Tuesday, August 24, 2010

Are Housing Prices Clearing? Timing and Matching v. Clearing

As someone who studies local housing markets, I have a hard time understanding what this question is supposed to mean when discussing national aggregates. Nevertheless, from the NAR we learn that:
Existing home sales dropped a record 27.2 percent from June to an annual rate of 3.83 million units, the lowest since May 1995.
Felix Simon comments:
The number is so low that it looks like a statistical aberration: let’s hope it is. Because if it isn’t, the news is gruesome. It means that despite record-low mortgage rates, people aren’t able to buy houses: essentially all the benefit from those low rates is going to people who already own their homes and are taking the opportunity to refinance.

The news also means that there’s a big gap between buyers and sellers: the market isn’t clearing. Sellers are convinced that their homes are worth lots of money, or will rise in price if they just hold out a bit longer; buyers are happily renting, waiting for prices to come down. And entrepreneurial types, whom one would expect to arbitrage the two by buying houses with super-cheap mortgages and renting them out at a profit, don’t seem to have found those opportunities yet.

I have a different take: We are observing the consequences of a adjustment in the timing of housing purchases. In fact, the Reuters article even makes the connection:

"This is a worrisome report and while it reflects the volatility caused by the end of the (government home-buyer) tax credits, it also indicates a deterioration in the underlying trend for housing demand," said Michelle Meyer, senior U.S. economist at Bank of America Merrill Lynch in New York.

The bold emphasis is mine, and I focused it on that part of the statement because the phrasing of it seemed to be intended for maximum scariness: "Volatility caused by the end of the home-buyer tax credits." Why did it cause volatility? People probably moved their housing purchases up by several months or even a few years in order to get the temporary tax credit. This inflated previous housing purchases, and deflated them in the post credit period. The volatility was not caused by the "end of the tax credits" so much as the existence of the temporary tax credits!

This also had another consequence, which is that people probably didn't just adjust on the time dimension, but also in terms of what kind of housing attributes are desired. Remember, no two houses are exactly the same, which makes the housing market a matching game. When a tax credit is on the line, you might settle for a house that you wouldn't have if you had more time. This temporal shift has likely caused a temporal mismatch of housing preferences between buyers and sellers. Having buyers change composition like that is likely to cause funny things to happen.

I would add to support for my claim, based on the article:

  1. First time home buyers, who were the ones eligible for the credit, declined in their representation as buyers.
  2. The addition to the inventory of previously owned homes for sale did not seem to have a similar increase to match the decline in sales (though it did increase).
The housing market might not be setting a market clearing price yet (which rose 0.7%), but since median national house prices mean very little, I am less inclined to view this data as indicating that a significant price decline is on the way. It could be. I think it could also be very reasonable for sellers to let the mismatch period pass before making big conclusions about what their house might be able to sell for.

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