Housing Prices And Wealth Loss

US home prices are down again.  The Case-Shiller home price numbers are pretty grim:

This leads naturally to wondering about the impact of such a massive loss of homeowner wealth.  But my friend Randy Pozdena, who blogs occasionally over at The Ornery Economist, offers these insights:

The Case-Schiller index is not the one I would use to measure wealth effects.  Although the indices attempt to crudely approximate a “same-home sales” protocol, in practice, they do not control for either within-region property location or distressed/thin market sale nature of current transactions.  I had the opportunity recently to work with a mass appraisal consultant (the folks who help assessors value properties for tax purposes) who showed me some GIS plots of recent vs. historical sales patterns.  It is clear that:

1.  The spatial pattern of sales is very different.  There are virtually no sales in the traditionally-high value subareas of large regions (e.g., Santa Monica within LA metro, or SF or Marin counties within the SF Bay Area). The transactions in these regions are dominated by foreclosure sales in places like Solano County, etc.

2.  The “market prices” being captured are not adjusted for illiquidity/thin market discounts.

Thus it is very problematic to, in effect, mark-to-market a whole metro area’s housing stock and then extrapolate from this to a one-to-one impact on wealth.  Doing so ignores the self-selectivity of sales and does not correct for illiquidity discounts.  To some degree, the problem is analogous to the one caused by the highly-flawed, FASB 157 mark-to-market rules as applied to business accounting in the current market.  Everyone recognizes that the poor language of this rule caused excessive mark-downs of assets that clearly would have higher value if trades could occur.  FASB at least recognizes it screwed up and has fast-tracked FASB 157-d to better value thin-market transactions.  (See the link below.)

But measuring the true trends in the market value of housing is further complicated by the legislation that was passed in 2008 that changed the ”exercise price” of an owner’s mortgage put option.  It did so by exempting 2006, 2007, and 2008 mortgages from the traditional IRS treatment of the abandoned loan value as “income”.  This has caused a “bubble” of walk-aways and, in turn, greatly enlarged the dominance of lenders (as opposed to owners) as sellers of homes with “underwater” mortgages.

This, in turn, enlarges the observed illiquidity discount and price depression.  As the Ong, Neo and Tu (2008) analysis of the so-called disposition aversion effect has shown, “lenders [selling foreclosed homes] may not act in the best interest of the foreclosed owners to get the best price possible [relative to owner-sales].”

With FASB 157 breathing down their necks, banks have an even greater incentive to push for a transaction with less regard to price.

I would add that the Case-Shiller 20-city composite is just that: a composite of 20 cities.  The smaller cities and rural areas are not covered.  They had less boom, and now have less bust.

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Comment by jlounsbury59

2009-02-28 16:25:48

Bill, how would you trade off the competing digressions from the Case-Shiller numbers. You propose that houses outside of the composite-20 markets may have had a smaller price drop. Countering that you suggest that foreclosure sales may represent too large a drop to represent the entire market. You also suggest that illiquidity discounts are not being recognized in reported surveys.

Can all this be sorted out as to how much wealth is actually being lost? Or is your conclusion that the wealth effect can not be accurately assessed in a quantitatve way??

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