What Robert Shiller Forgot To Mention In His New York Times Op-Ed Yesterday

Yesterday, Robert Shiller, co-founder of the Case-Shiller Index for Housing Prices, wrote an exceptionable short Op-Ed piece in the New York Times titled "Why Home Prices May Keep Falling".

Shiller starts out by saying,

HOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. Why would a sensible person watch the value of his home fall for years, only to sell for a big loss? Why not sell early in the cycle? If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.

I agree with Professor Shiller, especially when he says Real Estate is an asset class which can retract in price for years. I know this for a fact having studied the great Florida Real Estate Crash of 1928. Many of the mansions sold in 1928 have still not returned to their former price (figuring in inflation) after 81 years of Real Estate market moves.

Where I was hoping Shiller would continue going with his thinking was his mention of the price to rent ratio when he said,

Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

I will return to this mention in another blog later, because it brings up a subject I promised this weekend to write about this week: affordability.

Shiller continues his opinion piece by bringing up something most all students on the Housing Crash are very familiar with:

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient.

Why would a sensible person watch the value of his home fall for years, only to sell for a big loss? Why not sell early in the cycle? If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.

There are many historical examples. After the bursting of the Japanese housing bubble in 1991, land prices in Japan’s major cities fell every single year for 15 consecutive years.

What Professor Shiller failed to mention is a very important (and eerily similar to the U.S. Housing Bubble) fact: the Japanese Housing bubble took ten years (1980 to 1990) to blow.

The downleg of the Japanese Housing Bubble Crash took fifteen years before hitting a bottom. See chart below:

Let's see. Our Housing Bubble took 10 years to blow (1996 through 2006) and we are only in year 3 of our downleg. Meanwhile, Realtors are pounding their Sweat Lodge tom-toms and are singing, "The bottom is here! The bottom is here! There's never been a better time to buy Real Estate."

To which I will remind readers: almost all Realtors denied their was a Bubble until it burst. Then these vested interest members of the Real Estate cartel claimed the bursting was only a temporary stall in housing price declines. Now after 2 to 3 years of declines, Realtors, after washing the egg off their faces, and brushing the Crow feathers from their mouths, are telling us "the bottom is here!"

Realtors, in my view, are setting up their profession to further ridicule and it won't be long til home buyers and sellers are lowering their opinions of the Realtor profession even further . . . and that's saying something as Americans now think Realtors are lower than used car salesmen.

Do you think I'm using hyperbole to bust on Realtors? Let's look back at the near past. I'll remind you the National Association of Realtors' Chief Economist and Cheerleader-In-Chief, David Lareah, released a book as the market was topping titled (and I am not making this up): "Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade - And How to Profit From Them"

Notice too, Lareah released his book in 2005 and changed its title in 2006 to a more hopeful and less assertive title of "Why The Real Estate Boom Will Not Bust". Of course, I caught the book cover change in one of my earliest posts to this blog titled "David Lareah R.I.P." two years ago on June 19, 2007.

Moving on with Shiller's Op Ed piece from yesterday, he makes a very reasonable argument as to why people were too slow to sell their homes as the Bubble began to burst. He says,

Why does this happen? One could easily believe that people are a little slower to sell their homes than, say, their stocks. But years slower?

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.

I've been saying this for the past three years to my friends in denial who always point out, "Everyone wants to move to Key West."

My answer has been, "You can wish in one hand and face reality in the other. If you can't sell your home up North at a profit, you certainly don't want to move to Key West in a housing market which is still declining."

Today I add more arguments such as, "Keep in mind, too, that 24% of all Americans with mortgages are now upside down. And don't forget the majority of Option ARMageddon loans will reset in 2010 through 2013, while Commercial Real Estate is just beginning its crash and credit card foreclosures will cut off millions of Americans from credit in the future."

And even if your home up North is paid off, why sell into a declining market up there in hopes to catch a "bottom" in Key West, a market you do not know?

Shiller continues,

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. First, many owners don’t have a speculator’s sense of urgency. And they don’t like shifting from being owners to renters, a process entailing lifestyle changes that can take years to effect.

Among couples sharing a house, for example, any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable.

Again, I was hoping Shiller would take on the most important issue in Housing today, affordability, and I was especially hoping to read his views on unemployment statistics, the two worker heads of a family, real wage contraction since Reagan was President, and the shadow statistics government hides from the electorate.

(No problem, I'll attack this issue of affordability later this week. And I realize Professor Shiller is aware of this issue but was probably relegated to an 800 to 1000 word piece by the Editors of the New York Times. Hence he didn't have the space to write about affordability.)

Shiller then wraps up his piece with examples which strike close to home:

Imagine a young couple now renting an apartment. A few years ago, they were toying with the idea of buying a house, but seeing unemployment all around them and the turmoil in the housing market, they have changed their thinking: they have decided to remain renters. They may not revisit that decision for some years. It is settled in their minds for now.

My response: Shiller could change the adjective "young" in the first sentence to "middle-age" and it would describe my girlfriend and I to a "T". What he doesn't mention is that rents are falling in tandem with housing prices all over America, and this continues to skew the price/rent ratio for affordability.

Speaking of elderly people, Shiller says:

On the other hand, an elderly couple who during the boom were holding out against selling their home and moving to a continuing-care retirement community have decided that it’s finally the time to do so. It may take them a year or two to sort through a lifetime of belongings and prepare for the move, but they may never revisit their decision again.

As a result, we will have a seller and no buyer, and there will be that much less demand relative to supply — and one more reason that prices may continue to fall, or stagnate, in 2010 or 2011.

In 2007, my girlfriend helped one of her elderly friends in Key West to move from her paid off home (a cottage house in Old Town Key West) to a North Carolina retirement community.

At the market top in 2005-2006 in Key West, this dilapidated home was appraised for $600,000. This sweet lady offered to sell it to us for $400,000. We passed on the offer, and yet just last year (2008) someone finally purchased the place for $300,000. I shook my head in disbelief as both I and my girlfriend knew that house needed at the very least $100,000 in major renovation to be livable. I'll not be surprised when this new homeowner is foreclosed upon as that house is not worth $200,000 today.

Finally, Shiller finishes his piece by saying,

All of these people could be made to change their plans if a sharp improvement in the economy got their attention. The young couple could change their minds and decide to buy next year, and the elderly couple could decide to further postpone their selling. That would leave us with a buyer and no seller, providing an upward kick to the market price.

For this reason, not all economists agree that home price declines are really predictable. Ray Fair, my colleague at Yale, for one, warns that any trend up or down may suddenly be reversed if there is an economic “regime change” — a shift big enough to make people change their thinking.

But market changes that big don’t occur every day. And when they do, there is a coordination problem: people won’t all change their views about homeownership at once. Some will focus on recent price declines, which may seem to belie any improvement in the economy, reinforcing negative attitudes about the housing market.

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

To which I will add this brings to mind another glaring omission in this piece. What Professor Shiller did not even allude to is the coming Option-ARM Tsunami which I wrote about last week in my piece titled "Note to All Key West Realtors Who Say "The Bottom Is Here" . . . Get Ready For The Next Big Drop In Prices As DEBT Becomes The Ultimate 4 Letter Word"

As always, Caveat Emptor,

Rock Trueblood