The Housing Hangover: How Bad Will It Be?

By Erwan Quintin, Assistant Professor of Real Estate at the Wisconsin School of Business

According to the National Association of Realtors (NAR) sales of existing homes in the U.S. tumbled by 17% in December, the largest monthly decline since the Association began reporting this measure in 1968. Drops of this magnitude usually come with a simple explanation. In this case, we are witnessing the home buyer tax credit hangover that economists have been anticipating for months.

The home buyer tax credit program gives buyers who haven’t purchased a home in at least three years and who meet certain income criteria a tax credit equal to 10% of the purchase price of their new home, up to $8,000. The program was originally set to expire on November 30th, but was extended in early November in both time and scope. The program’s intent was to give potential homebuyers incentives to purchase homes now; and, to some extent, to bring new buyers into the market. The fact that home sales rose at a healthy pace in the second half of 2009 and are now falling is evidence that the program “worked.” The NAR’s report also contains more direct evidence that many first-time homebuyers accelerated their purchases to secure the credit: they accounted for 43% of purchases in December, down from 51% in November.

At first glance, it may seem surprising that sales tumbled while the median home price rose by 1.5%. However, this result is a false positive which is essentially the hangover effect at work. Until last November, the credit was limited to first-time home buyers whose income was below $75,000 for singles, and $125,000 for households. Households who meet those criteria tend to buy cheaper homes. When they left the sample of home buyers in December, median prices mechanically rose.

Most people would agree that the program had the desired effect: it has moved home purchases forward. One could argue that the goal of all stimulus plans (fiscal and monetary stimulus, accelerated depreciation schemes, etc.) is to cause a spending shift. The goal is to borrow from a presumably stronger future to support flagging activity today. All stimulus plans, therefore, are bound to come with a hangover. The hope is that the hangover does not overwhelm the initial gains. (For a more detailed discussion the hangover effect, click here.)

How bad will the hangover be in housing markets? Over the next few months, home sales will benefit from the extending the housing credit program to a broader set of buyers until April 30, 2010. However, the same set of questions will arise in May. As is the case with all stimulus programs, the timing of the withdrawal is critical. If economic conditions have improved sufficiently by May, and a recovery is under way, the losses associated with the credit expiration will have limited effects. If, on the other hand, markets remain dependent on policy support, then a relapse is certainly possible.

Take, for instance, the foreclosure crisis. Foreclosure rates have tripled since mid-2006. Without policy support, however, things may have been worse. One incentive for households who experience financial difficulties to hold on to their home is the prospect of selling their home at a good price in the future. (For more information on this topic, click here.) If it becomes clear in May that selling prospects have suddenly worsened, the hangover could come with yet another foreclosure spike.

As they say in policy circles these days, we need an exit strategy. I would like to recommend the “Wisconsin Foreclosure and Unemployment Relief" program, or WI-FUR, a plan developed by my faculty colleagues Morris A. Davis, Stephen Malpezzi, and François Ortalo-Magné.

New Global Real Estate Master (GREM) Ad Featured in Financial Times

Now that we've officially launched our new Global Real Estate Master (GREM), we are excited to get the word out! A new ad featuring GREM was published in the Financial Times yesterday in its "Business Education" magazine. The Financial Times was selected for its outstanding global readership, which is estimated at over 1.4 million people in more than 140 countries.

GREM partners Wisconsin’s 100-year tradition and expertise in real estate education, its active and vibrant network of alumni, and numerous international industry connections with three of the top business schools from around the world: HEC Paris (#1 in Europe, Financial Times), HKUST, Hong Kong (#1 in Asia, The Economist) and INCAE, Costa Rica (#1 in Latin America, América Economía). Participants enter the program as graduate business students in Paris, Hong Kong or San Jose. After completing one to three semesters at one of the three partner schools in their MBA program or in a specialized MS program, students from all three schools come together in Wisconsin for advanced training in real estate. In the end, they are awarded an MBA or MS from the partner school and an MS in Real Estate from the Wisconsin School of Business and become alumni of the Wisconsin School of Business and the school where they started their education.

We are now accepting applications for the GREM semester for Spring 2011. Visit the GREM website for more information, or contact Professor François Ortalo-Magné at fom@bus.wisc.edu.

Real estate students travel to South Africa

The Wisconsin School of Business offers many opportunities to study internationally, including trips overseas during winter break. Two separate groups visited Argentina, and the second-year real estate students traveled to Brazil. Five of the first-year real estate students, including myself, participated in an international business course trip to South Africa this January.

There, we had the opportunity to meet with the leadership teams of international companies in Johannesburg. We saw newly implemented processes in a Ford automobile
factory, visited the Johannesburg Stock Exchange, and talked with SAB Miller, the company that acquired Miller Brewing. After traveling to Cape Town, we met with two entrepreneurial companies, one that enables local farmers to produce at living wages, and another firm started by a UW alum that recycles and manufactures plastics.

We also had time to see the unique cultural and natural attributes of South Africa, including Nelson Mandela’s home and the site of his former incarceration. Our trip to Kruger National Park reminded me of Yellowstone, but instead of driving among buffalo and cougars we saw wildebeests and lions. Finally, we visited the wine region of Stellenbosch, sort of the South African Napa Valley.

A couple tips if you find yourself in South Africa: “pap” is a type of corn-based grits that is friendly for your fellow vegan travelers, also, it is illegal to get out of your car when you are in the vicinity of lions.

Travis Campbell is a first year MBA student in the James A. Graaskamp Center for Real Estate at the Wisconsin School of Business. He is glad to be home after extensive traveling over winter recess, but he is apprehensive to start this new semester.

Foreign Investors in Real Estate Again Pick U.S.

Results of the 18th annual survey conducted among the members of the Association of Foreign Investors in Real Estate (AFIRE), show a dramatic increase in the number of respondents identifying the U.S. as the country providing the best opportunity for real estate capital appreciation. This is the third year the survey was conducted by the James A. Graaskamp Center for Real Estate at the Wisconsin School of Business. Professor François Ortalo-Magné will present the survey results at the group's winter conference in New York in February.

The survey was conducted in the fourth quarter of 2009 among the association’s nearly 200 members. Survey respondents own more than $842 billion of real estate globally, including $304 billion in the U.S.

In this year’s survey:

• 51 percent of respondents identify the U.S. as providing the best opportunity for capital appreciation.
• This compares to 37 percent in 2008, 26 percent in 2007, and 23 percent in 2006.
• The last time respondents’ perceptions for U.S. real estate were this strong was in 2003, when the percentage once again reached 51 percent;
• the U.K. emerges as the second-best country for capital appreciation, receiving 30 percent of respondents’ votes. In third place, China receives 10 percent of respondents’ votes.
• two thirds of respondents plan to increase their investment in the U.S. in 2010 compared to 2009.

Among U.S. cities representing the best investment opportunities, survey respondents firmly select Washington, D.C. and New York, receiving much stronger scores than third-place San Francisco. This year, Boston makes a significant climb into fourth place, and Los Angeles falls one spot into fifth place.

For more survey results, read here.

2010 Wisconsin Economic Outlook

In the cover story for this month's Wisconsin Real Estate Magazine, Stephen Malpezzi shares his outlook on the economy in Wisconsin and beyond. In his article, he mixes the good news with the not-so-good:

"(A) number of observers, not least Federal Reserve Chairman Ben Bernanke and White House advisor Larry Summers, believe the recession is over. But the consensus view at the Graaskamp Center for Real Estate is that it’s too soon to be confident we’re in recovery."

"House prices are now roughly in line with fundamentals like incomes, interest rates, and rents...But we are concerned that just as house prices overshot going up, they could overshoot going down."

Visit the WRA for the full text of his outlook from the January issue.

Malpezzi also has an addition to his recommended reading list, "Carmen Reinhart and Ken Rogoff’s masterful This Time is Different: Eight Centuries of Financial Folly."

Share your thoughts on the book and the article in the comments.

Wisconsin Economic Forecast Luncheon

UPDATE: Here is a link to the Milwaukee Journal-Sentinel's coverage of the event, "Weak recovery won't be rushed."

Today at the Frank Lloyd Wright-designed Monona Terrace in Madison, Sam Kahan, senior Fed economist, Chicago, and Dean Michael M. Knetter, Wisconsin School of Business, will discuss the local, regional and national outlook for the coming year at the Wisconsin Economic Forecast Luncheon.

The event is presented by the Wisconsin Bankers Association in conjunction with the Wisconsin Realtors Association and the Greater Madison Chamber of Commerce. The word is out this morning that registration for this highly-anticipated event is fully-booked.

If you have a ticket, please come back and let us know some highlights from the discussion. And even if you're not attending, share your thoughts on the economic outlook in the comments.

Photo by joelrivlin via Flickr

2010 Wisconsin housing conference set for June 4th

Mark your calendars for June 4, 2010 for the Wisconsin housing conference.

The conference is organized by the James A. Graaskamp Center for Real Estate, the Wisconsin Housing and Economic Development Authority (WHEDA), the State of Wisconsin Department of Commerce Division of Housing & Community Development, and the Wisconsin Realtors Association.

The annual conference features a range of experts - from the public and private sectors, from government and business and from academia - who are on the front lines of housing market research, policy and practice. Last year's meeting looked ahead from crisis to recovery. This year's event promises to be particularly engaging as the outlook unfolds and extends into the future.

Stay tuned for more announcements on the program agenda and registration information. If you are interested in sponsoring the conference, please contact Lee Gottschalk at lgottschalk@bus.wisc.edu.

Reading for life

Stephen Malpezzi shares one of the titles on his "Reading for Life" book list.

At Wisconsin, we’re big on the idea of “lifetime learning.” The few years you spend in Madison in Bucky’s warm embrace are only the beginning of your real estate education. We want to partner with your education over the following 50 years, too. And, consistent with the Wisconsin Idea that the university has no boundaries, we want to be a part of your education even if you’ve never been lucky enough to set foot in Mad City.

In my urban economics courses, I try to find time to point out books and articles outside that course’s curriculum that fit that lifetime learning model. In that spirit, from time to time I’ll use this blog for short book reviews.

Let’s start with one of my recent favorites, In Fed We Trust: Ben Bernanke’s War on the Great Panic; How the Federal Reserve became the Fourth Branch of Government. If the full title is a little long, the double subtitles do give a fair view of the contents. The book was written by David Wessel, the Wall Street Journal's economics editor, and frequent contributor to National Public Radio. He is a very interesting and generally reliable voice on economic matters.

In Fed We Trust tells the story of the fall 2008 economic crisis, through the perspective of the actions of Fed Chairman Bernanke and a small group of policymakers, including Henry Paulson at Treasury, Timothy Geithner (then at the New York Fed), Kevin Warsh at the Fed, and others like FDIC’s Sheila Bair and the SEC’s Christopher Cox.

We're still in the middle of the economic crisis, and academics will argue over the causes and the policy responses for decades. Nevertheless, this book is a terrific first look. It's a clear and readable narrative focusing on a particularly critical time. Other books and articles dig deeper into the root causes, and present more data and analytics – see, for example, Restoring Financial Stability: How to Repair a Failed System, edited by Viral Acharya and Matthew Richardson; or Jim Barth’s Rise and Fall of the U.S. Mortgage and Credit Markets.

The broad outlines of the crisis are familiar. Over the long run, house prices in the U.S. rise slightly more than inflation, on average (see: Malpezzi and Maclennan, The Price Elasticity of Supply of New Housing in the U.S. and the United Kingdom, Journal of Housing Economics, 2001). But as my colleague Morris Davis and I show in this chart, starting around 1996, U.S. house prices began a decade-long run-up, increasing an inflation-adjusted average of 7 percent per year, clearly an unsustainable situation. Nevertheless, many borrowers, lenders, investors, and some analysts and policymakers appeared to believe large real house prices could be sustained indefinitely, in defiance of history and logic. After the 2007 turn in housing markets, and the subsequent collapse of mortgage backed security and other markets, by September 2008, U.S. financial markets and indeed the entire economy stared into an abyss. This book is the story of the small group of key officials whose responses to that crisis plausibly they kept us from falling into the abyss.

We all know that will never know the true counterfactual – exactly what would've happened to the economy really if the actions described in this book had not been undertaken. Based on the available data and reportage, my personal view is that it would have been extremely dire indeed. A complete freeze up of the global financial system could have led to a much larger contraction in real economic activity and does walk taken us down a path of deflation and extreme unemployment from which recovery would take years – see Japan’s experience. During this period Bernanke et al. dealt with massive failures at Bear Stearns, Lehman Brothers, AIG, IndyMac, Fannie and Freddie, and others.

It's interesting to contrast Bernanke with his predecessor Alan Greenspan. As an economist, by all accounts Greenspan is an excellent clarinet player. As a fellow data freak, I have to admit to a certain admiration for Greenspan's eclectic data-diving. But even data freaks need a good conceptual framework, and an ability to do serious empirics that make sense of the data; or at least we have to understand the frameworks and empirics of others. A good economist also needs to know when to step back and give up on a particular view. Keynes’ famous statement, “When I find I’m mistaken, I change my mind. What do you do?" comes to mind. Bernanke went into the crisis with many of the same prior beliefs as Greenspan, more or less. But it’s impossible to overestimate the importance of this difference between the two men: when events showed their prior beliefs about the economy’s workings, and the Fed’s appropriate policies, were mistaken, Greenspan was left only with an ideology, and his deep yet by then irrelevant knowledge of the more obscure economic statistics. Bernanke had the flexibility to adjust his conceptual framework, and move into a mode that was demanded by events. Nor did his flexibility devolve into a paralyzing uncertainty about the actions to be taken, once he believed he understood the situation.

Especially at this early stage it’s important not to turn hagiographic and believe Bernanke, or his policies, are better than they were. Nevertheless, from everything we know at this writing, we can be thankful we had Bernanke at the helm of the Fed in 2008. Henry Paulson by contrast comes across the way he did to many of us watching C-SPAN and reading the newspapers at the time: someone who was surprisingly ineffective at communicating just what they were doing or why. Last year more than once I found myself yelling at the television set as Paulson would again fail to articulate a focused diagnosis of the crisis or a clear rationale for their actions. Nevertheless, I have sympathy for Paulson’s position, too. As Treasury vacillated between a planned reverse auction to set prices for dodgy assets and flooding the market with liquidity, I did and still find it hard to be certain from Madison how much of the financial institutions’ problems were liquidity and how much was insolvency. Knowing the difference is the key, and it’s hard: I’m reminded of what I sometimes tell our students: “If you’re not confused, you’re simply not yet thinking clearly.” This book won’t sort out everything we need to know about the crisis and its aftermath; that book hasn’t been written, and I’m not sure it ever will. But In Fed We Trust is a great, readable start.

For a focus on liquidity as the prime issue, see work by John Cochrane.

One of the economists consistently emphasizing the role of insolvency has been Nouriel Roubini.

For more general discussion see Wisconsin Real Estate's insights on the crisis.

Racial issues in housing markets

From Stephen Malpezzi, professor and Lorin & Marjorie Tiefenthaler Distinguished Chair of Real Estate at the Wisconsin School of Business:

Several weeks ago I participated in a panel discussion on racial segregation at the Wisconsin Union. In response to a few requests I've attached some of the data and references I provided as background to the panel.



Among numerous points you can glean from these, note the following:

(1) Despite some slow progress, U.S. housing markets remain highly segregated by race. Segregation by income potentially explains some, but by no means all, of this segregation.

(2) Black-headed households are less likely to be homeowners than whites, even after controlling for income.

(3) Racial differences in housing prices are still debated somewhat; but the weight of careful studies that control for the quality of housing consumed suggests that housing in black areas trades at a discount. This is consistent with a world in which at least some whites are willing to pay a premium to live in white areas.

(4) Blacks are more likely to be turned down for mortgage loans than whites, and more likely to be offered a subprime loan, even after controlling for income. But it is devilishly hard to establish clearly whether this is due to discrimination (witting or unwitting), because nobody has yet been able to put together the kind of data needed to answer the question unambiguously. Partly it's a matter of obtaining all the variables (such as credit score, which has been obtained for a few studies) and partly because it's important to collect data on all stages of the process, e.g. including potential applicants who did not, in the end, submit an application (which has not been obtained for any studies I've seen).

(5) Foreclosures have hit many black neighborhoods especially hard in the past two years. The Wisconsin Foreclosure and Unemployment Relief Plan is one approach that aims to mitigate the foreclosure problem by tying a housing voucher to unemployment.

You can continue the discussion and share your thoughts in the comments.

Is inflation coming?

Greg Mankiw's recent blog post on the exploding monetary base sparked some discussion among UW faculty. Morris Davis, assistant professor of Real Estate and Urban Land Economics, shares his thoughts:

Historically there has been a fairly high rate of correlation of growth of trend m1 (which is not the same as growth in reserves), gM, and growth of trend in the consumer price level from NIPA, gP. The picture below shows the two series from 1959:1 – 2009:3. Trends are computed using the HP Filter. The overall correlation (59:1-09:3) is 68 percent and the correlation of the two series after 1985 is 88 percent.

Based on this picture, it does not appear as if we’re in for a sudden spike in consumer prices.
HOWEVER, the HP filter is discounting the recent growth in M1 we’ve had until we see more evidence that the new level of M1 is permanent. You can see this from the graph below that shows m1 and trend M1 from 2000:1 – 2009:3.

That is, in a few years time, the HP Filter might redo its “trend” to take on board the growth in M1 we’ve had (the HP Filter is a 2-sided filter, meaning that new data can affect historical trend calculations).

So I think we need to wait before we can be convinced any inflation is coming.

Also, for what it is worth, I agree with this paragraph from Mankiw:

"Does this mean that investors should stop worrying about inflation? No. Yet the worry should stem not from the monetary base but from the political economy and difficult tradeoffs facing monetary policymakers. As the economy recovers, interest rates will likely need to rise. Will the Bernanke Fed, feeling the political heat, get behind the curve and allow inflation to take off? Will it decide that a little bit of inflation is not so bad compared with the alternative of risking an anemic recovery, a double dip recession, or (gasp!) congressional action to reduce Fed independence? Maybe. This is, I think, the right way to argue that higher future inflation is a plausible outcome."