Arnold Kling  

Sticky-Priced, Illiquid Asset

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The Tick Petition... Adjusting Income for Age...

Chip Case and Bob Shiller write,


New home sales in July are 22% below July 2005. The decrease is 43% for the Northeast over that same period, and the inventory of unsold new homes is up 22%. Existing home sales are down to 6.33 million in July from over seven million at the end of 2005...

The U.S. now has a futures market based on home prices. The market that opened in May at the Chicago Mercantile Exchange is now showing backwardation in all 10 metropolitan areas trading. The backwardation can be expressed as implying a rate of decline of 5% a year for the S&P/Case-Shiller Composite Index by May 2007.


Housing is not a typical financial asset. Stocks and bonds do not build up such a huge unsold inventory in a down market. The drop in sales volume and rise in inventory suggests sticky prices.

Also, the futures market is telling me to sell my house and then buy it back a year from now. I could lock in an arbitrage profit by buying a futures contract now and then selling it when I buy back my house. But housing is not that liquid. The transactions costs would eat up the profit from the "arbitrage." Real estate commissions, title search, transfer tax (which is a really stiff tax in Maryland, where I live), etc.


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COMMENTS (7 to date)
Piso Mojado writes:

What is the ticker for the housing market future? How has the open interest changed over the last few months? It's going to be fascinating to watch this.

edhopper writes:

Though not as liquid as stocks and bonds, the investors, speculators and second home buyers in the last few years have made housing much more of an asset class than it has been in the past.

mjrmjr writes:

Whether transactions costs would be greater than your profit depends entirely on how much in value your house drops. Is a year going to be long enough to wait to maximize profit? My guess is no. Two to three years is probably more realistic. The last housing slump in the DC Metro region took at least five years to play out. While there's much evidence that says it will be quicker this time, I still don't think that only one year will be sufficient time.

People will move heaven and earth to pay their mortgage. And many sellers in the current market "need" to get a certain price level because of what they owe their bank(HELOCs and other loans against their house playing a *huge* role). These folks will dig in and hold on as long as they can. The reason they're not lowering their price is because they can't afford to. I'm not so sure that house prices are sticky by their nature(they sure werent sticky on the way up) rather than what we're seeing is a reflection of the fact that lots of people-if they were to sell at the market clearing price-would have to present their bank with a $50k check at closing and are more than a little reluctant to do so.

Once foreclosures rise(just one factor of many, and already happening) and banks start accepting short sales we'll see prices start to fall rapidly, imo. House prices are set at the margin(recent comps) and since prices are now falling it will be a very hard trend to reverse. I think that the DC region could easily see a 30% drop in real terms over the next few years. The main fundamentals that drive house prices-median wages and rents-are way out of whack.

Jason Ruspini writes:

Futures prices are biased estimators of future spot prices. It's possible that these prices are actually saying nothing about next year's home prices, but rather something about cost-of-carry, e.g. rent yields vs. the risk free rate.

JKB writes:

The real pressure for DC will come when the overdue reduction in federal spending comes. The run up in security spending is starting to wind down and if the economy slows the "pork" will be sent out to the districts to help the constituents. When the beltway bandits start contracts start ending then you'll see the squeeze on housing prices. Not to mention there will be an exchange of politcals in DC regardless of which party wins in 2008.

Stocks and bonds aren't dependent on locality as anyone can buy and sell them. Real estate however has a limited market of those wishing to live or leave an area. If the DC job market/economy takes a blip, it could tip the housing market into a vicious cycle.

mjrmjr writes:

JKB:
The decline has already begun in the DC region and it started at least a year ago as sales slowed and inventory started piling up. (check www.nvar.com for easily verified numbers) A slowdown in federal spending will quite likely make the situation worse but it won't be the cause of it by any means. There are many cities that saw housing prices increase as much or more than DC in which federal spending was not much of a factor at all.

JKB writes:

Oh, I wasn't contending that the housing price increase in DC was caused by the spending boom. My contention is that housing is a sticky asset as people buckle down and try to hang on to their house. The risk is their ability to ride out the downturn is directly related to their job security and with a reduction in federal money into contracts will push more people over the edge forcing them to sell or lose the house.

One new risk I see in this housing market is the number of people who were already teetering on the edge before the downturn. With a large volume of adjustable mortgages, high non-housing debt loads, and house payments that were hard to cover from the start, even a small blip in the local economy can force a lot of homeowners into default. Add to that the longterm owners who pulled out equity on now unreachable valuations and the numbers start to get real ugly.

A loss of appraised value isn't a real loss until you sell. The problem is housing is bought on credit and the creditors have to be paid or you can be forced to sell even at an inopportune time not of your choosing. Housing is immobile and few have the resources to maintain multiple residences if forced to move for employment so a job disruption can force a sell. Also, housing has expenses (taxes, homeowner assoc. fees, etc.) so regardless of the market, you must continue to "invest" in the property or be forced to sell. My point is unlike stocks usually owned outright, housing is on margin and it is starting to look like a margin call may be in the making.

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