Dr. Jaffe's Economic Forecast for 2010

Economic Forecast for 2010 or How I Learned to Stop Worrying and Love the Foreclosure Sale Austin J. Jaffe, Ph.D. Chair, Dept. of Insurance and Real Estate, and Philip H. Sieg Professor of Business Administration Penn State University PAR Business Meetings Harrisburg, PA January 25, 2010

Introductory Remarks
Thank you for having me back.
One of these times, you might even like what I have to say!
Perhaps today is the day?
Plug for PAR Blogs: Look at JustListed by our PAR Communications Team.
Today, I want to talk about various economic forecasts for the new year, including a few predictions of my own.
With apologies to Stanley Kubrick (for the sub-title), it is time to recognize that the real estate market is considerably different than in the past and this is not going to change anytime soon.

Overview of Presentation
Introductory Remarks
Summaries of Previous Remarks
Current Situation in U.S. Housing Markets
Quotes from AEA Experts in Atlanta
Some Very Recent Data for Pennsylvania
New PAR Data (released last week!)
New NAR Data (released this morning!!)
Jaffe’s Five 2010 Predictions
Conclusions
Q & A

Let’s Review
I have tried to be truthful in previous appearances:
January 2008: “Get ready”
January 2009: “Future will be challenging”
September 2009: “Real estate market will be driven by housing services, not by investment objectives”
January 2010: ??? (Soon …)

Housing Takes Center Stage in Atlanta
In January, there was a major academic conference held in Atlanta.
About 30-40 organizations participate annually including AEA, AFA, and AREUEA.
There was plenty of attention paid to the housing and financial crises in terms of presentations, panels, and interviews.
I was there and saw some of these sessions.

The Current Situation in National Housing Markets
From John Quigley (U of Cal – Berkeley)
House Prices
There is general agreement that prices have fallen 32-34% from their 2006 peak.
This results in about a $5 trillion loss in value.
Some in the industry have been excited by recent monthly median price upturns (each month since April, 2009).
However, recalculating the total decline with the recent increases results now in “only” 31% losses.

NAR’s Pending Home Sales Index
I

Expectations about Appreciation
In a 2004 survey, new buyers of housing expected 24% annual price increases!
Even in 2004, this is amazing.
More about consumer expectations later.
Mortgage Delinquencies
14% of all mortgages are now 90 day delinquent.
In Nov, 2009, it was 5% delinquent.

Negative Equity
25% of total borrowers have negative equity situations.
In a forthcoming blog for JustListed , I report the total as nearly 11 million households.
The majority are concentrated in a few states:
NV 65% of all homes
AZ 48%
FL 45%
MI 37%
CA 35%

Negative Equity and Option ARMs
Borrowers with Option ARMs are in the worst shape.
(Another forthcoming JustListed blog is devoted to Option ARMs.)
For example, there are scheduled to be one million resets of ARMs in 2010.
Also, billions of dollars of mortgages to reset through 2012.
See graph below.

Option ARM Resets

Foreclosures
Foreclosures are up 18% (from Nov 08–Nov 09)
Foreclosures are down 8% (from Oct 09-Nov 09)
50% of foreclosures are in CA, FL, IL, and MI) ( RealtyTrac )
Other foreclosure leaders: AZ, TX, OH, GA, NV, NJ ( RealtyTrac )
Latest (Jan, 2010) RealtyTrac Report reports 2.8 million cases, or 1 of every 45 households (up 21% from a year ago)!

Financial Capability of Homeowners
Many are not qualified for the homes they possess (they expected to refinance, flip, or used “liar loans”).
With falling prices, even more are not qualified.
Government Rescue Programs
No difference between Bush and Obama programs: dismal failures.

Government Rescue Programs
Hope for Homeowners
Grand total of 880 cases
Treasury Allocates Spending $75 Billion
Making Housing Affordable / Home Affordable Modification Program (HAMP)
Oral acceptances: 728,000 of 4 million targeted, resulting in 31,000 modifications.
About ½ of these mortgages are “liar loans” so only 1/3 turned in their applications.
Difficult to work with government (worry about fraud).
Even then, 1/3 of modified loans are already delinquent
WSJ just reported that banks have little incentive to modify since it is so costly to work with govt regs.

From Karen Pence (Fed in Wash DC)
Public’s HP Expectations
Cites a U Michigan survey that even now 37% of the population expect price appreciation in the future.
Also, national expectations dominate local thinking about appreciation.
In 2009, Bob Shiller predicted that there will be no house price appreciation until at least 2014.
(You have also heard similar predictions from me many times.)

“ Housing as an Investment Good is Deficient”
Her remarks were also reported in the media as “Housing Is a Lousy Investment.”
The prospects for housing appreciation are so poor that even supportive economists are bashing housing.
Yet, these economists develop federal policies to stimulate and support homeowners.
Here are some observations:

1. Housing is indivisible as an asset.
One cannot sell off house parts if over-allocated.
Try to sell that extra bathroom!
2. Housing investments are undiversified.
Most families have a very large portion of their wealth in their home. (This is a risky thing, not a good thing!)
The home is one big bet in one single neighborhood.
3. Transaction costs are high relative to other investments.
Compared with other investments, it is more costly to buy/sell real property.
This is due to “real estate agent fees, mortgage fees and moving costs.”

4. Housing is “asymmetrically liquid.”
Sorry for the academic jargon.
Translation: it is easier to get money out of your house (due to well-developed financial markets) when prices are rising (refinance, HEL, etc.)
When prices are falling, it is more risky to lend to borrower (and equity is diminishing or gone).
Therefore, leverage is not symmetric.
Also, the threat of pre-payment comes into play.
5. Housing is correlated with the jobs market.
Prices rise when labor market is improving and fall with a recession.
So if a homeowner is laid off, there is no help from the housing market: prices tend to fall as well, doubling the pain.

These ideas strike me as theoretically correct and quite plausible reasons for souring on housing as an investment.
However, how many of us thought about them during the “boom” period?
Watch for more thinking like this as expectations about investment returns continue to exceed reality in the next several years.

From Karl (Chip) Case (Wellesley U)
Chip was not on the panel but offered a few comments from the audience including a summary about housing in 2010:
Foreclosures are increasing
March 2010 will be the end of MBS purchases
Option ARMs are beginning to reset
High unemployment remains
Therefore, we have a recipe for further price declines (about 10-15% more).

From Mark Zandi (Moody’s Economy.com)
Taken from Fortune ’s “The 2010 Housing Outlook” (Dec 21, 2009)
Last year’s national average house price prediction: -14.5% (actual -13.2%).
This year’s prediction: -5.0 to -10.0%.
In other words, we are not finished yet.

From Mark Zandi (Moody’s Economy.com)
“ It is clear we’re closer to the end of this crash than the beginning.”
“ We’re moving in the right direction, [more affordable prices, low construction, increased sales] and that’s the reason for optimism.”
“… there’s about zero possibility of another US housing bubble anytime soon.”
(This is the optimism?)

Finally, here are a few remarks from some other famous economists from the Atlanta conference:
“ Strategic defaults on mortgages will grow substantively over the next year, among prime borrowers, and become identified as a serious problem…. Some people will take another look at their mortgage contract, and note that nowhere did they swear on the bible that they would repay.”
- Bob Shiller (Yale U)

“ U.S. interest rates will go up across the board. Probably more at the long end than the short end.”
- Alan Blinder (Princeton U)

Economic growth between 2009 and 2019 will be close to 1.9%, the same as the average for 1999-2009. “We’re not likely to have robust growth any time soon.”
- Joseph Stiglitz (Columbia U)

Large debt will be a “major headache” for the US economy. There will also be problems without an improved regulatory system.
- Ken Rogoff (Harvard U)

Conclusions from the Experts
Housing remains in serious trouble.
It will be years before there is a sense of “normalcy.”
The new real estate market will differ from the past dramatically .
Hold on! It is going to be rocky ride.
(But perhaps not so much in PA …)

Some Recent PA Evidence
As promised, here are some very recent PA numbers:
ANNUAL MEDIAN HOUSE PRICE CHANGES (in %)
2006-07 2007-08 2008-09 2006-09
PA 4.2 -2.3 -5.4 -3.6
Berks 4.2 -1.2 -10.0 -7.3
Bucks -1.0 -4.9 -7.2 -12.7
Centre 2.8 6.7 -4.5 3.2
Chester 2.7 -1.6 -11.1 -10.1
Delaware 9.1 2.9 -12.1 -3.8
Erie -2.2 2.2 0.0 -0.1
Franklin 2.3 -5.5 -5.8 -9.0
Note: Only counties with > 1000 annual transactions are included and only those who reported sales to PAR.
Data: PAR (Dec 2009)

ANNUAL MEDIAN HOUSE PRICE CHANGES (in %)
2006-07 2007-08 2008-09 2006-09
PA 4.2 -2.3 -5.4 -3.6
Lancaster 3.9 -1.1 -2.4 0.3
Lebanon 8.2 -4.4 -1.4 2.0
Lehigh 5.7 0.0 -5.7 -0.3
Montgomery 1.1 -2.9 -9.1 -10.7
Northampton1.9 -3.5 -8.0 -9.5
Philadelphia 2.3 -0.8 8.3 9.9
York 3.3 -5.7 -3.1 -5.7

ANNUAL CHANGES IN SALES NUMBERS (in %)
2006-07 2007-08 2008-09 2006-09
PA -1.6 -23.3 4.6 -21.0
Berks -0.7 -24.6 3.1 -22.8
Bucks 8.6 -24.4 7.8 -11.5
Centre -5.5 -4.9 2.7 -7.7
Chester 3.2 -20.8 5.9 -13.5
Delaware 5.9 -27.3 14.3 -12.0
Erie -5.7 -13.0 0.6 -17.5
Franklin -8.0 -19.5 -6.0 -30.4

ANNUAL CHANGES IN SALES NUMBERS (in %)
2006-07 2007-08 2008-09 2006-09
PA -1.6 -23.3 4.6 -21.0
Lancaster -5.1 23.0 1.4 -25.9
Lebanon -7.5 -20.6 0.7 -26.0
Lehigh -18.0 -22.9 -7.3 -41.5
Montgomery 4.7 -23.0 10.1 -11.2
Northampton-15.9 -23.1 -6.7 -39.7
Philadelphia 3.3 -27.2 12.4 -15.4
York -9.1 -23.3 1.3 -31.7

Also, from a NAR Press Release embargoed until … 10 am TODAY!, here is what NAR is reporting:
For Philadelphia : 1.1% median price increase from Dec 08-Dec 09 and 3.1% increase in sales activity.
For Pittsburgh : 12.0% median price increase from Dec 08-Dec 09 and 2.0% increase in sales activity.
(Except for median prices, no other information is available.)
Source: NAR, 2009

OK, can we have a drum roll, please …?
1. Will there be appreciation in PA housing?
Last year, I said “No growth is expected in home prices.”
This year: “Still no growth is expected in home prices.”
2. PA foreclosures are up but have slowed down recently. Expect an increase in foreclosures due to Option ARMs and continuing high unemployment.

3. Sales activities may increase due to lower prices but not as much if foreclosures remain a problem and unemployment remains high in PA.
4. Mortgage rates are headed upward and will continue to do so after “quantitative easing” is over (March 2010) and inflation returns (2011 or later). Credit will be very scarce for risky borrowers.

5. The Federal government will continue to be helpless in stemming the housing crisis. The only effective action is a very difficult one: writing down significant amounts of mortgage debt. Other attempts to modify loans will continue to be almost irrelevant.

Conclusions
Now: how much fun was that ?!
Have we all signed up to sit in the dentist’s chair for years?
As I argued previously, this is a new real estate market requiring a new real estate profession.
Housing will be viewed as consumption benefits with a long-lived, indivisible, undiversified, high transaction cost, durable good in a world where tax policy and land use controls work against future buyers even if and unemployment falls.

Conclusions
However, I am fairly certain that we will continue to move ahead as real estate professionals even without appreciation potential, a large inventory, and a slow, weak economic recovery.
Welcome to the new real estate reality!

Q & A …
Thank you for your interest and attention!
There are no silly questions!
We have time to discuss any of the issues raised here or any other real estate matters!

Dr. Jaffe's Economic Forecast for 2010

by Pennsylvania Association of REALTORS on Jan 27, 2010

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