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Past Perfomance is No Guarantee of Future Results:

Frank Nothaft, chief economist, Freddie Mac, toward the end of the bubble: "I don't foresee any national decline in home price values. Freddie Mac's analysis of single-family houses over the last half century hasn't shown a single year when the national average housing price has gone down." Yahoo News: "The median price of a home sold last month was $210,200. That marked a 3.3 percent drop from a year ago" (and a much greater drop from the June 2005 high of $230K). Not as big a drop, of course, as Freddie Mac's stock price. It wasn't until February '07 that Freddie announced "that it would stop buying those mortgages that have 'a high likelihood of excessive payment shock and possible foreclosure,'" and that "it would limit the use of loans that don't require income verification or other documentation, and will recommend that lenders collect adequate escrow for taxes and insurance payments."

A lot of bad decisions during the bubble were made based on past performance, with the decisionmakers failing to take account of the fact that the bubble was unique--prices had never risen so far, so fast, and there was unprecedented amounts of fraud and abuse in mortgage lending, tied to incredibly relaxed underwriting standards. Failure to use foresight instead of hindsight led all sorts of seemingly shrewd investors to put their money in mortgage-backed securities, anticipating that default rates would not exceed historic levels, in part because prices would continue to rise steadily and allow any borrowers in trouble to refinance or sell at break-even or beyond.

SenatorX (mail):
Government sponsored criminal enterprise = Freddie Mac
1.1.2008 2:20pm
Harry Eagar (mail):
About 35 years ago, the Twentieth-Century Fund published a study proposing that combining lending and investment banking in the same business would always result in what happened in the '20s and was prevented thereafter by Glass-Steagel.

Looks like they were right.

Another reason I'm not a Libertarian, I guess.
1.1.2008 2:27pm
taney71:
Well, I am hoping to buy a house this year so good times for me!
1.1.2008 2:27pm
Tracy Johnson (www):
I'm no financial whiz, but it seems apparent that thousands of municipalities depend on appraised property value as a baseline for their tax rate. Even if house values fall, I don't think any assessor's office is going to "let" them fall, (at least on their books.) Lest a city see a decline in revenue. Therefore, I think house value is going to be artificially high, at least until inflation catches up. (It may even be one of the causes of inflation.)
1.1.2008 2:31pm
Sean O'Hara (mail) (www):
How can you worry about the housing crisis when the world population is pushing 12 billion, there's massive famine and a serious lack of potable water, and we've deplete supplies of oil, coal, and other raw materials.

This message brought to you by the Club of Rome, advocates of trend-line extrapolation since 1968.
1.1.2008 2:35pm
Tony Tutins (mail):
Even if house values fall, I don't think any assessor's office is going to "let" them fall

When Silicon Valley house prices fell in the early 90s, the Santa Clara County assessor's office revised the assessed value of the most recent sales downwards. So that's one who did.

Personally I knew people, laid off in the dotcom bust, who were able to stay in their houses thanks to Ninja loans, which gave them a stack of cash to live on (and pay their mortgages with) till things got better. I would say that a good part of the runup and bubble bursting was caused by flippers and others who never intended to live in the houses they bought. The notorious Casey Serin had bought at least a dozen properties with less than no money down, as I recall from the late iamfacingforeclosure.com. No policy that encourages homeownership need or should provide a safety net for speculators, in my opinion.
1.1.2008 2:56pm
Peter Wimsey:
How can you worry about the housing crisis when the world population is pushing 12 billion, there's massive famine and a serious lack of potable water, and we've deplete supplies of oil, coal, and other raw materials.

This message brought to you by the Club of Rome, advocates of trend-line extrapolation since 1968.



All of this is much less worrying since the DOW hit 36,000 in 2005, just as predicted.
1.1.2008 3:01pm
PersonFromPorlock:
What we have learned just seen illustrated, for the umpteenth time, is that in business the long run is a whole bunch of short runs.
1.1.2008 3:20pm
Elliot123 (mail):
The Home &Garden channel is still broadcasting Flip This House and other similar shows that encourage amateurs to buy a house for $300K, spend $80K upgrading it, and sell it for $500K. Somehow the friendly and very helpful real estate agent is also a standard feature. They regularly showcase people with no experence who make $100K profit in a few months.
1.1.2008 3:32pm
Smokey:
Mr T:
No policy that encourages homeownership need or should provide a safety net for speculators, in my opinion.
That's exactly right. Buyers who provided a substantial down payment and who didn't exaggerate on their loan apps [AKA: fraud] aren't having problems. It's the ones who claimed a larger income than they really earned who are causing the problems now.
1.1.2008 3:57pm
Just Dropping By (mail):
Buyers who provided a substantial down payment and who didn't exaggerate on their loan apps [AKA: fraud] aren't having problems.

That's not exactly true. They just aren't having problems making payments on their homes. They still suffer from declining property values if they have to sell their homes.
1.1.2008 4:02pm
MarkField (mail):

Even if house values fall, I don't think any assessor's office is going to "let" them fall, (at least on their books.) Lest a city see a decline in revenue. Therefore, I think house value is going to be artificially high, at least until inflation catches up. (It may even be one of the causes of inflation.)


This won't affect the actual market value of the homes. Prices can continue to fall regardless of what the assessors do.
1.1.2008 4:03pm
OrinKerr:
Isn't this a common psychological error? I don't know what it's called, but my understanding is that when you experience something yourself you see that thing as much more likely to happen again as compared to if you merely reason through it or read about it.
1.1.2008 4:05pm
highway61:
It strikes me as interesting that people strain to distinguish a bubble from past market trends and show how the "old rules" don't apply. but later adopt more recent, past trends to prove that the bubble is going to continue.

The bursting of the bubble reminds me of Lord of the Flies, where the adults arrive and the alternate reality vanishes. I guess Warren Buffet is the closest thing we have to a sea captain?
1.1.2008 4:19pm
Cro (mail):
Joe Kennedy got out of the market when his shoe shine boy talked about the stock he bought on margin.

When people I knew were flipping houses, I knew it was a bubble. When everyone talks as if something will always increase in value, it's a bubble.

The next bubble? Gold and foreign currency. Not that I can predict the future any better, but they seem out of whack to me. When I see gold at such ridiculous prices relative to inflation, I wonder.
1.1.2008 4:22pm
Elliot123 (mail):
An interesting recent example of boom and bust in the housing market occurred in Anchorage in 1987(?) 86(?). Oil revenues enabled the state to guarantee loans to just about anybody, and just about all the anybodies took advantage.

When oil prices tanked in '87, people lost jobs, money dried up, and thousands just walked into the bank and turned over the keys. Falling prices and the mass defaults encouraged many well employed and very solvent people to join the rush to dump their houses. I bought a house for $100K in 1981. In 1987 two similar houses in the same neighborhood sold for $35K. I sold in 1991 for $95K.

Entire Sunday supplements were devoted to foreclosed properties, and they were always incomplete since state and federal agencies were not letting everything onto the market at once. Speculators and investors eventually stepped in and bought up the surplus. (Many were the well employed people who had previously given the keys back to the bank. Condos were available as low as $12K.)

The big difference with today is that the Alaska mortgages did not nearly approach the totals in trouble today, and government agencies took much of the loss. However, I expect in a few years we will be reading stories of how the Jones family was forced to sell to some rich guy who took advantage of the SubPrime mess by buying up houses at bargain prices. Orin Kerr's comment about personally experiencing something is right on the money.
1.1.2008 4:45pm
Le Messurier (mail):
Every boom (or bubble) busts... guaranteed. I've never understood why people forget that. It is as immutable as the law of gravity. "Oh, this boom's different". Ha! The real estate bust of the 80's; the dot com bust, and this one have the same refusal to admit that there is a boom bust cycle. What really astounds and galls me is Greenspan's failure to realize the dynamics at work in this present bust. And now he's out there trying to save is reputation by mouthing off when he ought to shut up.
1.1.2008 5:02pm
K Parker (mail):
OrinKerr,

In today's NY Times, John Tierney calls it the "availability heuristic":
When judging risks, we often go wrong by using what’s called the availability heuristic: we gauge a danger according to how many examples of it are readily available in our minds.
1.1.2008 5:25pm
neurodoc:
Not as big a drop, of course, as Freddie Mac's stock price.
I don't think the subprime debacle is the sole reason for the decline in Freddie Mac's stock price. Before the subprime credit markets started to crater, it was discovered that Freddie Mac, like it's cousin Fannie Mae, had been cooking its books for a long time. That's something investors don't like and to which they tend to abreact, strongly.
1.1.2008 5:35pm
OrinKerr:
K Parker,

Thanks -- yes, that's it.

Le Messurier writes:
Every boom (or bubble) busts... guaranteed. I've never understood why people forget that.
At least part of it is because different "booms" and "bubbles" end up "burting" in different ways and in different degrees. A "bubble" might go up 100% and "burst" by dropping 20%; still a great deal if you were in early enough, which makes it all a matter of timing. Or so I would think.
1.1.2008 5:52pm
Le Messurier (mail):
OK

"At least part of it is because different "booms" and "bubbles" end up "burting" in different ways and in different degrees. A "bubble" might go up 100% and "burst" by dropping 20%; still a great deal if you were in early enough, which makes it all a matter of timing."

Of course, no 2 booms/bubbles are the same, so percentages of up and down will vary. But very seldom do we not recognize collectively that we are in a boom. So... the question is not how much can we gain, but rather when will it bust. It is a matter of timing for the risk tolerant, but for the average guy, he'd better not take any more money to Las Vegas than he can afford to lose. Also, remember that this housing bust was not caused by falling prices. It was caused initially by variable rate mortgages (of all types) given out to those who could not afford the bump in monthly payments when the teaser rates ended. These people would not have been able to afford a regular mortgage but would be able to keep their homes if their rates hadn't changed. When the rates did rise the house of cards fell.
1.1.2008 6:41pm
Le Messurier (mail):
I think Highway61 and Cro have it exactly right, though I'm not so sure about gold and foreign currancy being the next bubble. First of all we had a gold bubble rather recently in the late 70's. It was caused by an attempted "corner". Foreign currency seems like an unlikely cause for a boom/bust as it is already a very speculative market and there are very few limits on supply other than governments. I guess anything is possible though.
1.1.2008 6:52pm
wm13:
What evidence is there of "unprecedented amounts of fraud and abuse in mortgage lending"? That's the sort of portentous thing people (especially academics) love to say; but I suspect that the amount of fraud and abuse in mortgage lending, as in many other things, is pretty constant over time. At any rate, that seems like the appropriate assumption to make until someone produces some actual evidence that there has been more fraud and abuse in the recent past than in the more distant past.
1.1.2008 7:32pm
MLS (www):
Failure to use foresight instead of hindsight?

I prefer to use hindsight, since it is always 20-20, whereas predictions are hard to make, especially about the future.
1.1.2008 7:52pm
Jupa (mail) (www):
you know, I think most of the blame can be pointed at the people who stuck their head in the sand when it came to reading the fine print of these "subprime" mortgage. Namely, everyone. Borrowers who didn't read their loan documents and therefore had no clue what was going to happen to their interest rates; lenders who didn't bother to verify income because they cared more about booking loan fees than they cared about what would happen in 5 years when the loans converted to high interest+principal repayment; investors who didn't bother to read the disclosures before sinking billions into securities chock full of these subprime mortgages.

And no way do I think this bubble is done bursting. It's going to get worse before it gets better.

- Jupa (www.thejuniorpartner.com)
1.1.2008 7:55pm
bellisaurius (mail):
Hate to use weael wording, but isn;t it possible for one to use the word avergae to indicate mean housing price, thereby still being honest, even though the median price has dropped (for the month, although the annual figure has almost certainly gone down too)?
1.1.2008 8:45pm
Happy-lee:
A profound comment by Professor Bernstein. It reminds me why I don't like mathgeeks on wallstreet. Crunching the past in order to predict the future gets you only so far. I sold at the top, and recently bought at the near bottom not because I looked at historical trends, but because I applied common sense. When runners at my firm were buying big homes with no document loans with ridiculous teaser rates, I knew it was time to bail.
1.1.2008 10:06pm
OrinKerr:
Le Messurier writes:
Of course, no 2 booms/bubbles are the same, so percentages of up and down will vary. But very seldom do we not recognize collectively that we are in a boom. So... the question is not how much can we gain, but rather when will it bust. It is a matter of timing for the risk tolerant, but for the average guy, he'd better not take any more money to Las Vegas than he can afford to lose.
I'm not so sure. I think that whenever a market goes up and then down, there are some who insist they always knew this would happen and they are just stunned that others didn't see it. Of course, when a market goes up and stays up, the prediction becomes that eventually it will come down -- it just hasn't happened yet.
1.1.2008 10:45pm
Sean O'Hara (mail) (www):
Isn't this a common psychological error? I don't know what it's called, but my understanding is that when you experience something yourself you see that thing as much more likely to happen again as compared to if you merely reason through it or read about it.


Anchoring error, perhaps? That usually refers to the tendency of people to believe the first thing they're told on a subject, or to stick by their initial impression of something, but biasing towards personal experiences sounds like it fits.
1.1.2008 11:35pm
A. Zarkov (mail):
“Freddie Mac's analysis of single-family houses over the last half century hasn't shown a single year when the national average housing price has gone down."

There are at least problems with this statement.

1. There is no correction for inflation.

2. Homes have increased in size and amenities like two-car garages, central air conditioning etc. Naturally large and better-appointed homes are going to cost more.

3. The median is a poor indicator especially on a national basis. The national median can go in the opposite direction from all the regional medians because houses sell at different rates and for vastly different prices depending on region.

The real price of housing is essentially flat. One study tracked the sales on a single street in Amsterdam and found a real increase in selling price of 0.1% per year over 400 years! Similar studies done in various US markets show about the same result: 0.4%. It makes sense because a house doesn’t change unless you do add-ons and up grades. Why should the same thing sell for more than inflation unless demand goes up in a particular location? If that happens then you will see an increase in rents, which reveals the demand for housing. But rents have been either flat or trending down over the past ten years. Didn’t the economists at Freddie Mac understand simple real estate economics?
1.1.2008 11:58pm
Truth Seeker:
I don't think we've bottomed out yet, I've had a surprising number of people come to me as say they own 7 or 15 homes that are upside down and they plan to stop making payments soon and what can they do to protect their other assets.

It looks like so far the foreclosure mills are not going after deficiency judgments. Is this going to change? Do they think it's too much work to hunt down debtors and their assets? I know they need to keep their legal time down since these are usually flat fee cases, but how do they decide when to do more than just take the property.

If the debtor is unavailable when the process server comes by and they don't get personal service and only take the property through constructive service it seems like it will be a lot harder to start over later.
1.2.2008 12:20am
Truth Seeker:
Even if house values fall, I don't think any assessor's office is going to "let" them fall, (at least on their books.)

If your house is asessed at $300,000 and a similar one next door just sold for $200,000 then you file an appeal of your asessment after the annual roll is announced and somebody like a Special Master takes your evidence and sees if the assessment is justified. If the values clearly dropped the assessor loses.

Lots of companies will do all the work and research for you for no upfront fee and just take a cut of what you save in taxes if they win.
1.2.2008 12:30am
Kenton A Hoover (mail):
"I'm no financial whiz, but it seems apparent that thousands of municipalities depend on appraised property value as a baseline for their tax rate. Even if house values fall, I don't think any assessor's office is going to "let" them fall, (at least on their books.)"

Governmental bodies have accounting standards to follow as well (GASB). They can't carry receivables as assets if they can't be realized, and additionally there is pressure to revalue property down during declines in value -- and assessors are usually elected officials.
1.2.2008 12:32am
Harry Eagar (mail):
wm13 asks: 'What evidence is there of "unprecedented amounts of fraud and abuse in mortgage lending"?'

An ad running in my newspaper offering jumbo loans with no income verification. I live in a place where prices have not fallen back much (not at all for some prime areas), and it looks as if some people figure there are a few more suckers out there.

I expect there are.

Not mentioned on this thread so far is the effect of bundling.

When mortgages were tied to a property, an investor could without too much effort -- maybe just a drive-by -- estimate how close the note was to market value.

Bundle 'em up and nobody can afford to figure out how much junk is in there. The market is not reacting nearly as much to price movements (which in many areas are still equal to where they were two years ago) as to uncertainty.

It's a version of Gresham's Law.
1.2.2008 2:18am
Tony Tutins (mail):
The real price of housing is essentially flat... Why should the same thing sell for more than inflation unless demand goes up in a particular location?

Supply and demand explains why you should buy property in land-limited Manhattan rather than limitless Manhattan, Kansas. Plus the demand curves are always changing. People are fleeing the center of the country for the coasts. The resale price of unchanged homes in Silicon Valley has shot up much higher than inflation, particularly over the past twenty years, as people irrationally choose to live in SV.

If that happens then you will see an increase in rents, which reveals the demand for housing. But rents have been either flat or trending down over the past ten years.

I don't know much about econ, but rental housing is an inferior good. People would rather scrimp and save to get into their own house than live surrounded by neighbors on four or five sides. Put another way: Both the number of T-bone steaks and the amount of ground beef are proportional to the number of beef animals slaughtered. But if people have a taste for steak and the money to buy it, the price of T-bones will rise faster than the price of ground beef.

Moreover, renters who lose jobs will simply move to where their chances of getting work is higher, or their expenses will be lower. Out-of-work homeowners are going to hang on for a while longer, while renters with secure jobs (government, health care) are still going to try to get into a house. Thus rents will drop much more quickly than house prices.
1.2.2008 3:38am
A. Zarkov (mail):

“I don't know much about econ, but rental housing is an inferior good. People would rather scrimp and save to get into their own house than live surrounded by neighbors on four or five sides.”

You seem to be comparing rental apartments to single family residential houses. To get an idea of the demand for the latter look at what they rent for. For condos, compare to similar apartments. For example, I rent a single family detached house for about 1/3 to ½ of what it would cost to buy. The housing market where I live is clearly overpriced and will eventually come down at least in terms of inflation corrected price.

“Supply and demand explains why you should buy property in land-limited Manhattan rather than limitless Manhattan, Kansas.”

While Manhattan is indeed an island, there is room to add more dwelling space by landfill (Battery City) and expansion into previous slums (Harlem). Now we see areas north of 96th street getting developed with new expensive rental and coop apartments. However in many ways Manhattan is a special case. Many apartments are still rent controlled. Apartment owners generally hold title in the form shares in a coop, which presents barriers to buying and selling, because the coop board must approve any new owner. All that being said, I wouldn’t buy a Manhattan apartment as an investment. I know New Yorkers think that somehow the global bubble doesn’t apply there—we will see.
1.2.2008 12:17pm
William Oliver (mail) (www):
"A profound comment by Professor Bernstein. It reminds me why I don't like mathgeeks on wallstreet. Crunching the past in order to predict the future gets you only so far. "

But it does get you quite a ways. The trend *is* your friend. The past is no *guarantee* of the future, but it is good circumstantial evidence. More important, there's a difference between long term trends and short term noise.

For instance, the stock bubble of the late 90s was exactly that -- a bubble -- and represented a blip on a fairly consistent exponential curve. The fact that the historical trend did not predict the bubble makes it no less true that the curve is pretty good for predicting long term trends.

The problem, really, is more about *what* trends in the past to focus on. People forget that in the 1980s and early 90s, Fannie Mae was predicting this downturn. When the housing bubble hit, people threw away the historical data and decided they would live in the present forever. Thus, in the late 80s, you have all sorts of papers predicting a downturn in 20 years based on demographics, and then when the bubble hit, you have people saying that historical data is useless and we will live in the bubble forever.

And then, when the bubble bursts, people forget the actual historical projections and think that the bubble talk constitutes the historical trend, and thus you can ignore historical trends. It doesn't, and you can't.
1.2.2008 1:06pm
SenatorX (mail):
Supply and demand explains why you should buy property in land-limited Manhattan rather than limitless Manhattan, Kansas

Tell it to the Japanese, 17 years of deflation and counting.
1.2.2008 2:38pm
neurodoc:
Moreover, renters who lose jobs will simply move to where their chances of getting work is higher, or their expenses will be lower. Out-of-work homeowners are going to hang on for a while longer, while renters with secure jobs (government, health care) are still going to try to get into a house. Thus rents will drop much more quickly than house prices.
I don't follow this reasoning. Between increase, stay the same, and decline in % of the population that owns the place they live, isn't the last of those, that is "decline in % who own," the almost certain outcome of the subprime debacle? And while one may be able to postpone purchases of cars and durable goods, shelter is pretty close on the heels of food as an immediate, non-postponable need, isn't it? A decline in % who own must mean an increase in % who rent, and more demand for something, e.g., rental housing, generally means higher prices for it. (I don't think rental housing is a so-called Giffen good.)

I have no data to cite here for the relationship between the price to own versus the price to rent, but I believe that in some markets (e.g., San Diego), rapidly rising real estate prices have produced some condo rental bargains, because speculators have been subsidizing rentors in order to have some income to offset their carrying costs until they could flip their properties at a higher price. I don't know that there has been enough of that tulip bulb mania sort of thing to influence the relative price of ownership versus rentals as this mess plays out, but I would bet against "rents will drop much more quickly than house prices." And I expect that when the dust settles, those who sunk money into true rental properties (apartment buildings) in those past couple of years will fare better than those who put the same number of $$$ into houses.
1.2.2008 2:56pm
neurodoc:
Tell it to the Japanese, 17 years of deflation and counting.
Right, the Japanese managed to take a beating on real estate here in the US, including Manhattan (Rockefeller Center), then one back home of huge proportions.
1.2.2008 3:01pm
A. Zarkov (mail):
"I have no data to cite here for the relationship between the price to own versus the price to rent, ..."

Here is a rent versus buy calculator. I haven't checked it out carefully. The New York Times provides another with somewhat less details. You have assume how much rents will go up over the course of your time frame. People usually underestimate the cost of owning. Some people neglect opportunity costs thinking it's some kind of accounting fiction.
1.2.2008 6:29pm
Aleks:
Re: Buyers who provided a substantial down payment and who didn't exaggerate on their loan apps [AKA: fraud] aren't having problems.

Not true. Some people who refinanced (with substantial equity representing down payments) were persuaded into getting ARMs due to the low teaser rates. And some were even talked into getting HELOCs to pay down credit card debt or student loans. Some of these folks are getting caught in the meat-grinder now too.

Re: It looks like so far the foreclosure mills are not going after deficiency judgments.

The deficiencies will ultimately be sold off to collection agencies; in fact this is already happening. Meanwhile Congress is about to change IRS rules so that these deficiencies, when charged off, will no longer be taxable (as they sometimes are today; the current rules are very complex), and the IRS is already accepting claims of "insolvency" from just about any foreclosed homeowner who pleads this.

Re: People are fleeing the center of the country for the coasts.

Really? That explains why Boise, Dallas, Atlanta, Phoenix etc are all turning into ghost towns, and why Florida would be losing population if you don't count immigrants.

Re: People would rather scrimp and save to get into their own house than live surrounded by neighbors on four or five sides.

Um, you can rent a single-family, detached house. I've done so since 2000.

Re: Thus rents will drop much more quickly than house prices.


Moreover homeowners who do move for jobs but can't sell are dumping their houses on the rental market as, of course, are the still solvent house-flippers who thought they could sell at a wonderful profit and now can't.
1.2.2008 7:16pm