Written by John Lounsbury
Econintersect: The question asked in the headline is the title 0f an Economic Letter Economic Letter posted by William Hedberg and John Krainer of the San Fransisco Fed. They point out that inventories of houses on the market have been quite constrained even as house prices have risen significantly in many markets over the past year and a half. The authors of the letter suggest that the number of homes for sale currently appear to be “unnaturally low“.
Econintersect has taken a close look at the analysis presented by San Francisco Fed article.
Hedberg and Krainer point out that starting in the second half of 2012 the prices of houses and the inventory available for sale have been moving in opposite directions. They ask:
Why did the inventory-price correlation break down for an extended period when the housing market was rebounding in 2012?
Hedberg and Krainer concluded:
History shows a long-run relationship between house prices and the number of houses available for sale. Thus, current inventories of homes for sale are low given more than a year of house price appreciation. County-level data suggest that many homeowners are waiting for prices to rise further in their markets. Markets that have seen the strongest house price appreciation and job growth are the ones where for-sale inventories have declined the most.
The following reproduction of the graph above shows that the divergence sited has occurred eleven times in the past 40 years. The ten green boxes define the divergences that occurred with prices level or rising and inventories falling. The eleventh (red) box occurred during the Great Financial Crisis (GFC) and is the only divergence with movements opposed in direction to the current one.
The current divergence is of a form that has occurred on the average of once every four years. The current situation certainly does not represent anything unusual as implied by the Hedberg and Krainer conclusion.
There is an inference that can be drawn from the data. To make this inference requires an assumption:
- The housing market from 1976-2000 can be considered normal and can be extrapolated to represent what the 21st century housing market would look like if the housing bubble had not occurred.
This assumption clearly does not take into account any demographic shifts that have occurred since 2000 and the effects of economic damage from the GFC. Recognizing those caveats, we proceed.
The graph above has two trend line estimates by Econintersect. The indication is that the divergence in price and inventory is mostly the result of mispricing of housing and inventory is right where it should be.
However there a arguments that can be made that the extrapolations made are not realistic but may be too high. Some of the economic factors that could be argued are depressing the housing market from a linear continuation of the last quarter of the 2oth century are discussed below.
- One serious headwind for housing demand is student Debt, which is now comfortably above $1 trillion. This will have a significant impact on “borrowing power” for mortgages. An example of how this can happen was outlined 23 October in GEI News (NAR: ‘Missing Households’ Cost 200,000 Home Sales):
The existence of this massive debt load can be viewed as a repository of used credit that might otherwise be available for mortgage borrowing. What portion of this total removes credit otherwise available for mortgages? It is just a guess, but let’s say it is $300 billion (less than 30%). Also assume that a first time home buyer would borrow on average $150,000 and quick arithmetic gives a total of 2,000,000 possible additional homes sales ($300 billion / $150,000) that are inhibited by college loan debt.
- The aging demographic of the U.S. is likely to have a depressing effect on demand for homes and on home prices. Household formation among seniors is likely to be lower than for younger age groups. (Statistics to support this have not yet been located by Econintersect.)
- Underwater mortgages trap people in homes that they might otherwise sell and prevent them becoming buyers. This drag on the housing market is discussed by Hedberg and Krainer.
- Median real household income has been trending down in the 21st century and this is likely to have a repressive effect on house purchase demand.
- The trend line for inventory rises by 100% since 1976 while population has increased by only 44%. On a per capita basis the trend line in much too steep.
In view of all the depressive burdens on the housing market, the study by Hedberg and Krainer is missing the most obvious conclusion:
The available inventory for housing is logically at the most generous where it should be and more conservatively too high. The implication is that to maintain the general correlation that has existed historically, house prices must come down.
It is worthwhile noting that at least one other housing market analyst, Bill McBride, who has an outstanding record of tracking the market over the past decade, is expecting a 10% to 15% inventory increase in 2014. See his discussion at Calculated Risk.