Paul Krugman: Housing Gets Ugly

Paul Krugman, like Tim Duy and Calculated Risk, is thinking about Eeyore:

Housing Gets Ugly, by Paul Krugman, Commentary, NY Times: Bubble, bubble, Toll’s in trouble. This week, Toll Brothers, the nation’s premier builder of McMansions, announced that sales were way off, profits were down, and the company was walking away from already-purchased options on land for future development.

Toll’s announcement was one of many indications that the long-feared housing bust has arrived. Home sales are down sharply; home prices ... are now falling in much of the country. The inventory of unsold existing homes is at a 13-year high; builders’ confidence is at a 15-year low.

A year ago, Robert Toll, who runs Toll Brothers, was euphoric about the housing boom... In a New York Times profile ... published last October, he dismissed worries about a possible bust. “Why can’t real estate just have a boom like every other industry?” he asked. “Why do we have to have a bubble and then a pop?”

The current downturn, Mr. Toll now says, is unlike anything he’s seen: sales are slumping despite the absence of any “macroeconomic nasty condition”... He suggests that unease about the direction of the country and the war in Iraq is undermining confidence. All I have to say is: pop!

Now what? Until recently most business economists were predicting a “soft landing” for housing. Even now, the majority opinion seems to be that we’re looking at a cooling market, not a bust. But this complacency looks increasingly like denial, as hard data — which tend ... to lag what’s actually going on ... — start to confirm anecdotal evidence that it is, indeed, a bust.

Why the sudden crackup? ...[W]ith prices falling in many areas, the speculative demand for houses has gone into reverse, as people try to get out with a profit while they still can. There’s now a rapidly growing glut of unsold houses. This is a recipe for a major bust, not a soft landing.

Moreover, it could be both a deep and a prolonged bust. Since 2000, much of the nation has experienced a rise in home prices comparable to the boom in Southern California during the late 1980’s. After that bubble popped, Los Angeles house prices began a slow, grinding deflation, eventually falling 20 percent (34 percent after adjusting for inflation). Prices didn’t begin a sustained recovery until 1996, more than six years after the downturn began.

Now imagine the same thing happening across a large part of the United States. It’s an ugly picture, and not just for people and companies in the construction business. Many homeowners — especially those who bought their houses with interest-only loans or with minimal down payments — will find themselves in financial distress. And the economy as a whole will take a hit.

As far as I know, Nouriel Roubini of Roubini Global Economics is the only well-known economist flatly predicting a housing-led recession in the coming year. Most forecasters consider his call alarmist, and many Federal Reserve officials remain optimistic. Last week, Richard Fisher, the president of the Federal Reserve Bank of Dallas, dismissed “Eeyores in the analytical community” who worry about a possible recession.

Call me Eeyore. While I don’t share Mr. Roubini’s certainty, I see his point: housing has been the main engine of U.S. economic growth over the past three years, and with that engine now going into reverse, it’s hard to see how we can avoid a serious slowdown.

Update: In Money Talks, Krugman adds:

Just a wonkish note about how bad the macroeconomics of all this could be:

If you look at the most leading of the indicators on housing, stuff like new home sales and applications for permits, they're off more than 20 percent from a year ago. If that translates into an equivalent fall in residential investment, we're talking about a fall from 6 percent of the G.D.P. to 4.8 percent. And this may be only the beginning; I wouldn't be surprised to see housing investment drop below its pre-bubble norm of 4 percent of G.D.P., at least for a while.

Add to this the likely effect of a housing bust on consumer spending and you've got a direct hit to G.D.P. of, say, 2.5 percent or more. That's bigger than the slump in business investment that led to the 2001 recession. And the main reason the 2001 recession wasn't as deep as some feared was that the Fed was able to engineer... a housing boom. What will the Fed do this time?

Maybe rising business investment and a declining trade deficit will soften the blow. But it's remarkably easy, playing with the numbers, to come up with scenarios in which the unemployment rate rises above 6 percent by the end of 2007. That's not a prediction, but it's well within the range of possibility.

_________________________
Previous (8/21) column: Paul Krugman: Tax Farmers, Mercenaries and Viceroys
Next (8/28) column: Paul Krugman: Broken Promises

Comments

[LJM]

Actually, George Soros has been saying for a long time that he thought we'd have a recession in 07. Others thought it was coming just after Bush would leave office, but surprise, it's going to happen on his watch. Who would you rather have dealing with a recession? I'd rather have a Democratic controlled congress and senate. I've seen what the Republicans do, after the one we had in 2001 and that wasn't pretty. This one is going to be harder.

[Movie Guy]

Krugman - "home prices ... are now falling in much of the country"

Is that really true?

I don't believe it. Regardless...I will move past that minor point.

While the economist, analyst, and blogger piling on is occurring with the issue of housing, I find it a bit odd that so many are whining over excessively high housing prices which are now balancing downward and interest rates rising to levels whereby excess activity can be reigned in.

What is the big deal? We're only seeing evidence that the Greenspan/Fed method of recovery marketing using the housing prop was an exercise that could not sustain the U.S. economy. Now, who is really surprised that housing asset pricing is being driven back down?

Where were all these alarmed voices on the way up, early on when it was obvious what the Greenspan plan was? I remember a time when only a few of us were raising hell over Greenspan's marketing comments to the American public to jump on variable rate loans. Back then, we had people in all three camps challenging our concerns.

Bottom line, housing was played. Game is ending. Move on. Find something else to prop up the U.S. economy while real wages, real compensation, and median income continue to slide. Find something else to balance the U.S. trade and current account deficits.

Do whatever you have to do to mask the real problems a little longer, if that is your game.

In the end, though, some serious-minded adults will have to step up and deal with the artifical vehicles by which all of the problem masking has been undertaken.

Housing? Handwringing? Alarm? Give me a break.

The whole idea was stupid from the start. One big con.

What's the next plan?

[anon/portly]

"Greenspan's marketing comments to the American public to jump on variable rate loans."

Is that a Sears poncho or is that a real poncho? (I mean, did Greenspan really say something that can be construed along those lines?).

[CalculatedRisk]

MovieGuy, I was doing my best to sound the alarm about the housing market.

anon/portly:

Alan Greenspan's advice:

"... many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade.
...
American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."
Alan Greenspan, Feb 23, 2004

Best to all.

[jason]

I agree with Krugman that house prices are destined to fall, but the US economy has proved very resilient. Also, there might be an income effect for buyers too, with cheaper housing in prospect. Additionally, given the success of the 03 tax cuts, we should consider more tax breaks, esp given monetary policy might lose its efficacy with housing deflating.

[Cyrille]

Was that supposed to be a joke Jason?

[Bruce Wilder]

My understanding has been that the real go-go in housing has been a coastal, blue State thing -- a phenomenon, which occured where low interest rates could interact with local sources of high incomes and some constraints on supply.

My recollection of the great L.A. housing bust of the early 90's was that it was a product of the departure of aviation from L.A., following the end of the Reagan defense build-up. A major source of L.A. high wage jobs disappeared, and took the housing market down in a prolonged wave of foreclosure.

I cannot help but notice that real wages have been declining under Bush; the rise in health care costs makes it seem like there has been an increase in fringe benefits, but you'd have to be a Prof. Mancow to be fooled by that. I don't know, but somehow I think the decline in wages may have been centered mostly in places, like the mid-west. (STR??)

So, I guess I am wondering if, even though the frothy upside was isolated to blue State, coastal urban areas, is it possible that the downside might be more general. If I really thought runaway speculation was the problem, I might make up a story that said the impact was going to be greatest, where the bubble had been greatest.

But . . .

Did large red State areas "escape" the bubble, because of the depressing effects of wage decline and labor market weakness? Is it possible that the downside will not be a simple mirror of the previous apparent excesses, but a more general slide, reflecting decling wage income, increasing personal debt, and poor prospects?

The domestic auto industry -- driven by pickups and SUVs -- is taking a nosedive. Though no one is saying it aloud, bankruptcy for both G.M. and Ford is not out of the question. Housing in Ohio and Michigan looks pretty cheap, if your night vision has been wiped out looking at Washington or L.A. prices, but maybe they are not nearly cheap enough, given local income trends.

I am speculating, my pessimism unconstrained by data. Someone save me. Tell me that Bush will attack Iran and increased war spending will save the economy despite $5/gal gas. No, wait. Don't tell me that. Tell me, again about how the economy has changed and inverting the yield curve does not "mean" what it used to mean.

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Vanguard Fund Returns
12/31/05 to 8/24/06

S&P Index is 5.0
Large Cap Growth Index is -1.3
Large Cap Value Index is 10.8

Mid Cap Index is 2.4

Small Cap Index is 3.1
Small Cap Value Index is 6.4

Europe Index is 17.9
Pacific Index is 4.8
Emerging Markets Index is 8.3

Energy is 16.5
Health Care is 7.9
Precious Metals is 25.7
REIT Index is 19.4

High Yield Corporate Bond Fund is 3.0
Long Term Corporate Bond Fund is -1.3

[ilsm]

In my market we peaked about '88, I sold in '90 a bit less.

I could have gotten it back in '95 in foreclosure at about 65% of what I sold it for. I missed that chance.

I bought again in '98. Sold in '00 with about 30% gain.

I came back to the market in '03 and aw the bubble and have been in rentals.

I think by '09 I will get the '00 price again.

[Arthur]

I wonder if this whole "red states have no bubble" thing is even true. I live in Tennessee, bought a house in '03 and its price has doubled since then. I lived in Boston before that and saw the prices rocket up there, but I've never seen anything like the construction boom going on here.

[Nels Nelson]

I've noticed a number of comments recently that have blamed the slowing market for residential real estate on the Nattering Nabobs of Negativism.

This brings to mind the character Oddball played by Donald Sutherland in the movie "Kelly's Heroes": “Always with the negative waves Moriarity, always with the negative waves. Why don’t you knock off them negative waves! Why don’t you dig how beautiful it is out here. Why can’t you say something righteous and hopeful for a change.”

Let's knock it off with the negative waves. That'll take care of things.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=6806&u=97|24|...

Short-billed Dowitcher Preening
Jamaica Bay NWR East Pond, Queens.

Well, I am all positive and cautious as heck for my positivism means little though sentiment after a while can be curiously reinforcing.

[save_the_rustbelt]

"...I wonder if this whole "red states have no bubble" thing is even true....

It is certainly true in the Rustbelt.

Tennessee has been having a mini boom in the economy so I can see some selective booming there.

We have no bubble to burst, but houses are sitting on themarket for a long, long time.

[nyuk]

A realtor once told me that perception is reality. Right now, I perceive that I have a certain amount of equity in my house, call it "X". Let's say that what I owe on my house is "Y". If I decide to sell my house, and I get offers that are less than X + Y, then I might be inclined to adjust my perception of X to match the purchasers perception of X + Y, in which case, the new X becomes the reality, minus the realtor's commission(RC), and any other closing costs(CC). Hopefully, X + Y -(RC + CC) will never be less than my purchase price. If X + Y is ever less than Y... that will really suck.

[Movie Guy]

I give all the credit in the world to Calculated Risk for nailing the problems with the housing price run up game from the beginning. Calculated Risk and some of the other housing blogs grasped the problem, explained it, and alerted us to the ongoing fallout long before it happened.

It's a real shame that there wasn't a major initiative or loud protest by economists and analysts all over the nation challenging what the Fed Reserve was orchestrating at the time. The second challenge, that to Congress and the Administration on tax policy changes was noted, but it wasn't strong enough either.

One doesn't always have to wait to see the outcomes of a given policy move. Sometimes, with an ounce of foresight, the outcomes are obvious.

And here we are.

What is the next plan?

[JRossi]

I bought a house in Napa CA for 170k in 1989 and sold it for 155k in 1997. It's now probably worth over 300k. (I no longer live in the area and don't follow housing prices there.) I have a friend who bought a condo in Bellflower CA in 1988 and sold in 1997 (job relocation)for 30k less than it bought it for. He's still paying off the loan he got from his dad to cover it.

[Ken Houghton]

I hate to rain on the parade, but the Red States have experienced the housing bubble--not so much as some of CA or NJ, to be certain (MA is a rara avis, in that it paused for a few years)--but nonetheless.

See CR on the Dallas area, for instance. Or the Miami condo market.

I just looked through the foreclosures for a couple of counties in IN. The decline isn't so much on a dollar basis, but on a percent basis I wouldn't have wanted to have bought the properties as "investments."

But, of course, that has always been true. My mother received about 4% p.a. on the Ancestral Home in 2000.

Location, Location, Location.

Now, if 5/3 was making a sizable amount of IO or Balloon loans on properties in that area, then there's a question of mismanagement on the institutional level(op. cit. WaMu). But that's separate from speculative losses and/or being unable to move because of inefficient use of capital.

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Notice, by the way, that bond investors have been moving to inflation protected, and high yield corporate and tax exempt bonds. The respective Vanguard funds are up 1.3%, 3.0% and 3.2% for this moderately negative year in bonds.

[Richard]

As for housing prices: I don't think it's a red state / blue state thing. I think it's an urban metro area / rural area phenomenon.

And remember: if you live in a very rural state, the city doesn't have to be very large to constitute "urban".

Like Bernstein, I measure the size of a market relative to its median incomes, and median incomes tend to be larger in the top fifty MSAs.

[lonesome moderate]

This roughly corresponds with what Krugman wrote a few months ago, that when it came to real estate the country was basically split between "flatland" (which has roughly 70% of our housing stock) and the "zoned zone". "Flatland" is those parts of the country where, if housing prices get bid up, developers can just build more. The "zoned zone" consists of those areas where, due to government or other restrictions, you can't easily do that. His argument was that the bubble was primarily a "zoned zone" phenomenon.

[slink]

do any of you remember a first baseman named cecil cooper
sweet lefty swing

paul k's got that swing these days

and its fun to watch him at bat

[anon/portly]

Thanks to Calculated Risk for trying to provide an answer to my question. Clicking the link turns

"... many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade."

into

"Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward."

Alan Greenspan was only saying something that was true, assuming the Fed's research really did show what he said it did. True, and carefully qualified. I'm not sure there's fault in that.

And maybe Greenspan musing, to credit union officials, on the possible savings with and the preferences in other countries for adjustable-rate mortgages, as opposed to American preferences for fixed-rate ones, amounts to "marketing comments to the American public to jump on variable rate loans," or maybe it doesn't. I'm not sure he sold a single ARM that day, but maybe he did.

Trying to sell the American public on using debt unwisely is like selling ice cubes to Eskimos in any case, isn't it?

[John]

The boom was general driven by cheap capital and mania. The southeastern red states (esp Florida) boomed. In addition, the only reason markets like the Midwest and Denver did not fall earlier in response to heavy job losses was the access to cheap mortgage capital and the psychic frenzy that went with."Neutral" vs. "down " was their version of the boom. Now that those props have disappeared the markets with weak fundamentals (esp job market factors) have crashed along with the coasts

[lonesome moderate]

As pointed out by "Geoff" at the Roubini blog, Toll Brothers "predicted" a housing bust a year ago. Not in their public statements, but in their insider trading.

[anne]

http://krugman.page.nytimes.com/b/a/257980.htm

August 25, 2006

The Bubble Bursts

Paul Krugman: There are For Sale signs all over the area where I live, too.

Paul Krugman: This goes back to a column I wrote last summer, "That Hissing Sound," where I made a distinction between the Zoned Zone — densely populated areas where building sites are scarce — and Flatland, where they aren't. The worst of the bubble is in the Zoned Zone; there are many places where prices have doubled since 2000. And that's where you expect the biggest price falls. The Northeast and the west coast contain most of the Zoned Zone; with the exception of coastal Florida, the South is mainly in Flatland. So I don't expect as big a bust there.

Paul Krugman: No, D.C. isn't bulletproof. It's somewhat insulated from those nasty macroeconomic events that Robert Toll thought were necessary to produce a housing slump, but D.C. is fully involved in the bubble and pop.

Paul Krugman: Just a wonkish note about how bad the macroeconomics of all this could be:

If you look at the most leading of the indicators on housing, stuff like new home sales and applications for permits, they're off more than 20 percent from a year ago. If that translates into an equivalent fall in residential investment, we're talking about a fall from 6 percent of the G.D.P. to 4.8 percent. And this may be only the beginning; I wouldn't be surprised to see housing investment drop below its pre-bubble norm of 4 percent of G.D.P., at least for a while.

Add to this the likely effect of a housing bust on consumer spending and you've got a direct hit to G.D.P. of, say, 2.5 percent or more. That's bigger than the slump in business investment that led to the 2001 recession. And the main reason the 2001 recession wasn't as deep as some feared was that the Fed was able to engineer... a housing boom. What will the Fed do this time?

Maybe rising business investment and a declining trade deficit will soften the blow. But it's remarkably easy, playing with the numbers, to come up with scenarios in which the unemployment rate rises above 6 percent by the end of 2007. That's not a prediction, but it's well within the range of possibility.

[anne]

The question that is presented is what takes the place of housing as housing falters and what does this mean for a portfolio? The answer so far is that housing has not faltered enough to bring a recession in any of the more developed economies since 2000. Will the case be different here? Of course this is not a satisfactory answer, so I will add commercial real estate as a startling vibrant market and wonder if relatively low long term interest rates and a halt or reversal of Fed policy can maintain the commercial market and limit price declines in housing.

[Wimpy]

Commercial realty has been vibrant, but where I live there is increasingly empty spec-built, commercial retail centers. This leaves me wondering if many of these commercial building projects are economically viable or just a product of excessive lending by banks starved for decent return on investment. On my twenty-minute commute to work, for instance, there are now three recently built-out retail centers. All remain empty. Such building appears to be a overly-bold use of investment funds at best and a complete waste of resources at worst.

[anne]

Paul Krugman wrote a column on April 20, 2004 suggesting locking in a 30 year fixed mortgage. The 10 year Treasury yield was 4.3% and the mortgage rate was 5.8%. The Treasury rate is now about 4.8%, while the mortgage rate is a remarkable 6.0%. Curiously, fixed rate mortgages are little more expensive now than they were 2 1/2 years ago though the long term Treasury yield has risen significantly.

Could a Federal Reserve lowering of short term interest rates, then, quickly stabilize or revive the housing market?

[anne]

http://www.nytimes.com/2004/04/20/opinion/20KRUG.html?ex=1397793600&en=b76f384741a7b890&ei=5007&partner=USERLAND

April 20, 2004

Questions of Interest
By PAUL KRUGMAN

"Yes, the republic is in danger," a friend said. "But what's going to happen to interest rates?" O.K., let's take a break from politics.

Over the past two years, interest rates have been very low. Last June the 10-year bond rate hit a 48-year low. Even three weeks ago the rate was still below 4 percent, a level last seen in 1963.

If the economy fully recovers — or even if investors just think it will — interest rates will rise sharply. In its World Economic Outlook report, to be issued tomorrow, the International Monetary Fund urges the Federal Reserve to prepare the economy for higher rates to "avoid financial market disruption both domestically and abroad."

But how far will rates rise? Let's not get into Greenspan Kremlinology, parsing the chairman's mumbles for clues about the Fed's next move. Let's ask, instead, how much rates will rise if and when normal conditions of supply and demand resume in the bond market.

My calculations keep leading me to a 10-year bond rate of 7 percent, and a mortgage rate of 8.5 percent — with a substantial possibility that the numbers will be even higher. Current rates are about 4.3 and 5.8 percent, respectively; you can see why the I.M.F. is worried about "financial market disruption."

Why 7 percent? Well, in the past 20 years the average yield on 10-year bonds has, in fact, been about 7 percent. Why shouldn't we think of that as the norm? ...

[anne]

Where Paul Krugman, based on past interest rate norms thought a 7% yield on the 10 year Treasury and an 8.5% long term mortgage rate realistic, we fortunately have the Treasury at 5.8% and the mortgage rate at 6%. So, I would like to think the Federal Reserve may have already allowed for another soft landing.

Curious credit market where the long term Treasury has gone from 4.3% to 5.8%, while the mortgage rate has only gone from 5.8% to 6.0%.

[anne]

I have noticed change in the performance of GNMA bonds looking back 25 years, that reflect a continually more consumer responsive and competitive credit market for mortgages. I suspect, along with Alan Greenspan, this change is important in adding to the flexibility of the American economy.

[anne]

Suppose then that we have an entirely different credit market for mortgages than 25 years ago, also that we are nearing a close to the tightening cycle of the Federal Reserve at a far lower long term interest rate level than at any time in 25 years. Households may just be in better condition than in previous tightening sequences. With a firm level of employment, there seems reason for a measure of confidence.

[anne]

Brad DeLong was worried in 1993 that the Federal Reserve had allowed short term interest rates to remain too low for too long, while in 1994 the worry was the Fed would have to raise rates sharply enough to severely limit growth. However, the tightening sequence by the Fed, which began in February 1994 and closed in a year, easily and surprisingly limited inflation and moderately slowed growth.

[lonesome moderate]

Thanks for the comments, Anne. I always find your postings to be informative and well thought out, even when I don't completely agree with them.

[johnjasonchun.com]

When I was selling all my properties in 2003-4-5-6, I was called "dumb"...
Sold at 11 to 1 profits.
Hmmmmmm who is the genius???

[Winslow R.]

No one is a 'genius' until your home price falls below what you sold it for and then you repurchase it before prices come back up.

I remember in 2001 a few people that sold their homes hoping to have 'hit' the top with the slowdown. They were not geniuses, nor will some of you be if we follow Japan's path toward the zero bound as we would likely have another 'peak' left.

If we take the opposite path and invade Iran leading to rapid inflation it is also unlikely you'd be shown to be a genius as the prices of real estate could go still higher.

How could anyone be considered a 'genius' for correctly guessing the outcomes of our current leadership? PK's credentials are burnished by his other accomplishments.

[thebizofknowledge.com]

Even in areas where the housing market has been particularly robust, there are now signs of a slowing down of sales. We may have become complacent that a good thing was going to continue indefinitely, and now we're about to hit that hard wall called reality.