The Housing Bubble

“I am on a kick of discrediting market averages,” Ballarino said. “Pricing is so localized, each property has to be valued separately.”

There is no national housing bubble. But some appraisals are a bit fraudy.

Probably not. He is to much of a fool.

Well done, but long in the teeth — predates the UK reflation…

That piece is a beautiful encapsulation of the ongoing discussion on this blog. Maybe Ben Jones and Gary Shilling should team up and write a book.

I have a bit of back-of-the-envelope analysis to add based on Chart 13 — Residential Construction as a % of GDP — which ought to lay to rest the bull (bullsh!t?) case that the construction downturn has or is about to bottom out. My apologies for any estimation errors due to misreading of the charts; anyone who wants should feel free to look up the actual numbers on which to base a more precise estimate, but I don’t think the qualitative conclusions would change much. I also took the liberty of throwing out some guesses for the denouement of the current construction downturn (indicated by ?).

I drew on one additional data source, which is the NBER dating of recessions:

http://nber.org/cycles/cyclesmain.html

I use the following abbreviations below:

P = peak year of construction as % of GDP (peak % level in parens)
T = trough year of construction as % of GDP (trough % level in parens)
D = depth of construction downturn as % of GDP
E = length of preceding construction expansion
R = length of ensuing construction recession
N = dates of next subsequent GDP recession

P 1964 (5.5%)
T 1967 (3.5%)
D 2%
E 4 years
R 3 years
N 12/69-11/70

P 1973 (5.8%)
T 1975 (3.7%)
D 2.1%
E 6 years
R 2 years
N 11/73-3/75

P 1978 (5.7%)
T 1982 (3.2%)
D 2.5%
E 3 years
R 4 years
N 1/80-7/80, 7/81-11/82

P 1987 (5.0%)
T 1991 (3.3%)
D 1.7%
E 5
R 4
N 7/90-3/91

P 2005 (6.3%)
T 2009? (3.4%?)
D 2.9%?
E 14!!!
R 4???
N ???

Conclusions:

1) The periods of the three most recent residential construction recessions overlapped with GDP recessions.

2) The 2005 peak of residential construction as a % of GDP was the highest since 1960 — 6.3% versus the next highest level of 5.8% in 1973.

3) The recent residential construction expansion (aka housing bubble) was the longest in duration — 14 years versus six years for the next longest period (1967-1973).

4) Previous residential construction recessions bottomed out at 3.4% of GDP on average. This time it would take a drop of 2.9% in the residential construction share of GDP to get down to the average of the past troughs, and that does not factor in ripple effects (i.e., GDP will likely drop farther due to downstream effects on consumption and employment). And Chart 13 shows the downturn has only just begun.

You saw my back-of-the-envelope forecast for a 2.9% drop in only the home-construction component of GDP, with a bigger drop when downstream effects are added in. The Fed chair has a much more benign forecast. But I am missing how his forecast meshes with past data. Does he believe that this time is different?
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Bernanke’s Forecast

Fed Chairman Bernanke said that housing weakness could knock 1% off real GDP growth. It did so, 1.12% at annual rates, in the third quarter, after a 0.72% negative effect in the second quarter. That, of course, is what the housing bulls hope will be the bottom of residential construction weakness. They also hope house appreciation will return to a roughly 5% annual rate, enough to keep speculators from bailing out and enough to allow subprime mortgage borrowers to refinance and avoid disastrous mortgage rate-reset shocks.

The housing bulls are hardly prepared for the 5% to 10% peak-to-trough decline in prices that other housing bears and the futures market predict. The futures market indicates that the Case-Shiller Housing price index will decline 7.5% from its June 2006 peak to August 2007. Using median existing single-family house prices nationwide, a somewhat different series, we expect the decline of 4.6% from their October 2005 peaks to September of this year to extend to 18% by the third quarter of 2007 and to nosedive over 25% from the earlier peak to the final trough in the first quarter of 2008.

Chart #10 in the safe haven analysis reflects a 27% drop in price between peak and trough in just 18 months…

Where are the blogs RE balloon floaters now?

“Developers say having high-rise buildings on the lakefront was only a matter of time because land along Florida and California waters is nearly built out.” Don’t forget Hawaii. What a lie, even in Hawaii, there is alot of ocean view land for sale now just sitting. 1/2 acre lots in my subdivision are now asking 112,500 and not selling. Summer 2005 a few sold for 180-190k. Most lot owners paid 19-20k as recently as 2002.

They are doing the same thing to downtown Austin. Ruining it, if you ask me.

Addition/revision to 3.: Fed rates become almost irrelevant as flight from dollar drives bond yields up rapildy with oil and precious metals rising accordingly

How do you know the market has not factored in the GDP revision which will come out November 29th? The bust in the transport component was picked up in some of the media although “not official”.

How do you know the market has not factored in the GDP revision which will come out November 29th? The bust in the transport component was picked up in some of the media although “not official”.

Before anyone slams you for not googling this question:

1.) A stock option is the right to purchase (a call option) or sell (a put option) a stock at a given price (the strike price) within some timeframe in the future.

For example, let’s say the spot price is $5, and you buy a call option with a strike price of $10, and the price of the stock goes to $20, you exercise the option buing the stock at $10 and immediately resell the shares at $20 pocketing a $10 profit.

Options are purchased at a small cost compared to the value of the underlying stock. At the end of the option period, the option expires and the money paid to purchse the option is lost. Options can be used as a hedge against price volitility, or as a pure speculative vehicle.

2.) Backdating options is cheating because if you know what current price is (the spot price) you can just backdate the option to create a favorable spread between some earlier spot price and the strike price without incurring any real risk. It is essentially a way of giving a bonus for which the beneficiary would only be liable for capital gains tax, not income tax.

Corrections welcome.

A stock option is a contract to purchase a stock at a future date for a certain price (usually the market price of the stock when the option contract is issued). They’re used extensively as incentive-based compensation of executives under the theory that if the stock prices goes up, then senior managers are doing a good job.

For example, say that I was hired as CEO of GM last December. Part of the compensation package was 500,000 stock options. Back then the price of the stock was ~$20/share. Fast forward a year later, and the stock has gone up to ~$40 a share. I exercise the options and pocket $10,000,000 (at cost to the company/shareholders).

Now let’s say that I get greedy and see that back in February the stock price dipped to $10/share (it didn’t, just for illustration). I get together with a few other senior managers (CFO, general counsel, VP Human Resources) and get the paperwork changed on my stock options to reflect a different option date (ie, the one where the stock price was the lowest). This practice is called backdating the option and it is illegal. Now when I go to exercise the options at a future date when the stock price is up to ~$40/share, I pocket $15,000,000 rather than $10,000,000.

This additional $5,000,000 is basically coming out of the shareholders’ pockets without their knowledge or consent, which is why its illegal. Essentially, by backdating the option I’ve increased my income at the expense of the company. At the same time, there’s a good chance that I’ll get away with it because if the stock price has gone up, its likely that my stockholders are happy with me and the performance of the company. Also, $5M is a relatively small amount for a large, publicly traded company, so there’s a good chance that this practice will go undetected if no one is looking for it. But in actuality, it is stealing, just as if I had falsified expense reports for my personal benefit.

“What is “back dated” stock option”

It is a felonious CRIME perpetrated by the thieving corporate class as a means to empty the pockets of shareholders. It’s akin to a bank employee entering a database and moving decimal places to their balance.

David B, I just reviewed a prospectus from an apartment REIT where the case was made that a 4 times gross apartment sale (10 times was usually considered safe) with a 10 year hold time would give the buyer a better return ” ROI ” on investment than any other safe 10 year investment. Leverage makes that happen. The REIT in question has gone up 30% this year, so somebody is buying into this

It is popular wisdom that homebuilders can afford to cut their prices whereas individual homeowners cannot. I disagree. The difference is homebuilders are acutely aware of their cost of capital while individual homeowners are dimly aware or not aware at all.

What individual homeowners are aware of is loss aversion. It may take months or years of “throwing $10,000 off a bridge every month” (to borrow from a recent poster) before the cost of not cutting the price sinks in.