What happened in Vegas, this time, didn’t stay in Vegas. There, 2 out 3 houses are upside down: they owe more than their homes are worth.


the number of borrowers who are underwater climbed to 20.4 million at the end of the first quarter from 16.3 million at the end of the fourth quarter. The latest figure represents 21.9% of all homeowners, according to Zillow, up from 17.6% in the fourth quarter and 14.3% in the third quarter.


Robert Shiller, one of the guys behind the S&P Case-Shiller Index, spoke at Seattle Pacific University; his presentations focused on the role that psychology plays in economic markets. The primary thesis is that economic markets are strongly influenced by psychology that seems rational to individuals, but on the whole is “collective madness”.

During the session, Shiller mentioned a localized Los Angeles housing bubble in 1885, describing the mentality in 1885 Los Angeles as people thinking “Los Angeles is special!” He quoted from an article in the LA Times which was published during the aftermath of the collapse in 1886:

We Californians have learned something. And that is that home prices can’t just go up forever—they have to be supported by something. Never again will Californians make this mistake.

SeattleBubble.com has the notes of the presentation and even the audio. Interesting.

The bursting of the housing bubble is arguably the main factor behind the current recession. So it makes sense people would be checking the housing market and looking for a sign of reversal of the downward trend. Even back in 2007, BusinessWeek was already hoping for a reversal of fortune.

Last time I checked, it seemed the crunch would take longer than expected. Yet six months later there are signs prices are returning to where they should be. at least according to a housing affordability ratio based on median household income and median house prices.

Last data for the median household income from the Census Bureau is from 2007. Applying the nominal Home Price Index from S&P Case-Shiller (last data is for the 2008 Q4), and adjusting for inflation using the Consumer Price Index from BLS, we are reaching again the 3-3.5 range.

Median Home Price / Median Income

Median Home Price / Median Income

The question now is whether there will be a soft land or an overshoot, with prices drilling down the historical range. With the deepening recession, there is no reason for prices not to go beyond current bottoms, especially in specific markets. Detroit, for example.

The Federal Reserve Bank of Philadelphia produces a state-level coincident index combining four indicators: nonfarm payroll employment, average hours worked in manufacturing, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average). This index has been around since 1979.

And since 1979 (thanks to Calculated Risk for pointing out), throughout four recessions, there was a never a moment when indexes for consecutive months were negative for all 50 states… until now.

Number of states with positive growth

Number of states with positive growth

Recession is widespread, no state is spared:

Red states

Red states

Robert Shiller at the WSJ thinks the stimulus “isn’t big enough to restore confidence“. Not enough… despite knowing that just one in seven dollars of a huge $18.5 billion investment in energy efficiency and renewable energy programs would be spent within a year and a half.

But just like there are no atheists in foxholes, everyone is a keynesian during a recession. Investing in infrastructure and public works is the keynesian way of creating demand and getting out of a recession, they say. Or is it?

“Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.”

Keynes, Collected Writings, vol. XXVII, p.122

Not to mention how the Federal Reserve, knowing we have more homes for sale than buyers, will embark on a program to buy $500 billion of mortgage bonds in the first half of 2009. Instead of letting prices get to their own level, we will stimulate artificial housing demand. How keynesian.

Alan Greenspan, then chairman of the Federal Reserve, at a hearing of the Senate Banking Committee almost five years ago:

The government-sponsored enterprises’ special advantage arises because, despite the explicit statement on the prospectus to GSE debentures that they are not backed by the full faith and credit of the U.S. government, most investors have apparently concluded that during a crisis the federal government will prevent the GSEs from defaulting on their debt.


Importantly, the scale itself has reinforced investors’ perceptions that, in the event of a crisis involving Fannie and Freddie, policymakers would have little alternative than to have the taxpayers explicitly stand behind the GSE debt.


It’s basically creating an abnormality, which the system cannot close around, and the potential of that is a systemic risk in — sometime in the future, if they continue to increase at the rate at which they are.”


Christopher, agreeing with this article from ClusterStock:

The underlying problem is the inability of some homeowners to pay their mortgage. Falling prices don’t cause foreclosures, no income does.

Does it? “No income” implies unemployment or underemployment, two issues that are on the rise now. But when the housing crisis began that wasn’t a problem.

The crisis started when, with higher interest rates on the market, those adjustable rate mortages became impossible once the “teaser rate” expired, forcing houses back to the market. As in any supply and demand scenario, sudden increase of supply forced reduction of prices, making it even more difficult to refinance.

With market prices stagnant or dropping, flippers were in trouble. The quick-gain investment deals relied on the promise of constant price increase, a concept that was close to fact of life for a few years. But regardless of the quality of the loan, credit history or job situation, a stagnant home pricing will break the chain and cause a foreclosure.

In Nevada and Arizona, 29% of all the prime mortgage loans written in 2005 were for non-owner occupied home purchases. In California, it was 14% and in Florida 32%. These are quality loans for people that have had no income problems, but that also never planned on living on those properties. The plan, since the beginning, was to sell shortly for a quick buck.

Yet, with housing prices falling, their business models went down the drain: non-owner occupied properties are 32% of the Nevada’s prime mortgage defaults, and 24% of Nevada’s subprime defaults. For Arizona the numbers are 26% prime and 18% subprime; in California, 21% prime and 15% subprime.

The existence of subprimes wasn’t the sole cause, but fueled the fire: more buyers with cash in hands would pump up prices, creating rosy invesment scenarios that attracted more flippers. When the teasers expired, they would be the first to have trouble refinancing, thus pushing prices even lower.

Non-Owner Occupied home purchases, 2005-2006

Non-Owner Occupied home purchases, 2005-2006

So yes, the problem is indeed the inability of some to pay their mortgages. But not because of lack of income; the main factor, as in any economic bubble, is the interruption of the self-feedback loop of rising prices. If a magical superpowerful entity would buy every foreclosure for 105% of the pay-off amount, prices would slowly creep up again, credit would become available, and the bubble would live on.

Luckily most of us don’t want that. And here I agree with Christopher: we are living in a bust, and the only alternative is to simply adjust to reality.