Sunday, May 3, 2009

Housing Price Simulation

Okay, so here's the premise of the computer simulation. Take 65% of the BLS average weekly wages and apply them to the cost of basic home ownership. I have assumed that 1.5% of the price of the home is needed to pay property taxes, insurance, and miscellaneous per year. The rest is used to pay principal and interest on a 30-year conventional mortgage. This is a "what do you want your payments to be" simulation, since that is the society we seem to live in.

If two people are working, that works out to about 1/3rd of all income. How did I come up with that number? It simply did a good job of helping the model match reality (in other words, the red line most closely matches the black line in the chart below).




Note that there are two reasons that housing prices have increased over the years as far as the model is concerned. First, wages rose thanks to inflation. That meant that people could afford higher monthly payments. Second, interest rates have been dropping for decades. That allowed people to afford more expensive homes.



The following shows what happens when it is adjusted for inflation. From 1982 to present the computer model expected inflation adjusted prices to rise substantially due to falling interest rates, and they did.



So what went wrong? The computer model suggests we should be doing pretty good right now, but we're clearly not.

It is a "what do you want your payments to be" problem. Since housing prices were rising faster than overall inflation, housing prices were also rising faster than the cost to build the homes. Thanks to capitalism, that meant that more and more homes would be built. Eventually, there were just too many homes and everyone started to realize it. Oops! At that point, it stopped being a "what do you want your payments to be" problem and became a "how do I unload my home before it tanks to its true value" problem, or should have been anyway.

You will also note that the model expected falling prices in the 1970s, since interest rates were skyrocketing (and homes were therefore less affordable). That didn't happen either. People were scared of inflation and were buying up hard assets. It wasn't a "what do you want your payments to be" problem in my opinion. It was a "what do you want to spend your money on before it is worthless" problem. Using hindsight, 1979 was a bad time to be buying a home though (just like 1989 and 2006).

That's one way to look at the data, but here's a few more ways. The blue dot represents where we are now.



We have an unemployment problem right now. If people don't have jobs, then it certainly makes it harder to afford a new house. My simplistic computer model above cares nothing of unemployment and/or excess housing inventory though. Perhaps it could get a job at the National Association of Realtors? ;)



We also have low interest rates though. That should help in theory. However, as seen in the following chart something doesn't quite seem right.



Low interest rates AND high unemployment? Why am I in this "blue" hand basket and where am I headed? Japan?

Based on what I see here, stagflation does not appear to be imminent. May it never arrive. As a saver, I'd be just fine with that. On the other hand, we're clearly not out of the deflationary woods yet nor am I expecting a huge rebound in America's growth engine.

I turned bearish in 2004 based on the idea we were trying to borrow our way back to prosperity. I grow more permabearish with each passing year and/or with each passing trillion dollars of new debt. Oh sure, we'll probably get a recovery of some sort just like we did the last time. I certainly wouldn't bet against it. Where will we be in 10 more years though? Exiting the woods or burning them to heat our homes?


Worries Rise on the Size of U.S. Debt

The nation’s debt clock is ticking faster than ever — and Wall Street is getting worried.

Source Data:
Census: Median Home Prices (PDF)
St. Louis Fed: CPI-U
St. Louis Fed: Employment & Population
FRB: Selected Interest Rates

10 comments:

mab said...

Stag,

Why am I in this "blue" hand basket and where am I headed? Japan?.

As shown by the blue dots, we are clearly in uncharted territory. Check that thought. I just realized something. Now that you've actually charted the data, it's completely inaccurate for me to say we're in uncharted territory - even though we are.

Oh boy, now you've really done it. We're doomed.

To me, the over-arching problem is excessive and unpayable debt. Tens of millions of ordinary Americans were living like millionaires. They mortgaged their futures. The money leaves a slave, it comes back a master.

Stagflationary Mark said...

mab,

If it makes you feel any better, I had done those charts before. When I updated them, some of those blue dots were actually off the charts. No joke!

Those blue dots look a bit lonely, but if I had data going back to the Great Deppression I could probably give them plenty of buddies. Sigh.

Stagflationary Mark said...

One more thought...

If interest rates can remain tame AND oil remains well supplied AND we can work off some excess housing inventory AND we can think up a few million job ideas AND we can raise taxes relatively painlessly AND somewhat inflate our way out of our debt problems without resorting to hyperinflation then I might actually think housing prices might even look reasonable right now based on these charts. How's that for optimism? Anything is possible I suppose.

In any event, as of 2004 I'm done swinging for the fences. I'm more than happy walking to first base, assuming that the wild pitches don't bean me in the head that is. ;)

Stagflationary Mark said...

Yet another thought...

In 2004 I remember saying that I did not want to be a buyer of stocks with near record low unemployment. What would happen if unemployment reverted to the mean?

In order to be consistent in my reasoning, I should not wish to be a seller of stocks right now. Unemployment is quite high.

Perhaps permabearish isn't quite the right term. As of 2004, I've become permacautious. That's not quite the same thing. History may show that my behavior change may have been a mistake. Who knows? I doubt it will show that the timing was all that bad though. Without a job, it was only a matter of time before I stopped taking financial risks. If one must "panic", at least "panic" first they say. That's what it feels like most days. Since I am a baby boomer, perhaps some small part of me simply wanted to cash out before the older baby boomers did.

My gut still says we've got way too many restaurants but my gut isn't always right. My brain wants actual proof. Nothing related to the economy is that easy though. If we all had proof, the stock market would be risk free.

dearieme said...

A friend told me at the weekend that he's remortgaged his house - interest rates are so low, aren't they? - and used the cash to buy a flat in London for his son. Had he, he demanded, done the right thing?

Oh dear, oh dear.

Stagflationary Mark said...

dearieme,

Your anecdote gives me that same uneasy feeling I was getting in 2004.

It certainly backs the theory behind my housing price simulation.

This is a "what do you want your payments to be" simulation, since that is the society we seem to live in.

Anonymous said...

Goldman Sachs Group Inc. reaped more than $100 million in trading revenue on a record 34 separate days during the first three months of 2009, up from the previous peak of 28 in last year’s first quarter.

For December, there were 10 trading paydays bigger than $100 million, the New York-based firm said today in a filing with the U.S. Securities and Exchange Commission. The first- quarter number was almost double the total for all of 2005.

Goldman Sachs, which took $10 billion from the U.S. Treasury’s bank-rescue program in October, reported a record $6.56 billion in revenue from trading fixed-income, currencies and commodities in the first quarter. David Viniar, the company’s chief financial officer, said on April 14 that the trading success was due to “favorable competitive dynamics,” wider margins and higher volatility.
http://www.bloomberg.com/apps/news?pid=20601110&sid=a7HGVAn8w73Y

Your tax dollars at work blowing a new bubble Mark. I think when the dollar collapses under the weight of government spending and FED money printing maybe the new currency should have IN GOLDMAN SACH'S WE TRUST What do you think has kind of a nice snappy sound to it doesn't it?

Kevin

Stagflationary Mark said...

Kevin,

"David Viniar, the company’s chief financial officer, said on April 14 that the trading success was due to “favorable competitive dynamics,” wider margins and higher volatility."

I'm thinking that perhaps all these Trading (for Dummies? ;)) courses might be helping Goldman Sachs out a bit lately, lol.

Not a month goes by when Ameritrade isn't pushing more educational information towards me in an effort for me to compete with Goldman Sachs of the world on a more level playing field, lol.

This month...

"Technical Analysis Night School"

"Get an overview of charts, trends, risk management and more"

Goldman Sachs, watch out! I'm gunning for you! Hahaha! Sigh.

I haven't made a trade in years, unless you count the TIP fund I buy in my IRA automatically each month as part of the free dividend reinvestment plan. Good luck to Goldman Sachs if they can extract much trading profit out of that. Good luck to Ameritrade as well, since I'm not exactly racking up trading profits for them either come to think of it.

flin said...
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Stagflationary Mark said...

SPAM deleted.