Home prices are down again. The Case-Shiller home price numbers are pretty grim:
This leads naturally to wondering about the impact of such a massive loss of homeowner wealth. But my friend Randy Pozdena, who blogs occassionally over at The Ornery Economist, offers these insights:
The Case-Schiller index is not the one I would use to measure
wealth effects. Although the indices attempt to crudely approximate a
"same-home sales" protocol, in practice, they do not control for
either within-region property location or distressed/thin market sale nature of
current transactions. I had the opportunity recently to work with a mass
appraisal consultant (the folks who help assessors value properties for tax
purposes) who showed me some GIS plots of recent vs. historical sales patterns.
It is clear that:
1. The spatial pattern of sales is very different.
There are virtually no sales in the traditionally-high value subareas of
large regions (e.g., Santa Monica within LA metro, or SF or Marin counties
within the SF Bay Area). The transactions in these regions are dominated by
foreclosure sales in places like Solano County, etc.
2. The "market prices" being captured are not
adjusted for illiquidity/thin market discounts.
Thus it is very problematic to, in effect, mark-to-market a whole
metro area's housing stock and then extrapolate from this to a one-to-one impact
on wealth. Doing so ignores the self-selectivity of sales and does not
correct for illiquidity discounts. To some degree, the problem is
analogous to the one caused by the highly-flawed, FASB 157 mark-to-market rules
as applied to business accounting in the current market. Everyone
recognizes that the poor language of this rule caused excessive mark-downs of
assets that clearly would have higher value if trades could occur. FASB
at least recognizes it screwed up and has fast-tracked FASB 157-d to better
value thin-market transactions. (See the link below.)
But measuring the true trends in the market value of housing is
further complicated by the legislation that was passed in 2008 that changed
the "exercise price" of an owner's mortgage put option.
It did so by exempting 2006, 2007, and 2008 mortgages from the
traditional IRS treatment of the abandoned loan value as "income".
This has caused a "bubble" of walk-aways and, in
turn, greatly enlarged the dominance of lenders (as opposed to
owners) as sellers of homes with "underwater" mortgages.
This, in turn, enlarges the observed illiquidity discount and
price depression. As the Ong, Neo and Tu (2008) analysis of the so-called
disposition aversion effect has shown, "lenders [selling foreclosed homes]
may not act in the best interest of the foreclosed owners to get the best
price possible [relative to owner-sales]."
With FASB 157 breathing down their necks, banks have an even
greater incentive to push for a transaction with less regard to price.
I would add that the Case-Shiller 20-city composite is just that: a composite of 20 cities. The smaller cities and rural areas are not covered. They had less boom, and now have less bust.