Transcript Property Rights and the Rise of the Western World

Economic Predictions for the
New Year: 2009
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 26, 2009
Overview of Presentation
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Introductory Remarks
Some Amazing Data
2008 Overview
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Updates for 2009
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“Ten Events That Shook the Real Estate
World” The Pennsylvania REALTOR (December
2008)
Nationally
Pennsylvania
Jaffe’s Five “Big-Time” Predictions
Concluding Comments
Q&A
Introductory Remarks
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Thanks for the invitation.
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Pleased to be back in “Central PA”
PAR Blogs, a new feature: “Just Listed”
“A Fine State of Affairs” (L&H)
It was suggested that I talk about the
“state of the economy and how it affects
housing in general and PA in particular.”
There is a great deal of uncertainty in this
business currently and the next few months
may be challenging.
My plastic shields have been raised, so feel
free to throw whatever tomatoes you wish!
Some Amazing Data
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I have only 2 graphs today.
There are many more available
but we will look at only these
today.
Some pictures can be
important:
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(1 Picture = 1000 words)
Then we’ll look at several
issues.
Conclusions from Case-Shiller and
Shiller Data
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We have yet to hit bottom of the national
house price decline.
Whether one uses the 10-City or 20-City
(or “100-City”) Indices, housing markets
are very highly correlated, especially now.
Most experts predict further declines in
house prices and housing transactions
during the year ahead.
Most experts predict further increases in
time on the market, defaults, and
foreclosures during the year ahead.
Conclusions from Case-Shiller and
Shiller Data (cont’d)
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Examining the long-term house price data
series, the boom in house prices from
about 1996-2006 was unprecedented.
There are several reasons for the
boom/bubble in house prices.
The fact that the traditional equilibrium
ratios are still considerably above historic
levels suggests continuing falling prices.
The economic environment is making life
even more difficult.
Are We Having Fun … So Far?
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These developments are the ultimate reality
check for many people in our industry.
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How many of us argued that there was a housing
bubble growing and one day it would burst? (Very
few of us.)
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Who knew how toxic the MBSs were despite AAA
ratings? (None of us.)
Who expected continually falling house prices which
turned all financial calculations upside down?
(Absolutely no one?)
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How many times did you refer to housing as a
financial asset rather than as a consumption
decision for the household? (Over the past 15-20 years,
almost always!)
Well, There is Some Good News!
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Pennsylvania is not like the formerly “hot”
markets (e.g., Nevada, California, Florida,
Arizona).
Pennsylvania is not even like its western
neighboring states (e.g., Michigan, Ohio).
While Pennsylvania’s population tends to
be unevenly distributed across the
Commonwealth, few urban areas are in as
serious trouble as in those above.
2008 Overview and 2009 Updates
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The PAR staff asked me to write a
summary piece for The Pennsylvania
REALTOR about the turbulent year which
has just passed.
It was entitled “Ten Events That Shook
the Real Estate World” (December 2008).
Today, the plan is:
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a) to review these seismic events from 2008,
b) to update them for 2009, and
c) to focus on Pennsylvania (where possible).
2008 Overview and 2009 Updates: #10
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“The term ‘subprime mortgages’
became part of our vocabulary.”
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The rise of Subprime and Alt-A mortgages
was widely heralded when property values
were rising and credit was readily available.
Qualifying for mortgage finance was often
trivial and aggressive, new mortgages were
used.
By late 2006, the party was over and
housing prices began to fall (and they have
not stopped declining for at least 25
consecutive months).
2008 Overview and 2009 Updates: #10
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“The term ‘subprime mortgages’ became
part of our vocabulary.”
2009 Update:
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Subprime mortgages are dead; new
subprime borrowers are non-existent; old
subprime borrowers are often in trouble and
where they have refinanced, they are often
back in default.
In Pennsylvania:
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Considerably lower incidence of subprime
mortgage borrowing/lending existed than in
most states; part of “The Pennsylvania Story”
is the relatively low amount of housing
speculation.
2008 Overview and 2009 Updates: #9
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“Foreclosure filings rose significantly
during 2007.”
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Defaults and foreclosures became major issues
since 2007.
Recent data indicates more than 3 million
foreclosures occurred nationwide.
More recently, foreclosures resulted from
traditional economic problems (unemployment,
weak economy); in 2006, problems stemmed
from ARM resets and falling house prices.
More attention paid to foreclosures now than
any time since the 1930s.
2008 Overview and 2009 Updates: #9
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“Foreclosure filings rose significantly during
2007.”
2009 Update:
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Most recent RealtyTrac data shows foreclosure
numbers are up 81% at beginning of 2009 from a
year ago.
However, virtually half of all foreclosures in AZ, CA,
NV, and FL.
In Pennsylvania:
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Foreclosures are up more than 127% from 2007-08
in the most recent study.
Yet, PA ranks 32nd amongst 50 states and DC at
about 1/3 of the national average.
I would expect foreclosures to be problematic in
only a few counties in PA.
2008 Overview and 2009 Updates: #8
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“Financial problems led to bankruptcies.”
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Many large residential lenders failed in 2007
(e.g., Ownit Mortgage, ResMae Mortgage and
New Century Financial) and others followed
(e.g., Countrywide Financial and Washington
Mutual Bank) during 2008.
Many of the loans made at these institutions
were highly risky.
With falling house prices, they did not have a
chance to survive.
2008 Overview and 2009 Updates: #8
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“Financial problems led to bankruptcies.”
2009 Update:
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Despite billions in TARP funds for lenders, it is not
clear that the financial crisis is over for institutions
with “toxic” mortgages on their books.
Giants have fallen during 2008 and will more
tumble in 2009?
In Pennsylvania:
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I am not an expert on the status of PA banks but if
the financial system does not settle down,
mortgage lending in PA will definitely be affected.
Smaller, state-chartered banks claim they have
plenty of funding since they have not been
mortgage market players.
2008 Overview and 2009 Updates: #7
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“Mergers and acquisitions grew in the
mortgage market.”
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Countrywide and Merrill Lynch became part of
Bank of America, Bear Stearns and Washington
Mutual were taken by JP Morgan, Lehman
Brothers is being sold in pieces, Wachovia is
gone too (now part of Wells Fargo).
Equity values collapsed overnight as fear rose
about the declining values of large MBSs (e.g.,
CDOs).
Mortgage products became unwanted goods.
2008 Overview and 2009 Updates: #7
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“Mergers and acquisitions grew in the
mortgage market.”
2009 Update:
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It appears that the major changes occurred
during the second half of 2008.
However, there is still plenty of trouble (e.g.,
can Citigroup survive? Which smaller, regional
banks are heading for failure? AIG might need
more?).
In Pennsylvania:
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Does anyone have any new data? My guess is
that PA will produce fewer bank failures than
other states.
2008 Overview and 2009 Updates: #6
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“Mortgage and mortgage-backed security
(MBS) write-downs hit Wall Street.”
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From 2007 onward, every major investment
bank had major write-downs including UBS,
Morgan Stanley, Merrill Lynch, Citigroup, AIG,
Bank of America, HSBC, others (except
Goldman Sachs).
Many banks had several write-downs in various
periods (earnings quarters).
These are billion dollar losses (e.g., $5-15
billion is common, and some have multiple
write-downs).
2008 Overview and 2009 Updates: #6
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“Mortgage and mortgage-backed security (MBS)
write-downs hit Wall Street.”
2009 Update:
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It was said that after TARP financing, the problems
would stop.
Now there are new fears that there are more toxic
loan portfolios on several balance sheets.
Continual falling prices will make conditions worse.
The Fed may pursue an aggressive policy of buying
up billions of these mortgage pools to stabilize
mortgage markets.
In Pennsylvania:
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There will continue to be fallout in PA from this Wall
Street turmoil.
Weak financial markets are now taking their toll on
financial industries in PA.
2008 Overview and 2009 Updates: #5
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“Fannie Mae and Freddie Mac became
illiquid and nationalized on September
7th.”
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Also, AIG was bailed out (now at $150 billion);
GSEs cost taxpayers $200 billion.
The was a genuine fear of the collapse of the
entire financial system.
Note: shareholders did not get bailed out.
The future is uncertain for Fannie and Freddie.
2008 Overview and 2009 Updates: #5
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“Fannie Mae and Freddie Mac became illiquid and
nationalized on September 7th.”
2009 Update:
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Fannie and Freddie were instrumental in running the
secondary mortgage market and held ½ of the
mortgages made and sold nationally.
One way or another, the GSEs will be reinvented since
they are a fundamental part of the US financial system.
They may be reconstituted as federal agencies.
They will definitely not reappear as they were before.
In Pennsylvania:
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PA mortgage lenders are limited (as elsewhere) with the
freezing of credit and mortgage markets.
The experience of liquidity “sloshing about” including
mortgage credit, is definitely over for some time.
No more easy credit and loose lending standards for
years to come.
2008 Overview and 2009 Updates: #4
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“ ‘Underwater’ took on a new
meaning.”
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It used to be called “negative equity” and it
was relatively rare.
Now, one is “drowning” when the amount of
the mortgage exceeds the value of the
house.
This is not due to non-amortizing loans; it is
due to falling prices throughout the country.
Estimates are that as many as 20% of
homeowners are “underwater” during 2008.
2008 Overview and 2009 Updates: #4
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“ ‘Underwater’ took on a new meaning.”
2009 Update:
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Expect the problems to continue: perhaps as
high as 15 million households!
In Pennsylvania:
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Since property values have not dropped very
much in most PA cities, negative equity is a
relatively rare experience in the
Commonwealth.
Nonetheless, where negative equity conditions
occur, watch for defaults and foreclosures,
just like anywhere else.
The PA numbers will be smaller, but the pain
will be just as tough for those involved.
2008 Overview and 2009 Updates: #3
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“The federal government took an active
and historic role in the mortgage
markets.”
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First, Hope for Homeowners (FHA decides to
refinance programs to avoid foreclosure but
only to a small percentage in need).
Next, TARP funding (but not used directly to
bail out mortgage borrowers).
Then, the Fannie and Freddie rescue attempts
(the results are still not clear).
2008 Overview and 2009 Updates: #3
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“The federal government took an active and
historic role in the mortgage markets.”
2009 Update:
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Expect a continuing, active role for Treasury and
the Fed.
New administration may be even more activist.
Look for more attention to be focused on
avoiding foreclosures than on stabilizing the
financial system.
Also, $1 trillion “fiscal stimulus” plans abound …
In Pennsylvania:
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Weakening economy will exasperate problems in
mortgage markets: just announced 6.7% PA
unemployment figures.
Mortgage lending in Pennsylvania will return but
probably at a slower pace.
2008 Overview and 2009 Updates: #2
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“The nation continued to witness
declining house prices.”
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Falling house prices has to be the
biggest surprise (and most significant
problem) of the crisis.
The price/income and price/rent ratios
remain historically very high (see data
below).
Any new building and foreclosure sales
make things worse.
2008 Overview and 2009 Updates: #2
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“The nation continued to witness declining house
prices.”
2009 Update:
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Price/income and price/rent ratios are still too high.
Prices will not stabilize until inventories are
reduced (now at 11-12 month levels).
There is no evidence in the empirical data that the
bottom is near: sorry!
In Pennsylvania:
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Since PA housing markets tend to lag national
figures, expect greater losses than in previous
periods. More to come …
However, PA price changes will never be as
significant as in many other states.
2008 Overview and 2009 Updates: #1
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“Finally, we can welcome 2009 as
the ‘year of the thaw’.”
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This was CNN’s recent prediction.
However, the economic news has not
been good since the end of 2008.
Many experts continue to expect
(hope) for the beginning of a recovery
during the second half of 2009.
2008 Overview and 2009 Updates: #1
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“Finally, we can welcome 2009 as the ‘year of the
thaw’.”
2009 Update:
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There is no question that a thaw has begun in credit
and some mortgage markets.
However, there is a long way to travel down this road!
Even if credit spreads return to normal, housing
markets will take even longer to resemble normality.
In Pennsylvania:
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I expect the second half of 2009 to be much better for
PA housing markets.
We are fortunate that while a thawing in PA is
welcome, it is not as desperately needed as in many
other states.
However, if the general economy continues to decline,
“all bets are off.”
Jaffe’s Five “Big-Time” Predictions
This is the grande finale … 
 I am fairly confident about each
of the following claims and
predictions.
 However, only time will tell if they
are correct …
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“Big-Time” Prediction #1
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House prices will continue to fall
(despite our hopes and prayers to
the contrary).
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Evidence: the standard price/rent
and price/income ratios remain out
of line. (See next slide.)
Also: futures markets suggest
continuing lower prices.
Other Studies Predict Lower House
Prices in the Future
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From 2001-06, house prices rose 74%, yet
household incomes rose only 15%. (MSNBC, 2007)
From 1960-95, average rent/house price ratio was
5.0%-5.25%. By 1996, the ratio was 3.48%. (WSJ,
Jan 3, 2008)
From 2000-05, the ratio of house price to family
income rose 42% above the mean ratio for the
previous 25 years. As of Aug 2007, ratio was still
32% above the mean. (Goldman Sachs, 2007)
Fortune Magazine (Nov 7, 2007) compared current
price/rent ratios with 15 year historic averages:
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Orlando: Current 23.8 / Traditional 14.9
Miami: 27.2/16.0
Philadelphia: 18.6/12.5
Etc.
Thus, they reported that real estate markets were
poised to fall 20-35% over next five years.
“Big-Time” Prediction #2
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One turning point in the housing crisis will
be when the rate of foreclosures slows
down.
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Evidence: foreclosures have dramatically
weakened prices since they increase the
supply of housing units available on the
market.
Foreclosures began due to sub-prime
defaults, but now are being complemented
by households who are unemployed and are
being rejected by credit markets.
Sheila Bair (of FDIC) has persistently argued
for new governmental programs to stop
foreclosures. Watch for some developments!
“Big-Time” Prediction #3
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Another turning point will signal the
end of the housing crisis.
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Evidence: when house prices stop falling,
market confidence will quickly return.
After all, at that point, down payments and
equity build-up will no longer be at risk.
Also, this event will tell borrowers and
investors: “it is safe to go back in the
water.”
“Big-Time” Prediction #4
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Low or falling interest rates will lead
more to additional refinancing of
existing mortgages rather than to
new purchases.
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Evidence: the financing gains to current
borrowers have begun to stimulate a new
round of “refi” financing.
This is very good for current homeowners
but does not affect the real estate
brokerage industry directly.
Mortgage interest rates are important for
a housing recovery but less so than other
factors this time.
“Big-Time” Prediction #5
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Housing in Pennsylvania has its own, unique
characteristics.
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Low appreciation rates since the 1990s.
Low depreciation rates since 2006.
Significant lags in price changes compared
with other states.
Less risky borrowing practices.
A stronger state economy (despite some
weakness) than the national averages.
Finally, one of the best groups of REALTORs
and the best REALTOR association in the
country! 
Concluding Comments
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I hope these remarks have stimulated some
interest, new thinking and forthcoming
conversation (later today in small groups).
I hope it has not been too depressing!
2008 is likely to be the most difficult year in
real estate since the early 1930s.
2009 appears to be when recovery begins.
However, much depends on national politics,
the overall economy, and the inventory of
housing on the market.
Reminder: Local markets are never identical to
regional or national markets, but they are very
often positively correlated.
Q&A…
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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!