by Calculated Risk on 8/15/2006 02:48:00 AM

The LA Times reports: Real Estate Economist Leaves UCLA Forecast

Bearish real estate economist Christopher Thornberg, who says the Southern California housing market is a bubble beginning to pop, has left UCLA Anderson Forecast to strike out on his own.

Thornberg, 38, will continue to teach economics at UCLA but will no longer be part of the quarterly Anderson Forecast on the economies of California and the nation.

"I wanted to start my own business and do things I wasn't able to do before," said Thornberg.

His new consulting firm, Los Angeles-based Beacon Economics, will prepare forecasts for regions he thinks are underserved, perhaps including San Diego, the Inland Empire, the Bay Area and Sacramento, Thornberg said. His partner at Beacon is San Francisco economist Jon D. Haveman of the Public Policy Institute of California.

Many of us have noticed that the Anderson Forecast has become less bearish on housing. I've suspected for some time that Thornberg disagreed with the consensus Anderson Forecast view that prices would be "flat" for several years.

Now Thornberg can speak freely:

Thornberg said his expectations are growing more gloomy.

"My guess is we're going to have a hard landing," he said. "It's ugly out there."

There has been large-scale overbuilding of homes and condominiums nationwide, he said. "And here in Southern California we have had this massive price appreciation that is just not justifiable by any kind of standards of reasonable economics," he said.

Although home prices in most Southern California markets are still higher than they were a year ago, "there has been no appreciation for four or five months," Thornberg said.

With interest rates rising in recent months and sales declining, "the bubble is popping, just like a bubble is supposed to," he said.

In a soft landing, prices would level out and economic growth would be flat or slow while adjusting to the loss of jobs and spending in the construction, real estate and mortgage industries.

A hard landing could come if housing prices begin to fall, Thornberg said, in large part because that would scare consumers accustomed to watching their net worth rise on paper. Their spending pullback and a corresponding drop in construction could push the economy into recession.

by Calculated Risk on 8/14/2006 03:56:00 PM

Reading EconLog, I noticed Professor Kling's comment on Roubini's recession predictions:

Apparently, the echo chamber of left-wing macro pundits has pronounced a recession to be imminent. For example, Nouriel Roubini writes,

"Given the recent flow of dismal economic indicators, I now believe that the odds of a U.S. recession by year end have increased from 50% to 70%."

For these pundits, the most dismal indicator is that we have a Republican Administration. They have been gloomy for six years now.

This is a good point; we have to be careful about our biases.

From a stock market perspective, the current period reminds me somewhat of '94, especially market sentiment. Check out this Citigroup poll from MarketWatch: Citigroup poll shows wealthy worrying

"Investors' outlook for the nation's investment climate has fallen to an all-time low. Only one-quarter say the climate is better now than it was a year ago, down more than 20% from the start of the year," the report's authors said.

Among those polled, 58% believe that the economy is in a slowdown, 12% say we're in a recession and 7% see the economy as going through an expansion.

Almost half of investors polled say the investment climate is worse than a year ago.

Sentiment is at an "all-time low" for this poll. Note: For a laugh, check out their definition of "wealthy"!

Back in '94, I remember it was very lonely being bullish. I still get congratulations for my VERY BULLISH call in Dec '94. I'm sure the market bulls are feeling pretty lonely now too.

There are several similarities between the current situation and late '94: the Fed stopped raising rates in Feb '95 and the Fed has probably just stopped raising rates in this cycle (although that isn't completely certain).

In '94 investors were saying the Fed rarely accomplishes a soft landing. We are hearing those same comments now.

Much of the bearishness in '94 was ideological. There were some prominent conservatives (one has a show on CNBC) who thought we would have a severe recession or even depression based on Clinton's fiscal policies. As Kling notes, much of the bearishness now is ideological. Many pundits think Bush is clearly the worst President in history and that colors their views.

I need to be careful and recognize my potential bias: I am strongly in the "Bush is the worst" camp, not because Bush is a Republican (as Kling suggests is the source of the bias), but because I believe Bush is incompetent and mendacious.

Even the earnings picture is similar.

S&P 500 earnings grew 50% over the two year period from '92 through '94, taking the PE down to around 14.5 in December '94. In the current expansion, S&P 500 earnings have grown substantial for four straight years (almost 40% over the last two years from '03 through '05). This has taken the PE down to about 16.4 at the end of last year, and based on current earning projections, the PE will be under 15 for the first time since '94.

Interest rates were higher in '94 than now, so all else being equal, a similar PE is even better today. So I could make a bullish argument based on earnings.

HOWEVER, there are significant differences between '94 and the present. Here are a just a few. First, housing. In '94, residential investment was recovering from the housing bust of the early '90s. Now residential investment has peaked and will almost certainly fall over the next few years.

Second is earnings diffusion: the oil companies are making a disproportionate share of earnings. In '94 earnings were more evenly distributed.

Third is imbalances: the General Fund deficit was falling in '94, currently it is rising (although we might see a small temporary decline this year). The trade deficit was 1.4% of GDP in '94, currently it is around 5.8% of GDP.

Fourth, the US consumer was in much better shape in '94. The savings rate in '94 was 4.8% and the Financial Obligations Ratio (FOR) was 14.5%. Now the savings rate is negative and FOR is 17.5%.

Also energy consumption, as a percent of GDP, was much lower in '94 and geopolitical risks were lower and improving. I may be biased, but I think geopolitical risks are high and rising today.

And finally, in '94 I thought the U.S. would avoid recession and the economy would grow nicely (call it a good guess that was partially based on my views on technology). Currently I think the odds of a recession are high.

Although I am biased, I think it's fair to say the economy has many more risks today than in '94. Still, if there is a soft landing, the markets will probably do reasonably well. If there is a hard landing (recession), look out below.

It's your call ...

by Calculated Risk on 8/14/2006 10:53:00 AM

From Berson's Weekly Commentary: Almost all refinances in the second quarter of 2006 involved equity extraction.

While refinancing activity has been slipping (we estimate that the refinance share of single-family mortgage originations fell to 36 percent in the second quarter from 52 percent in the first quarter), the share is still strong given the generally rising interest rate environment. So if borrowers aren't refinancing to reduce mortgage payments, why are they refinancing? Most are refinancing to take equity out of their homes (a so-called “cash-out refinance”) and an increasing share are refinancing out of adjustable-rate mortgages into fixed-rate mortgages...

The share of refinances involving equity extraction increased to 90 percent in the second quarter of 2006 -- the highest cash-out share recorded since we started keeping track in 1992 (see [graph]). We expect the cash-out share of refinances to increase when refinance activity is sluggish as the incentive to refinance to obtain a lower rate is diminished. We should also not be surprised to see a high cash-out share in a period of unprecedented house price appreciation.

This corroborates the data from Freddie Mac and the BEA; homeowners were still using the Home ATM in Q2.

by Calculated Risk on 8/11/2006 11:15:00 PM

The following graphs are based on pricing and transaction data from DataQuick.

Click on graph for larger image.

The first graph shows the monthly median home prices for Los Angeles, San Diego and Orange County since 2002.

Prices in San Diego started lagging the other markets in 2005 - prices peaked in November 2005, and prices are now falling. For San Diego, the July 2006 median home price is 6% below the peak of last November.

Median prices for both Los Angeles and Orange County are currently at, or just below, their respective peaks.

The second graph shows the year-on-year change in the median price for the three markets. YoY price appreciation is falling for all three markets.

There was one last surge in 2005 for LA and OC.

The third graph shows the YoY change in the number of transactions. For LA and OC, there was a final surge in activity that corresponds to the price action (previous graph).

For San Diego, YoY activity has been falling for 25 consecutive months.

My guess is San Diego is a few months ahead of LA and OC in the current down cycle, and that LA and OC prices will peak in the next few months - if they haven't already peaked.

NOTE: I compared the DataQuick numbers to the OFHEO House Price Index for the three markets (Los Angeles-Long Beach-Glendale, San Diego-Carlsbad-San Marcos, Santa Ana-Anaheim-Irvine). The appreciation since 2002 is very close using both data sets. When the OFHEO data series for Q2 is released in September, I expect San Diego's YoY appreciation to be close to zero and the quarterly prices to decline about 3%.

by Calculated Risk on 8/11/2006 04:07:00 PM

From the San Diego Union: County home prices drop for second straight month

San Diego County's home prices dropped for the second straight month in July and the dominant single-family resale market was flat for the first time in a decade, DataQuick Information Systems reported today.

The overall median price stood at $487,000, down 1.8 percent from July 2005. That was a decline greater than the 1 percent drop recorded on a year-over-year basis in June.

Local home prices have not been this low since they stood at $484,000 in April last year.
...
It was in sales activity that today's changing real estate market showed up most starkly.

The overall sales count of 3,370 homes sold in the county in July was down 21.6 percent from June and 29.3 percent from July 2005. It was the slowest July since 1996, near the end of San Diego's last major real estate recession, when there were 3,096 sales. July was also the 25th straight month to see a year-over-year sales decline.

July sales often trail those of June, but this year the month-over-month drop was the biggest since DataQuick began keeping records in 1988.

And from the LA Times: Rise in L.A. Home Prices Slowest in 6 Years

Los Angeles County home prices in July rose at their slowest pace in six years while values in San Diego County continued to fall, more evidence that the Southland's real estate market continues to slump, data released today show.

Sales in Los Angeles County plunged 25%, the eighth consecutive month of declines, according to La Jolla-based research firm DataQuick Information Systems.

The median price of all Los Angeles houses and condominiums that closed escrow in July reached a record $520,000, up 6.6% from a year ago but virtually flat when compared to June's median of $517,000.

And from the OC Register: Home-sales slump approaches '91 depths

When the housing stats for all of July come out next week , the numbers will be ugly. With roughly a week of data still to be tabulated, DataQuick finds O.C. house sales running 35.3% below year-ago levels. Last time a bigger slump hit? In March 1991!

It sounds like July was terrible for the housing market in SoCal.

by Calculated Risk on 8/11/2006 12:24:00 AM

From the NY Times: Economy Often Defies Soft Landing, here are a few predictions:

Analysts and other experts say that if Mr. Bernanke is serious about his goals for controlling inflation, at least two million more workers may have to lose their jobs over the next two years.

"The economic slowdown has to be much more substantial than anybody in the Federal Reserve or on Wall Street is expecting," said Robert J. Gordon, a professor of economics at Northwestern University, who has analyzed the trade-off between inflation and unemployment for the last several decades.
...
Mr. Gordon said the last few decades had shown a grim but consistent trade-off: to reduce inflation by one percentage point, the unemployment rate has to rise by about two percentage points for a full year.

To reduce inflation to the upper limits of what Mr. Bernanke and other Fed officials consider acceptable, more than three million jobs would be lost, a bigger drop than in the recession of 2001.

And that is Mr. Gordon’s relatively upbeat hypothesis, which assumes no other shocks to the economy — no additional increases in energy prices, no collapse in the dollar’s value, no collapse in housing.

"I think the Fed is facing an absolutely classic case of stagflation," Mr. Gordon said, "a situation in which they cannot win."

Here are some numbers from the late '80s Fed hikes ('91 recession):

YoY CPI decreased from 6.3% to 3.0%
YoY Core PCE decreased from 4.5% to 2.2%
The economy lost 1.6 net million jobs.
And the unemployment rate rose from 5.2% to 7.8%

On the job losses, the economy needs to add around 150K jobs per month to keep the unemployment rate steady. So in addition to losing 1.6 million jobs, the economy didn't create the needed 1.8 million jobs per year. That is why the unemployment rate rose from 5.2% to 7.8%

Currently inflation is not as high as in 1990. Last quarter core PCE was 2.9%, still below the 4.5% YoY peak in 1990. So maybe the unemployment rate will not rise as far as in 1992. That is what Allen Sinai believes:

Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting.

The chief forecaster at Decision Economics, Allen Sinai, said unemployment would have to rise to at least 5.5 percent, from 4.8 percent today, putting a million more people out of work, before inflation begins to decline.

That still sounds pretty grim.

by Calculated Risk on 8/10/2006 11:32:00 AM

The Census Bureau announced the U.S. trade deficit for June was $64.8 Billion. I recommend Professor Chinn's discussion of the trade deficit with most of the graphs I was going to post (and more): The June 2006 Trade Figures


Click on graph for larger image.

This graph is similar to Chinn's figure 1. It appears the trade deficit, excluding petroleum, might have stabilized (red). This might indicate a slowing U.S. economy and is consistent with a slowdown in the U.S. housing market.

The trade deficit story is really in three parts: petroleum, China, and everyone else. Here is a little more on China:


This second graph is year-to-date imports from China.

Imports from China are still growing quickly indicating that deficit with the rest of the world (excluding petroleum) is falling.


But the growth of imports from China is slowing too. Although YTD imports from China have increase 16.8% from the same period in 2005, this is a significantly lower growth rate than the three previous years.

As the U.S. economy slows, this might put additional pressure on China to revalue the RMB. I'll leave this analysis to Roubini and Setser.

As an aside, Roubini is on a roll: The Next Move by the Fed Will be a Cut, Not a Hike, as the US Slips into a Recession...

ALSO: Roubini in the Financial Times: The world must prepare for America's recession

by Calculated Risk on 8/09/2006 11:51:00 PM

UPDATE: From the NY Times: For Housing, a Finger in the Wind


Click on photo for larger image.

Denis Poroy/Associated Press
A roadside in Encinitas, Calif., illustrates some of the fallout from a slowdown in housing prices.

From the NY Times: Hot Market for Second Homes Hits Slump. Some excerpts:

As the overall housing market weakens, the interest in buying vacation homes ... appears to be falling faster. Unlike most metropolitan areas - where underlying demand and the normal turnover in primary homes as a result of job moves, new households and family changes provide a more solid floor under prices - the second-home market relies on a different set of motivations that tends to exaggerate booms and busts.

"Second-home buying is very discretionary," said Edward Leamer, an economist at the University of California, Los Angeles. "There is no force of demographics that is pushing people into buying homes as there is in primary home markets."
...
Vacation homes, like other luxury items, are frequently caught up in booms that appear to defy gravity. But they depend on a relatively narrow slice of the population, mostly affluent baby boomers, leaving them vulnerable to sudden downturns.
...
A survey of consumer finances conducted every three years by the Federal Reserve found that the overall interest in second homes tends to closely follow the ups and downs of the economic cycle. In 1989, some 13.4 percent of those responding said they owned a second home, but that figure fell during the recession in the early 1990Â’s and reached a low point of 11.9 percent in 1995. Such ownership rose to 13 percent in 1998 but fell back to 11.4 percent in 2001 before rising again to 12.6 percent in 2004.

Anecdotal evidence suggests that vacation homes might have reached a new high-water mark in 2005.

Second homes are probably the ultimate discretionary purchase. Perhaps there was more speculation in second home markets than primary markets, and this isn't an indication of an economic down cycle.

Perhaps.

But more prosaic discretionary purchases, like boats and casual dining, are slumping too.

by Calculated Risk on 8/09/2006 06:40:00 PM

UCLA Professor Christopher Thornberg writes for the East Bay Economic Development Alliance: California: Singing the Housing Blues. Here are a few excerpts:

The once loud debate over the existence of the bubble has now been replaced by a debate over how hard a landing it will be, whether home prices will drop, and most importantly what it means for the rest of the economy. What we do know is that we have not come close to the bottom of the market, and it promises to be painful.

On what is a bubble:

... a bubble is when the market price of an asset becomes misaligned with its fundamental value. In the case of housing the fundamental value is the net present value of the rental streams the house offers to its owner over its life. Such mis-valuation is driven by speculators who are betting not on changes in underlying values but simply expected appreciation. This self-fulfilling prophesy can drive the market for a short period of time but must eventually come to an end. What a housing bubble is not, is a period of time when asset prices fall sharply. This may happen at the end of a bubble in stock markets, but the fixed costs of transactions in housing markets causes overall market liquidity, rather than prices, to fall rapidly when the bubble ends. Housing prices fall slowly as a result. This suggests prices will remain overvalued for years.

And on the impact on the economy:

This does not mean the pop will not be harmful to the economy. The real estate and mortgage industries will be hit hard, as will those recent buyers who put themselves in an unsustainable financial position by buying a house far out of their income range hoping for continued appreciation to bail them out of their problems. Consumer spending will take a hit as well, as the home appreciation ATM machine will suddenly run dry.

On California employment (see The Fragile Economy):

The labor markets have been doing fairly well. Unemployment rates remain at very low levels, for the U.S. at about 4.6%, while here in California it has dropped to 5%. But there has been a very distinct slowdown in job creation since the start of the year, both at the national and state levels. At the national level monthly job creation has trended down from the range of 150,000 to 200,000 new jobs per month to 100,000. Here in California the strong pace of job creation in the latter part of 2005 has come to a complete halt, with the total number of jobs barely above where they were at the start of the year. And this time, we don’t have a surge in informal employment making up the difference. Instead, this slowdown is real.

There is much more in the forecast, and especially given the above excerpts, the forecast is actually fairly positive. Here is the entire Quarterly Economic Outlook.

by Calculated Risk on 8/09/2006 04:39:00 PM

Today's OC Register has an interview with PIMCO's Paul McCulley: Housing drove Fed

Q. How big a role did a shaky housing market play in Fed's decision?

A. Huge.

Q. What does this non-action mean for mortgages?

A. Mortgage rates down a touch over last month, likely to hover 'round here, even as "affordable" products (novel home loans containing pay options or negative amortization) abate with tighter underwriting standards and fear.

Q. Should I keep my adjustable mortgage? Is the rising-payment pain over?

A. Yes.

Q. Which is worse for housing: higher rates previously feared or the economic weakness the Fed's sniffing?

A. What's bad for housing is that it has turned, as a result of hikes plus spent speculative forces. Housing is the most reflexive market in the world. Very momentum driven, hard to turn, but once it's turned, it stays turned.

Q. "Soft landing" or disaster ahead for housing?

A. Somewhere in between. How about a "hard-soft landing?"

My comments:

I'm still trying to find out the timing of the "Nontraditional Mortgage Guidance". I wrote to the FDIC last week, and this was their response:

"The agencies are currently reviewing the comments received and developing final guidance."

Not much help.

I'm not sure if McCulley was referring to this new guidance when he mentioned "tighter underwriting standards" or if he thought the industry would react to higher delinquency rates, like LEND reported today:

"Delinquent loans (30 or more days past due, including foreclosures and real estate owned) were 3.76% of the serviced portfolio at June 30, 2006, compared to 2.47% at December 31, 2005 and 1.79% at June 30, 2005."

And I'm not sure what a "hard-soft landing" means. Housing will probably land hard with the loss of 15% to 30% or more of all housing related jobs over the next couple of years. How can that be anything but a "hard landing"? Maybe "hard-soft" means hard for housing, but soft for the economy (slow growth, but no recession).