Friday, January 8, 2010

Characteristics Of The Housing Bubble

Given the incredibly outsized intervention efforts in the residential real estate market, I think it is important to examine some dynamics of the real estate bubble.

Here is a chart from the 12/15/09 Contrary Investor commentary that I believe is interesting, as it depicts some underlying residential real estate fundamentals. It shows the equity and mortgage debt situation. The underlying data is from the Federal Reserve Flow of Funds:

As far as real estate prices are concerned, I would like to show two charts, both from the CalculatedRisk blog:

The first chart was posted on 12/21/09 and is the LoanPerformance Price Index from 1976:

Next, a chart posted on 12/29/09 showing the LoanPerformance Index as well as Case-Shiller, from January 2000:

As others have commented, it appears as if the overall intervention efforts are aimed at reflating (or to re-inflate) the housing bubble. Conventional (investment) wisdom has held that reflating a burst bubble is impossible.

However, I think given the tremendously outsized intervention efforts in housing, we are truly in a unique situation. I don't believe there has ever been such a large intervention effort in our country, at least in the last 150 years. Depending upon how one would measure such intervention efforts, it might even be among the largest interventions in world economic history.

A casual observer might assume that such an outsized effort would be destined to be successful. However, (economic) life is not that simple.

From an "all things considered" standpoint, I don't believe the residential real estate bubble has actually burst. It appears to me that it has somewhat deflated. I base this view on a variety of fundamental and technical factors.

Assuming this view is correct - that the residential real estate hasn't popped - the implications are immense. I think it is likely that one of two possibilities will occur from here, and each could happen in a relatively rapid fashion. The first possibility is a "successful" reflation of the residential real estate market, with accompanying economic activity. The second possibility is a collapse of the residential real estate market with accompanying economic repercussions. As to the path real estate will travel from here - my previous writings on interventions, bubbles and real estate indicate my thoughts on the subject.

If a "successful" relation occurs, one is led to wonder as to the characteristics of such a "successful" reflation of the real estate bubble. Among other critical questions is how long would such a reflation last?

I think it very important to note the quality and durability of the economic activity that occurred in the first phase of the bubble, which peaked in 2006. Can one hope for any better outcome during a subsequent reflation?

These issues are critical to the concept of Sustainable Prosperity, of which I have previously frequently commented.

SPX at 1137.37 as this post is written

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