Affordable Housing Institute : US

When Greenspan speaks, markets listen — even though he has a reputation for oracular obscurity that he likes to burnish:

 

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said”

 

He was in full metaphoric flight yesterday in testimony before Congress’s Joint Economic Committee:

 

Federal Reserve Chairman Alan Greenspan said today that the U.S. economy is generally healthy but faces several risks, including the possibility that surging home prices could fall in some local markets.

 

 

He repeated that he does not see a national housing “bubble,” but he does see “signs of froth in some local markets where home prices seem to have risen to unsustainable levels.”

 

 

“We certainly cannot rule out home price declines, especially in some local markets,” he added.

 

Beyond that unremarkable statement — yep, something might go down somewhere, some time — the Fed chairman actually provided a pellucid explanation of why housing — that is, homeownership housing — differs in many fundamental ways from other markets, such as stocks or commodities. 

 

“Are you claiming I was clear?”

 

 

 

 From his full remarks:

 

The housing market in the United States is quite heterogeneous, and it does not have the capacity to move excesses easily from one area to another.  

 

Instead, we have a collection of only loosely connected local markets. Thus, while investors can arbitrage the price of a commodity such as aluminum between Portland, Maine, and Portland, Oregon, they cannot do that with home prices because they cannot move the houses.   (Emphasis added, of course)

 

We all know housing doesn’t move:

 

Well, almost never moves …

 

… but its physical immobility is a barrier to the commoditization of equity values.  We can commoditize debt, because money is the ultimate numerical, information-based commodity, which means it moves at internet speed.  But home ownership equity is highly local, and therefore it does not homogenize:

 

As a consequence, unlike the behavior of commodity prices, which varies little from place to place, the behavior of home prices varies widely across the nation.

 

Additionally, there’s another very practical barrier to housing fluctuating like a stock or commodity: almost everyone who buys it as an investment also uses it:

 

Speculation in homes is largely local, especially for owner-occupied residences. For homeowners to realize accumulated capital gains on a residence–a precondition of a speculative market–they must move.

 

“We got such a good price when we sold the house in Tulsa!”

 

A home cannot be day-traded.  Selling a home is more than an investment decision, because before you can sell, you have to shift house.  And unlike day-trading, which costs almost nothing, the transaction costs of home sales are high, both in time and in money:

 

Another formidable barrier to the emergence of speculative activity in housing markets is that home sales involve significant commissions and closing costs, which average in the neighborhood of 10%of the sales price.

 

Where homeowner sales predominate, speculative turnover of homes is difficult.

 

Ordinarily one would not consider a bit of financial entropy a positive, but in this limited case, it acts to reduce the level of whim involved in a housing decision.  That may depress realizable equity (bad), but it also brakes asset-swapping (good) and reduces price volatility (also good).

 

This works fine if we have habit-ogamy, one house per household.  What if we become poly-habitants?

 

But in recent years, the pace of turnover of existing homes has quickened. It appears that a substantial part of the acceleration in turnover reflects the purchase of second homes–either for investment or vacation purposes.

 

Over the last century, US housing consumption has shown two very powerful demographic trends:

 

1.       Average household size gets smaller (fewer people per home).

2.       Average home size gets larger (more rooms, more square feet, more consumption of cubic). 

 

Once we move to poly-habitation, a new factor is introduced:

 

Transactions in second homes, of course, are not restrained by the same forces that restrict the purchases or sales of primary residences–an individual can sell without having to move. This suggests that speculative activity may have had a greater role in generating the recent price increases than it has customarily had in the past.

 

Got that?  The second home, the vacation home, the buy-to-let home — they’re all financial assets divorced from being physical consumption assets.  The dynamics change.  Prices go up, sure, but so does volatility, because these buyers and sellers are acting on financial comparisons, not household imperatives.

 

On he goes:

 

The apparent froth in housing markets may have spilled over into mortgage markets. The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern.  To be sure, these financing vehicles have their appropriate uses.  But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is beginning to add to the pressures in the marketplace.

 

“And with these hands, I command markets to rise!”

 

Once again, Mr. Greenspan is not saying that interest-only loans are materially riskier from the homebuyer’s perspective.  His conclusion is of a second order: by allowing investor-buyers to reach for a bigger house, interest-only financing may — Mr. Greenspan is clearly conditional and speculative here — be pushing up the prices of those houses, and since second homes are often indistinguishable from primary, this may be pushing up all home prices.

 

Still, even if the balloon is over-inflated, it is unlikely to pop:

 

Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications:

 

1.       Nationwide banking and widespread securitization of mortgages make it less likely that financial intermediation would be impaired than was the case in prior episodes of regional house price corrections.

 

In previous housing-boom cycles, banks were geographic, so a given bank (or savings and loan institution) would hold principally loans from its same area.  If a systemic risk hit that region, all the loans went bad, so the bank went bad.  Now, with loans securitized and so many more banks national (thank you, Congress, for repealing Glass-Steagall!), regional housing-recession risk is diversified across the entire industry.  Banks are much less likely to fail even if housing crumples in one part of the country.

 

2.       A substantial rise in bankruptcies would require a quite-significant overall reduction in the national housing price level because the vast majority of homeowners have built up substantial equity in their homes despite large home equity withdrawals in recent years financed by the mortgage market.

 

Even though prices of houses that trade have risen dramatically, most people own their home for seven years or more.  At any given time, only a small fraction of the inventory is or will ever be on the market.  That relative illiquidity — imagine a stock where you knew 85% of the shares were held by mom-and-pop who aren’t selling — is actually a cushion against systemic risk.

 

Clarity, thy name is Greenspan.

 

“My work here is done.”

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