell a sharp 10.6% in October, the Commerce Department reported Wednesday.

New construction on housing units dropped to a seasonally adjusted annual rate of 529,000, the lowest level since April. The 10.6% drop was the biggest percentage decline for starts since January.

Both single-family homes and multifamily units declined last month.

Prior to the October decline, housing starts have been flat for four straight months, on the heels of a big rebound earlier in the year from historic lows for the home-building industry.

As you know, I don't put much stock in month-over-month changes. However, I suspect October's decline was tax credit related. Since it was uncertain in October whether the homeowner tax credit would get renewed, this may give us an idea of what to expect when the tax credit finally goes away next year (hopefully).

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Five myths about homeownership

Joseph Gyourko, chairman of the real estate department and the director of the Zell/Lurie Real Estate Center at the University of Pennsylvania's Wharton School, lists five myths about home ownership:

1. Housing is a great long-term investment.
2. The homebuyer tax credit makes buying a house more affordable.
3. Homeownership is good for society because owners make better citizens.
4. It's safe to buy a house with a very low down payment.
5. Owning a home is cheaper than renting one because you save on rent.

For his explanation of why they are myths, click here. I don't necessarily agree with all of his conclusions.

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When did the housing bubble begin?

The Wall Street Journal asks when the housing bubble began:

Why should we care when it all began? It’s politics. If the housing bubble began during the Clinton administration, it can be blamed on the Democrats and their efforts to expand homeownership to people who, in some cases, may not have been quite ready for it. If it began under George W. Bush, then it can be imputed to the Republicans’ love of deregulation.

Of course, as we all know, the causes of today’s mess are far more complicated than either of those hypotheses allow. But nuance rarely figures in the debates of our age.

Edward Pinto, a mortgage-industry consultant who was the chief credit officer at Fannie Mae in the late 1980s, argued in a WSJ op-ed essay Friday that “most agree that the housing bubble started in 1997.”

I asked Mr. Pinto why he chose 1997. He pointed to a chart of long-term home prices patched together by Robert Shiller, a Yale economist. The chart shows inflation-adjusted house prices starting to move up sharply in the late 1990s. ...

Tom Lawler, an independent economist who worked at Fannie Mae from 1984 to 2006, says few housing gurus think the bubble began as early as 1997. In his view, the bubble began around 2002. The collapse of the tech-stock bubble in the year 2000 prompted many people, searching for other types of investments, to focus on real estate.

I spotted the housing bubble in spring of 2001, so I think people who claim it began later than that are fools. Anybody who looks at Robert Shiller's graph of house prices can easily see that the uptrend in real housing prices began in 1997-1998. We were in clear bubble territory by the end of 2000. Rather than blaming it on politicians, the strongest argument coming from economists is that the bubble was caused by a global savings glut that began in the late 1990s.

Here's my graph of nominal and inflation-adjusted housing prices since 1970. Look for yourself. When do you think the housing bubble began? (Click on the graph to see the full-sized version.)

Update: I notice that the Edward Pinto article blames the housing bubble on the Community Reinvestment Act (CRA). For Republicans who want to blame the bubble on the CRA and for Democrats who want to blame the bubble on bank deregulation, let me point out that the housing bubble was a global event. There was/is a simultaneous housing bubble in the United States, Australia, Britain, Ireland, and Spain, to name a few countries. The CRA does not explain why there was a bubble in Spain. Also, the November, 1999, passage of the Gramm-Leach-Bliley Act does not explain why real U.S. home prices began their ascent two years earlier.

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Why eminent domain should be used sparingly

This is karma:

The private homes that New London, Conn., took away from Suzette Kelo and her neighbors have been torn down. Their former site is a wasteland of fields of weeds, a monument to the power of eminent domain.

But now Pfizer, the drug company whose neighboring research facility had been the original cause of the homes' seizure, has just announced that it is closing up shop in New London.

To lure those jobs to New London a decade ago, the local government promised to demolish the older residential neighborhood adjacent to the land Pfizer was buying for next-to-nothing. Suzette Kelo fought the taking to the Supreme Court, and lost. Five justices found this redevelopment met the constitutional hurdle of "public use." ...

Scott Bullock, Kelo's co-counsel in the case, told me: "This shows the folly of these redevelopment projects that use massive taxpayer subsidies and other forms of corporate welfare and abuse eminent domain."

The City of New London forcibly took people's homes away from them and got what in return? A field of weeds and jobs that are gone in a decade? Screw the City of New London.

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Jeffrey Sachs: How to stimulate the economy

Columbia University economist Jeffrey Sachs criticizes the Democratic and Republican ideas for stimulating the economy:

Following a Keynesian approach, the Obama administration has focused on restoring consumer spending. They have gone about this with a combination of near-zero interest rates, massive Fed financing of mortgages and various consumption incentives, such as rebates for new homebuyers and cash for clunkers.

During the previous bubble, the US consumer was encouraged to over-borrow. Recreating a new bubble is like offering just one more drink, on the government’s account, to overcome a mass hangover. ...

The Republican alternative is equally fatuous. For every problem there is a single Republican answer: tax cuts.

What does Dr. Sachs propose as an alternative?

There are three parts of a long-term solution. The first is to promote greater exports, partly through dollar depreciation and partly through expanded government support for export financing, for example extended to credit-constrained low-income countries that want to purchase US-produced technology. ...

A second component is a massive expansion of education spending and job training. The unemployment rate among college graduates is only 4.7 per cent, while it is 15.5 per cent among those without a high-school diploma. The US woefully under-invests in education outlays for the poor, who drop out of school and then cannot find gainful employment.

A massive expansion of education and training would address the current unemployment crisis in three ways: by shrinking the numbers of young people searching for work, by building job skills for the future, and by increasing total spending in the economy through education outlays.

The third component is to spur an investment boom in areas of high social return that are currently blocked by the lack of clear policies. The conversion to a low-carbon economy would create jobs in the short run, a more productive economy in the medium run, and US technological leadership in the longer run.

The same is true with the overhaul of America’s ageing infrastructure at a time when cutting-edge technologies can dramatically improve the efficiency of resource use, the safety of the built environment, and the sustainability of our ecosystems.

I'll let readers decide, but it seems to me that one of the most respected economists in the world agrees with me that education and infrastructure spending make for good economic stimulus, while the home buyer tax credit and cash for clunkers do not.

Again, education and infrastructure spending stimulate the economy in the short run and promote long-term economic growth because they add to our country's stock of capital (both human and physical). On the other hand, the home buyer tax credit and cash for clunkers may stimulate the economy in the short run, but they subtract from long-term economic growth.

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Robert Shiller conflicted by housing data

Fox Business journalist Alexis Glick describes her recent interview with Robert Shiller:

Today it was clearly visible that the historical data he looks at to predict the future is not working. The current appreciation in housing and other economic indicators are not what the models would suggest. Time and time again he said “this is a time of great uncertainty.” He’s clearly puzzled by the rapid appreciation in home prices while disturbed by the “bail out economy” and the national deficit. He admitted, “Things seem to be working right now but we’re in a GRAND experiment.” I found it incredibly telling.

At one point I said, “You seem so conflicted.” He said, “I am terribly conflicted. This is the most uncertain time that I can remember. Things are violating the laws that I learned. The turn around in real estate is so dramatic. The whole country is experiencing an upsurge but I don’t know what to make of it.”

He's had other recent interviews:


Government has been dumping $40,000-$80,000 in cash into each marginal home purchase. With that kind of money, it would be shocking not to have a housing recovery. That spending gets added to the national debt. The people who get the hand out are often different from the people who pay the bill, so this is a case of robbing Peter to pay Paul.

Also, this massive spending changes the mark-to-market (short-term) value of homes, but since it does nothing to change the owner-equivalent rents those homes generate, it does not change the discounted cash flow (long-term) value of homes. Like credit card spending, we'll still be paying the cost when the benefit is long gone.

Hat tip to an anonymous blog commenter, who shall remain anonymous, and hat tip to Kevin for a link to the video.

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Fannie Mae needs another bailout; Freddie Mac will need one

Fannie Mae is in more financial trouble:

Fannie Mae, the federally controlled mortgage finance giant, said Thursday it lost $19 billion in the third quarter and had submitted a request to the Treasury Department for $15 billion in more aid to stay afloat.

District-based Fannie Mae and its McLean sibling, Freddie Mac, were seized in early September 2008 by the federal government. Since then, Fannie Mae has lost $111 billion. The $15 billion in aid it has requested comes on top of $45 billion it already received. Freddie Mac has received $51 billion in aid.

In total, the seizure of Fannie Mae and Freddie Mac has cost taxpayers $121 billion, among the costliest of the government's interventions to stabilize the financial markets.

Fannie Mae said its losses and its need for additional government aid are both likely to continue. And it said activities it was undertaking at the behest of the Treasury Department, such as modifying mortgages to help homeowners avoid foreclosure, were magnifying its losses. ...

In its earnings statement, Fannie Mae said its assistance to struggling homeowners "could adversely affect our economic returns, possibly significantly."

Meanwhile, Freddie Mac doesn't need another bailout yet but it will:

Freddie Mac said it didn't need any additional federal aid for the second straight quarter as it reported a loss of $6.3 billion for the third quarter on Friday.

But the company said it expected to ask for more handouts from the U.S. Treasury in the future as rising unemployment and falling home prices continue to drive higher credit-related losses for both Freddie and its larger rival, Fannie Mae.

The government really didn't have much choice but to take control of Fannie and Freddie when they were teetering on collapse. However, government didn't have to keep these failed companies operational. The loses they will endure for continuing to lend during a declining housing bubble can be justly blamed on the politicians. The government should simply shut down Fannie Mae, Freddie Mac, and AIG. There's no good reason to keep these failed companies in business.

To put the costs in perspective, $121 billion in losses divided by 105 million American households means that these two companies have cost your household roughly $1,150.

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Congress and president renewed home buyer tax credit on Friday

As I'm sure you've heard, Congress and President Obama renewed the home buyer tax credit on Friday. It's a massive waste of money that will simply add to the national debt. Unlike infrastructure spending, which will enhance long-term growth while helping to bail the country out of its current financial mess, spending $40,000+ each just to transfer existing houses from one person to another will harm long-term economic growth. It will harm economic growth because the government is not getting anything substantive in return for its spending and because it will have to pay perpetual interest on that deficit spending.

Washington Post columnist Steven Pearlstein reiterates why the home buyer tax credit is wasteful:

Politicians in Washington are desperate to show that they're doing something about jobs.

Unfortunately, what they're proposing to do is to spend a lot of money that they don't have in ways that won't work to help too many people who are neither desperate nor deserving.

Topping the list of idiotic ideas is the bipartisan push to reinflate the housing bubble by not only extending the tax credit for struggling first-time home buyers for six months but also expanding it to another "neglected corner of human misery," as the Heritage Foundation's Ron Utt so aptly put it -- affluent homeowners who want to trade their current places for something better.

This $10 billion boondoggle is nothing more than a giveaway to the real estate industrial complex and people who could afford to buy a new home anyway. Even its most prominent supporters acknowledge that of the first-timers who have already claimed the credit, only one in five wouldn't have bought a home without it, which works out to a cost per sale induced of $45,000. A more impartial estimate, by Goldman Sachs, puts the figure at $75,000. That is almost certain to go even higher once the credit is extended to existing homeowners with incomes of up to $225,000 buying houses worth as much as $800,000. ...

It is disappointing enough that President Obama and his team of crackerjack economic advisers have not had the wisdom or courage to oppose what any first-year graduate student would recognize as truly lousy policy. But perhaps that's because the Panderer in Chief is himself knee deep in stimulus hokum of his own with his proposal to shower Social Security recipients with a $250 cost-of-living increase this year even though their cost of living has actually declined. At a cost of $14 billion in borrowed money, it's a grossly inefficient way to stimulate the economy, create jobs or even boost consumer confidence.

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October 2009 job numbers

The unemployment rate has reached the highest level since the early 1980s, rising to 10.2% in October 2009. The last time the U3 (official) unemployment rate was this high was April, 1983. (As a kid back then, it really didn't seem that bad—although I'm doing well now, too.)


Initial weekly unemployment insurance claims continue to improve—or more precisely, they are getting worse at a slower rate. This graph shows year-over-year numbers. Ideally, we'd like the YoY numbers to be below zero for an extended period of time.


The government's job loss numbers show a continuing, but slowing, contraction in the job market. Remember, we need monthly job gains of 100,000-200,000 just to keep up with population growth.


For conspiracy theorists who don't believe the government's numbers, here are the monthly job loss numbers as measured by Automatic Data Processing, Inc.


Readers, how will these job numbers affect foreclosures and home prices?

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BMW 5 Series 1989-1995 Service Manual

Whether you're a professional or a do-it-yourself BMW owner, this manual will help you understand, care for and repair your E34 5 Series.

Models and engines covered:

- 525i (M20 with DME 1.3) 1989-1990
- 525i (M50 with DME 3.1) 1991-1992
- 525i (M50TU/VANOS with DME 3.3.1) 1993-1995
- 530i (M60 with DME 3.3) 1994-1995
- 535i (M30 with DME 1.3) 1989-1993
- 540i (M60 with DME 3.3) 1994-1995

Transmissions covered:

- Manual (remove, install, external service)

Getrag 260/5 and 260/6
Getrag S5D 250G
Getrag S6S 560G

- Automatic (remove, install, external service)

ZF 4HP22/EH
A4S 310R (THM-R1)
ZF A5S 310Z

Technical highlights:

- Maintenance procedures from brake fluid changes to resetting the Service Indicator. This manual tells you what to do, how and when to do it, and why it's important.
- Engine and cylinder head service, repair and reconditioning, including M50 and M60 timing chain setup and adjustment.
- Extensive engine management information for specific BMW 5-Series driveability problems, including reading Check Engine light fault codes.
- Transmission maintenance, troubleshooting, adjustment and repair, including hydraulic clutch, gearshift linkage, and driveshaft.
- Body adjustments and repairs, including sedan sunroof removal and adjustment.
- Heating and air conditioning repair, including A/C micro-filter and A/C component replacement.
- Wiring schematics for all circuits, including power distribution, grounds, and component locations.
- Comprehensive BMW factory tolerances, wear limits, adjustments, and tightening torques that you've come to expect from Bentley manuals.

Download

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The definitive guide to modifying Citroen Saxo

Would you like to modify your Citroen Saxo, but would prefer to carry out the jobs yourself? All you need to know on Saxo modifying is contained within this guide.

Download

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Fiat Tipo and Tempra Repair Manual and Owner Reference Information

This manual applies to: Fiat Tipo and Tempra:
-Petrol engines: 1.4 (1372cc) and 1.6 (1580cc)
-Diesel engines: 1.7D (1697 non-turbo), 1.9D, 1.9TD and 1.9TDs (1929 turbo and non-turbo)
-Hatchbacks, Saloons and Estates 1988-1996
-Manual and Selecta (automatic) transmission models

This manual contains highly detailed, easy-to-follow service instructions, ideal for beginners and experts alike. It is illustrated with hundreds of clear photographs and line drawings, and is approved by the manufacturers themselves. It includes hints, tips, official wiring diagrams and electrical contact numbers.

Download

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Home buyer tax credit = more global warming

According to Harvard economist Edward Glaeser, Congress and the White House are intent on harming the planet:

ENVIRONMENTALISTS who are worried about global warming should pay attention to the congressional debate about extending the home buyers tax credit. Federal tax policies toward housing have long encouraged Americans to emit more carbon. President Obama could do the country, and the planet, a service by either refusing to sign the extension of the $8,000 credit or by insisting that it be accompanied by offsetting reductions in the home mortgage interest deduction.

According to the Residential Energy Consumption Survey, per person energy use in owner-occupied housing is 39 percent higher than in rental units. Energy use, per household member, is 49 percent higher in single-family detached houses than in apartments in buildings with more than five units. These differences reflect the strong connection between home size and energy use. The average four-bedroom house consumes 72 percent more electricity than the average two-bedroom house.

Yet the tax code encourages Americans to live in big, energy-guzzling homes, instead of thrifty apartments, and Congress seems intent on further unbalancing the federal budget to egg on home buyers.

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Homebuyer tax credit nearing renewal

Stupid stuff like this is why, after a decade of voting straight Democratic in state and federal elections, I decided to stay home yesterday and let the winds of change blow. I'm disgusted with both political parties.

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How the crisis could change economic theory

Here's an interesting look at how our little housing bubble may change macroeconomic theory.

The crisis exposed the inadequacy of economists' traditional tool kit, forcing them to revisit questions many had long thought answered, such as how to tame disruptive boom-and-bust cycles. ...

"We could be looking at a paradigm shift," says Frederic Mishkin, a former Federal Reserve governor now at Columbia University.

That shift could change the way central bankers do their job, possibly leading them to wade more deeply into markets. They could, for example, place greater emphasis on the amount of borrowing in the economy, rather than just the interest rates at which borrowing is done. In boom times, that could lead them to restrict how much money various players, ranging from hedge funds to home buyers, can borrow.

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D.C. area foreclosures double year-over-year

From last Wednesday's Washington Post:

The number of Washington area homeowners in foreclosure has more that doubled in the past year, according to a report to be released Wednesday that shows the problem remains most acute in a few counties and could get worse as more borrowers fall behind on their payments.

About 2.7 percent of local borrowers are in the foreclosure process, meaning that the bank has started the legal process to take back the property, according to the report by the Urban Institute, a nonprofit policy research group based in Washington. That was slightly below the national average of 2.9 percent.

But that is up from about 1.4 percent in June 2008 and 0.5 percent in June 2007, according to the report. (The report excludes Howard and Anne Arundel counties.) ...

But the problem is far worse in three counties: Prince George's, where 5.2 percent of borrowers are in foreclosure; Charles with 3.9 percent; and Prince William with 3.7 percent. These areas had high concentrations of minority borrowers who were more likely to take out subprime loans, according to the report.

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