US Real Estate Markets

Look Out Below

By N.A. 1elttek@gmail.com

Pundits ranging from the well known CNBC host Jim Cramer to Smart Money’s Donald
Luskin to Alan Greenspan have called a bottom to the housing collapse and appear to have
neglected readily available public information that would suggest that they are all very wrong.

"the drop in U.S. home prices will probably end well before' early next year as the number of
houses on the market diminishes, aiding an economic rebound."
-Alan Greenspan, April 8 2008

“I'm not here to tell you that home prices are at absolute bottom this very moment. But I can
argue pretty persuasively that they might be. Or that they are close.”
-Donald Luskin May 2, 2008

“I am indeed sticking my neck out right here, right now,” Cramer continued, “declaring
emphatically that I believe the market will not revisit the panicked lows it hit on July 15.”
-Jim Cramer July 30, 2008

Between the US Census, Federal Reserve, and Case-Shiller data, one can put together a picture
which suggest that the majority of main stream prognosticators continue to make call after call
that ignores historical trends and the current fiscal condition of the US and its citizens.

Looking at the 90’s housing bubble gives some perspective to the current bubble. The 90’s
bubble rapidly overshot the historical median for that period, peaked and then rapidly dropped
below the median. This was followed by a long slow climb back towards the median value as
seen in the Case-Shiller data in Figure 1. This demonstrates a classic reversion to mean type
pattern that has been seen in many markets and in many nations, including Britain and Japan in
the late 80’s and early 90’s.

The current data for the US as a whole represented using the Case-Shiller Composite 10 data
set (Figure 2) suggest that the current bubble began to form in 1998-1999. A sudden rise in
the index can be seen in the composite and in the NY area data set (Figure 3). The growth of
the housing bubble continued for about seven years, peaking both locally and nationally around
2006.

What amount of the growth seen in the last seven years has been sustainable and what might
have driven it? If we look at the median income, both nationally and regionally, we see that
income has remained essentially flat. Since income did not appreciable increase, then home
buyers were left with two choices. They could either borrow more money from the banks or
the prices of homes had to decrease. It is well known that numerous types of exotic financing
have been used for the duration of the growth phase of the current housing bubble. The effect
of the housing debt expansion should be obvious in the home loan to household income ratio.
Using data from the US Census, two versions of the household income to home loan ratio were
created. The first version (Figure 5) shows the ratio assuming a 20% down payment on the
home, or an LTV of 80%. The second version (Figure 6) shows a ratio assuming a 0% down
payment on the home, or and LTV of 100%. While an LTV of 100% was probably less then
50% of home buyers, it is still useful to see what sort of risks a significant portion of buyers
were putting themselves in.

“The survey covered people who bought and sold homes from August 2004 through July 2005.
The association (NAR) said 43 percent of first-time buyers surveyed financed 100 percent of
their homes, up from 28 percent two years ago when the trade group began tracking such
figures”
- Washington Post Jan 20, 2006

By 2001 a clear trend of an increase in the household income to purchase price ratio is visible
(Figure 5). Given that there was an increasing rate of buyers using exotic financing to
purchase homes and that LTV was generally increasing throughout the growth phase of the
housing bubble, it may be helpful to look at (Figure 6) to get an idea of what sort of financial
situation a non-trivial portion of home owners may now be in. The data used to generate the
income to purchase price charts was the median purchase price data. So a home owner that
purchased a home in the northeast with a traditional LTV of about 80% would be taking out a
home loan about four times their annual household income. By the peak of the bubble the data
shows the loan to income ratio peaking between 6.5 and 7 times household income.

History shows that during the last US housing bubble in the 90’s, people who were underwater
were generally able to continue paying the house note and as such there was not a significant
spike in foreclosure. Such a trend would suggest that in the Northeast region, the income to
loan ratio of 4X is sustainable. The Peak value of 6.5 – 7 times household income is clearly
unsustainable as we are now reading about the growing “foreclosure crisis”. People bought
homes substantially outside their ability to financially support in the long term while counting
on short term gains created from bubble driven growth to make up the difference.

An additional view of the real estate bubble can be seen in home ownership rates. The
historical rate of home ownership tends to be between 64% and 65%. The current bubble has
pushed home ownership to 69% while the nest closest high was 66% in 1983. This is a
significant difference in historical terms as can be seen in Figure 7.

This collection of data alone is capable of putting forth a very strong argument for a brutal
reversion to mean in the housing market. Virtually any argument that the bottom is near in
national or even regional terms is specious at best. The recent housing bubble appears to be
the greatest housing bubble in the last 100 years. The only growth that has kept pace with
housing is the indebtedness of the US as a people and as a nation (Figure 8).

The question at hand is how far we have to fall. The chart in (Figure 9) shows the current
Case-Shiller values for each of the twenty urban areas that are represented by the data set.
Note that the Case-Shiller data for Dallas TX does not begin until 2000 and there for does not
reflect pre-bubble trends. The percentage data for the reversion to mean is located in (Table 1).
While the percentage drops just to reach historical median values seem drastic, reversion to
mea usual entails an overshoot. If history is any indicator, then the actual drop as represented
by the Case-Shiller index could very well hit 80% from peak in a hand full of regions. If the
90’s housing bubble is any guide then there is the potential for the overshoot to be almost as
large as the undershoot.

The timing of this event is really anyone’s guess. The last bubble bottomed out approximately
as quickly as it overshot the median value at the time. However, Japans house bubble in the
80’s is a demonstration that once the government gets involved in attempting to control and
artificially support prices that most educated guesses are out the window. Japans housing
market declined for 20 years. As the US government continues to encroach further into market
manipulation the question is quickly becoming will we stabilize quicker then Japan did?

Table 1
% Drop Peak to % Drop Current to
Median Median
AZ-Phoenix 60% 29%
CA-Los Angeles 65% 45%
CA-San Diego 66% 45%
CA-San Francisco 65% 44%
CO-Denver 43% 37%
DC-Washington 63% 49%
FL-Miami 68% 47%
FL-Tampa 62% 44%
GA-Atlanta 27% 14%
IL-Chicago 47% 37%
MA-Boston 57% 49%
MI-Detroit 26% -12%
MN-Minneapolis 48% 33%
NC-Charlotte 32% 27%
NV-Las Vegas 60% 33%
NY-New York 61% 55%
OH-Cleveland 27% 16%
OR-Portland 50% 42%
TX-Dallas 8% 2%
WA-Seattle 49% 42%
Composite 10 64% 50%
Northeast 59% 53%
South 25% 0%
Midwest 32% 14%
West 55% 36%
 Figure 1
90's Real Estate Bubble In Perspective
CS Composite 10 and Northeast Composite
Medians calculated from data range 87-99
100
Composite-10
95 Composite 10 median
Northeast Composite
90
Northeast Median

85

80

75

70

65

60
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Figure 2
Cas-Shiller Composite 10/20
Composite 10 median Value = 82
Median for 87-08
250

225 Composite-10
Composite-20
200 Comp-10 Median

175

150

125

100

75

50

25

0
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
 Figure 3

New York Area Case-Shiller

220
210
200
NY-New York Median
190
180
170
160
150
140
130
120
110
100
90
80
70
60
1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009
Figure 4
Data Source: US Census
Median Income (Inflation Adjusted to 08 $)
1975 - 2007 For Total US and Each Region
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$0
1975 1980 1985 1990 1995 2000 2005
United States Northeast Midwest South West US Median
 Figure 5
Home Price As a Multiple of Household Income
(assum ing 20% dow n paym ent)
6.0
United States
5.5
Northeast
5.0

4.5

4.0

3.5

3.0

2.5

2.0
1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Figure 6
Home Price As a Multiple of Household Income
(assum ing 0% dow n paym ent)
7.0
6.5 United States
6.0 Northeast
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
 Figure 7
US Home Ownsership Rate
70.0
69.0
68.0
67.0
66.0
65.0
64.0
63.0
62.0
61.0
60.0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03
05
07
United States Median +1 Stdev -1 Stdev

Figure 8
Growth of American Indebtedness
$5,000 20,000

$4,500 Total Consumer Credit (Billions) 18,000

Consumer Debt / Person

$4,000 16,000
Total US Population (10's of thousands)

$3,500 14,000

$3,000 12,000

Population
$ $2,500 10,000

$2,000 8,000

$1,500 6,000

$1,000 4,000

$500 2,000

$0 0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
 AZ
-P

0.00
20.00
40.00
60.00
80.00
100.00
120.00
140.00
160.00
180.00
200.00
C ho
A- en
Lo ix
s
An
C ge
le
A-
Sa s
C n
A- D
Sa ie
go
n
Fr
an
ci
sc
C o
O
-D
N en
V- ve
La r
s
Ve
ga
O s
R
-P
or
tla
W nd
A-
Se
D at
C-
W tle
as
hi
ng
to
n
Current CS Value

FL
-M
ia
m
FL i
-T
am
pa
G
Figure 9

A-
At
la
N nt
a
C-
C
ha
rlo
tte
Median CS Value

TX
-D
al
la
IL s
-C
hi
ca
go
M
I-D
M
N et
ro
-M it
in
ne
ap
O ol
H is
-C
le
ve
la
nd
M
A-
Bo
st
N on
Y-
Ne
w
Yo
rk
 Home Price As a Multiple of Household Income
(assuming 0% down payment)

7.0 $60,000

6.5
$50,000
6.0

5.5 $40,000
Multiple of Income

Median Income
5.0
$30,000
4.5

4.0 $20,000

3.5
$10,000
3.0

2.5 $0
1975 1980 1985 1990 1995 2000 2005 2010

United States Northeast

Median US Income (inflationn Adjusted to 08) Median NE Income (Inflation Adjusted to 08)

US and Regional Home Ownership rates

80.0

75.0
70.0

65.0

60.0

55.0

50.0
65

68

71

74

77

80

83

86

89

92

95

98

01

04

07
19

19

19

19

19

19

19

19

19

19

19

19

20

20

20

United States Northeast Midwest South West

 North East Home Ownsership Rate
66.0
65.0
64.0
63.0
62.0
61.0
60.0
59.0
58.0
57.0
56.0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03

05
07
Northeast Median +1 Stdev -1 Stdev

Midwest Home Ownsership Rate

75.0
74.0
73.0
72.0
71.0
70.0
69.0
68.0
67.0
66.0
65
67
69
71
73
75
77
79
81
83
85

87
89
91
93
95
97
99
01
03
05

07
Midwest Median +1 Stdev -1 Stdev

South Home Ownsership Rate

72.0
71.0
70.0
69.0
68.0
67.0
66.0
65.0
64.0
63.0
62.0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93

95
97
99
01
03
05
07

South Median +1 Stdev -1 Stdev

 West Home Ownsership Rate
66.0
65.0
64.0
63.0
62.0
61.0
60.0
59.0
58.0
57.0
56.0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93

95
97
99
01
03
05
07
West Median +1 Stdev -1 Stdev

Reigon Definitions:

Northeast: Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island,

Vermont, New Jersey, New York, Pennsylvania.

Midwest: Illinois, Indiana, Michigan, Ohio, Wisconsin, Iowa, Kansas, Minnesota,

Missouri, Nebraska, North Dakota, South Dakota.

South: Delaware, District of Columbia, Florida, Georgia, Maryland, North Carolina,

South Carolina, Virginia, West Virginia, Alabama, Kentucky, Mississippi, Tennessee,
Arkansas, Louisiana, Oklahoma, Texas.

West: Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah, Wyoming,
Alaska, California, Hawaii, Oregon, Washington.