On Monday, October 3, 2011, economist Karl “Chip” Case, recently retired from Wellesley College, spoke at the UMass Lowell Inn & Conference Center as part of this year’s Moses Greeley Parker lecture series. Along with Robert Shiller and Allan Weis, Case developed the Case-Shiller index, a widely respected and quoted quarterly report on changes in home prices across the United States.
After completing his service in the United States Army back in the 1970s, Case came to Boston to pursue a graduate degree. Along the way, he purchased a home and saw its value rapidly increase. This got him interested in home prices but he found that while there was data for individual homes and median sales price calculations, there were no data that accurately tracked changes in home sales. He set out to solve this omission by constructing a model that, using sales records obtained from registries of deeds, tracked changes in sales prices of the same house over time. This is the basic methodology of the Case-Shiller index.
In Monday’s talk, Case made some general comments about the housing market. Prices are volatile, he said, and there is a great deal of inertia, meaning that when prices go up, they will go up more than they should (based on people’s expectations of continued increases) and that the same phenomenon occurs when prices go down. This inertia “is not a characteristic of an efficient market.” Case also said that there is “downward stickiness” which means that even though values go down, owners will hesitate to lower the asking price for longer than they should; that owners set an artificial “floor” that’s not based on the market but on how much they paid for the house or how much they owe on their mortgage.
Case then sought to explain how our present housing crisis came about. From 1975 to 2005, US national housing prices never went down. Prices in New England might have slumped, but whenever that happened, prices in another part of the country went up, so there was a cancelling effect that allowed the countrywide prices to continue upward. This led to a feeling that you couldn’t lose in the housing market, that housing prices would always go up. This attitude skewed all the models of default rates. The big national lenders like Fannie Mae, Freddie Mac, Countrywide and others used a “huge set of data that showed constant price increases.” Case said that data made loans that now look “stupid” look not so bad at the time they were made.
Despite forty years of constant increases in national home values, prices fell 33% nationally when the bubble collapsed. In 1995, the value of owner occupied housing in America was $8.1 trillion. By 2000, that value had risen to $12.1 trillion, an increase of $4 trillion. By 2006, that value had risen to $22.9 trillion, a $10.8 trillion increase in just six years. But by 2010, that value had dropped to $16.5 trillion which constituted a loss of $6.4 trillion in value.
Case was pessimistic about the future of housing. He said that Fannie Mae, Freddie Mac and the FHA ensure 90% of all home loans in America. They all continue to carry bad loans on their books, not at their current fair market value but at their face value which means that they have huge unrealized losses. With Congress now determined to privatize these agencies and to basically get the Federal government out of the home mortgage insurance business, Case predicts that the real cost of obtaining a mortgage in the not too distant future will increase substantially. He added that if Congress were to simultaneously eliminate the income tax deduction for home mortgage interest and property taxes (as many now advocate in the name of deficit reduction) on top of privatizing the home mortgage industry, it would be a devastating blow to our nation’s already moribund housing market.
Case, who will be testifying before the US Senate finance committee today, went on to say that perhaps the biggest problem now is that we have lost the housing sector as an instrument of monetary policy. Historically in a recession, interest rates go down which causes housing to go up which energizes the economy and leads the recovery. That’s not happening this time. Interest rates can’t get any lower than they are today but housing shows no signs of life. In January 2006, for example, there were 2.37 million housing starts (new houses). From 1952 until 2006, the number of housing starts went below 1 million in only 22 months of that 54 year period. We have now been beneath 500,000 housing starts for 34 consecutive months, something Case said was “unheard of.” Nationally, we are not producing new units because for every new one that is built, an old one is torn down. Case said the housing sector is a “nightmare” and that there is “not a single sign it’s coming back anytime soon.” The end result of all this, according to Case, will be to cause a “fundamental change in the American Dream” of home ownership as we proceed into the future, meaning I think that fewer and fewer Americans will have the opportunity to own their own homes.