Home » 2009 (Page 28)
Yearly Archives: 2009
Not your average-Joe recession
Albeit the recent positive signs in the economy, the current recession is far more severe than all postwar recessions. Here is another research piece that looks at the current recession in historical context from Council of Foreign Relations. It came with a lot of nice graphs.
Shiller: Home prices may keep falling for years
Bob Shiller explains why he thinks home prices may take years to fall. In economics, house prices are often used as an example to demonstrate the 'sticky prices'. (Source: NYT)
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.
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.
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.
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.
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.
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.
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.
Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.
Paul Samuelson warns against the US Dollar
The great economist Paul Samuelson warns against being too complacent about the economic outlook, and he predicts "some day — maybe even soon — China will turn pessimistic on the U.S. dollar".
Both had a point.
But back in the early 1930s, during the Great Depression, President John F. Kennedy's father, Old Joe Kennedy, made two fortunes betting that stocks would keep falling and unemployment would keep growing.
He disbelieved in early New Deal recoveries.
By contrast, the leading U.S. economist at Yale, Professor Irving Fisher, after (1) marrying a fortune; and (2) earning a second fortune by inventing a profitable visual filing system, nevertheless ended up losing no less than three fortunes!
The story of these two opposites illustrates how and why economics can never be an exact science.
Joseph Kennedy Sr. was a tough and crafty speculator. Apparently he sold stocks short from 1929 to, say, 1931 or 1932.
Professor Fisher early on first lost his own fortune when the stocks he bought went bust. So he restudied the Wall Street and Main Street statistics.
Admitting that he had been too optimistic, Fisher wrote a new book. In it he admitted his previous error. But his new book said: The stock market is now a bargain.
Alas, his heiress wife's assets collapsed under this guidance. Stubborn Fisher persisted in his optimism. He went on to advise his sister-in-law, the president (I believe) of Wellesley College, to stay with stocks! This time she balked and fired him as investment adviser.
While Fisher was going broke, Joe Kennedy persevered by selling short the stocks that still were falling. No paradox.
However, as the New Deal recovery program finally began to succeed, Kennedy Sr. left the stock market and bought the Chicago Merchandise Mart Building — the biggest structure in the world at that time.
Which speculator was right? And which was wrong between these two well-informed giants? No sage can answer that question.
Today, Federal Reserve Gov. Ben Bernanke glimpses a possible recovery by year's end.
He is a cautious scholar, backed by the best forecasters in the world at the Federal Reserve Board.
I would be a rash fool to quarrel with this official's quasi-optimistic view that by year's end some stability will occur.
You and I should hope that there will indeed be a glimmer of light at the end of the tunnel ahead.
But shift our vision now to the future.
**************************************
Even if the short run prospect for a 2009-2010 recovery turns out to be good, I must warn once again that the long-run outlook for the U.S. dollar is hazardous.
China is the new important factor.
Up until now, China has been willing to hold her recycled resources in the form of lowest-yield U.S. Treasury bills. That's still good news. But almost certainly it cannot and will not last.
Some day — maybe even soon — China will turn pessimistic on the U.S. dollar.
That means lethal troubles for the future U.S. economy.
When a disorderly run against the dollar occurs, I believe a truly global financial panic is to be feared. China, Japan and Korea now hold dollars not because they think dollars will stay safe.
Why then? They do this primarily because that is a way that can prolong their export-led growth.
I am not alone in this paranoid future balance-of-payment fear.
Warren Buffett, for one, has turned protectionist. Alas, protectionism may well soon become more maligned.
President Obama struggles to support free trade. But as a canny centrist president, he will be very pressed to compromise.
And he will be under new chronic pressures. His experts should right now be making plans for America to become subordinate to China where world economic leadership is concerned.
The Obama team is a good one.
But will they act prudently to adjust to America's becoming the secondary global society?
In the chess game of geopolitics between now and 2050, much stormy weather will take place. Now is the time to prepare for what the future will likely be.
"Trust me", says the Fed
I wish to trust Richard Fisher, the Dallas Fed President, because he is a well-known inflation hawk. But I am not convinced the Fed knows when is the exact right time to rein in the massive liquidity (we know monetary policy works with more than 12 months lag), and whether they could be able to do it given the almost certain prospect of double digit unemployment rate, and the political pressure they are about to face.
Watch this interview of Richard Fisher on inflation and the Fed.
College towns are recession proof: the Euro version
College towns are relatively recession-proof in the United States. This recent Deutsche Bank research says this is true also in Europe:
The recession is also affecting the European real estate sector. True, many German housing markets are regarded as relatively stable. However, differentiation is called for, since regional differences, as in other countries, are considerable in Germany as well. Two simple criteria are good indications of price dynamics of housing investments: for one thing, the share of students in a city, and for another, the share of the manufacturing sector.
The economic crisis has unsettled many investors. Currently, they are looking less for risky products with high yield potential but rather for low-risk investments with a stable return. This is precisely why many people are turning to residential property: they are interested either in owner-occupied housing or in buying rented property. Is this a sound assumption? Although no housing bubble for residential markets has occurred in Germany yet, the low financing rates currently also make residential property an interesting investment. Thus, an investment in German residential property currently offers potential.
It should be kept in mind, however, that investments in residential property per se are not risk-free. In particular, investors should always be aware of the location risk of housing investments. But what makes a good location in housing? No doubt, good utility connections and the proximity to infrastructure systems are among the key criteria. In particular, such micro factors require a case-by-case examination of properties, i.e. very good market knowledge, though. Before starting the selection, the quality of a region, that is its macroeconomic factors, should be checked. What are the prospects for the economic structure? How good is the location with regard to transport links? For these factors have a decisive influence on the future demographic and income situation and thus the development of house prices.
In a thorough location analysis, forecasts have to be made of a very large number of macro factors. This is a very demanding task, especially as various factors have reciprocal effects, and some variables can change quickly, e.g. the registered office of a major company. Thus, factors subject to only minor fluctuations are particularly useful indicators for risk-averse real-estate investors. This can be illustrated by two selected factors: the share of students and the share of employees in the manufacturing sector. To show the influence of these two factors, the average price development of new owner-occupied housing units in over 100 German cities over the last ten years has been analysed.
This shows the 20 cities which post the best gains do not only include the usual suspects like Munich and Hamburg but also smaller cities such as Marburg, Heidelberg, Trier, Wuerzburg and Muenster. These five cities are marked by a very high share of students in the residential population. The value development in typical university towns was more favourable all in all than in towns without a sizeable share of college students. In the last ten years, the average value increase of new condominium apartments in university cities, i.e. towns with a share of college students of at least 15% in the population, rose by roughly 0.75 percentage points more than the increase in house prices in towns with very few students or no students, respectively – annualised, that is. This applies to both east and west Germany. At first glance it may come as a surprise that the value of residential property – and even more so, condominiums – in university towns has increased disproportionately well, for the disposable incomes of college students are of course by no means above average. The correlation is plausible, though: first, universities serve as large employers, and many jobs in university towns are not influenced by the economic cycle. Second, many college students stay in their college town after graduation as they still find their university town so attractive. The incomes of these graduates usually exceed that of people without a college degree. University towns therefore – also in times of crisis – are a safe haven for housing investments.
Risk-conscious investors should currently act cautiously with regard to typical industry locations. Average house prices in highly industrialized towns (with a share of employees in manufacturing of over 30%) were about 0.50 percentage point per year below price levels in towns with very small industrial bases. Even though the number of manufacturing employees increased strongly in the latest upswing, the gap reflects Germany’s continuing structural change towards a service society, especially wage moderation in many segments of manufacturing. As in the current recession manufacturing is severely battered by the decline in exports, it is plausible that towns with a strong industrial base in this crisis will be hit even harder than in the last ten years. Thus, investors considering towns such as Ludwigshafen, Schweinfurt, Ingolstadt and Salzgitter as locations for an investment will probably have to pay a higher risk premium at present.
Investors should be aware of the fact that these two correlations are stable and statistically verified. It should be kept in mind, however, that these are only two individual criteria. Not every university town can guarantee value, and the risks among industrial towns do vary. In particular, the microeconomic factors mentioned above always play a major role. What is more, attention must also be paid to the change in value retention and the yield. For example, Wolfsburg and Ludwigshafen are the beneficiaries of a relatively favourable multiplier while the ratios for Freiburg and Bamberg are rather unfavourable.
Milton Friedman: Don’t rely on the ‘right man’
Who said Friedman’s ideas were out of date? Watch this video you will know exactly why his ideas are as refreshing as it was 30-40 years ago.
One lesson to take away: don’t rely too much on the Fed’s exit strategy and its promise to get inflation under control. Smart investors should protect themselves ahead of the curve. There is probably 80% chance that inflation will NOT get out of control if the right man, Ben Bernanke, acts wisely; but if the 20% chance prevails, you want to make sure you have inflation-hedge in your portfolio.
(video haptip: TMGM)
No need to say Friedman’s idea also has important implications to different political systems we are living in. Think China vs. the US —with the former relying too much on the ‘right man’ to make the right decisions.
How serious is America’s budget deficit?
Charlie Rose —A conversation about the growing fiscal deficit with Alan Blinder, Professor of Economics at Princeton University and Director of Princeton’s Center for Economic Policy Studies, David Leonhardt of “The New York Times” and Alan J. Auerbach, Professor of Economics and Law, Director of the Burch Center for Tax Policy and Public Finance, University of California, Berkeley.
Grantham on value investing and China
Jeremy Gratham of GMO talks about value investing: high growth does not mean high return to capital; it all depends on your entry point. He applies this classic investment philosophy to China. (source: Morngingstar Investment Conference, May 2009)