patrick.net

"I’m wondering how many of you have ever had to sit down and write a check for $10,000 and mail it to the IRS"

Yes, for us employees, about 1/3-1/2 gets taken out of every pay check. How lucky are we?! ;-)

Zephyr, for a different perspective on deflation, read my post Nov 22, 5:55pm in this thread.

Nov. 22 (Bloomberg) -- Inflation outside of food and energy will probably accelerate next year, prompting the Federal Reserve to raise rates another three-quarters of a percentage point, according to a survey by the National Association for Business Economics.

Not everything is as rosy as some would have you believe...

http://www.usatoday.com/money/economy/2005-11-22-wages-1a-cover-usat_x.htm

From a Cincinnati rag...

"Greater Cincinnati/Northern Kentucky and most housing markets across the country are safe from a feared investment bubble, according to the top forecaster for the National Association of Home Builders."

Oh gee a "top forecaster"! I guess we're all wrong then, huh?

Oh gee a “top forecaster”! I guess we’re all wrong then, huh?

A nameless top forecaster?

I'm waiting for troll brothers to start advertising....buy one McMansion, get one free. :)

.........but then again, it's probably still not worth it.

"A nameless top forecaster?"

Yes, but it is "...according to THE top forecaster", so there can only be one ;-).

Based on listings from realtor.com for NYC tri-state area, number of homes for sale on average have been increasing >100% annualized over the past several weeks. Some areas such as Paramus, NJ are close to 200%. Not what I would expect during fall/winter and with holidays right around the corner.

You californians might want to read the piglet book...especially those in sacromento http://tinyurl.com/bn8j8

Alot of good information on this site as far as taxpayer protection
http://www.cagw.org/site/PageServer

“Second, the re graph is purposely linear and not log-normal or you could see that current returns are far from unprecedented.”

This would certainly make the exponential increases look less dizzying, wouldn’t it?

Self-serving statistics, Lesson #47: If you don't like what the graph is showing you, arbitrarily change the scale and/or data until it does. If that doesn't work, try discrediting the graph-maker.

Problem solved!

"Yes, we’ve all heard the story before – if prices are falling, consumers stop buying because they expect the prices to be lower if they wait, blah, blah, blah. This is nonsense. We all know that the latest electronic gadget will be cheaper next month, we all know that this season’s must have outfit will be 50% off in the Spring, we all know that Christmas gifts for the kids will be cheaper in January. Still, many of us are compelled to buy the costlier product precisely because we want it NOW!"

"All these under-consumption theorists should be required to spend several weekends with their five-year old nieces and nephews at Toys-r-Us to teach them a little about the effort involved in deferring instant gratification."

LOL - well put, Frank!

As a compulsive saver and value shopper, I totally agree with you that deflation would be better for us and probably better for the economy in the long run, by quickly wringing out excesses, favoring saving over consumption, etc.

Here's the problem: The Fed/government doesn't share that view, nor do the powerful corporate & banking interests who wish to see the lucrative debt cycle continue. In fact, the Fed has made deflation Enemy #1.

Say hello to "Helicopter" Ben :-( ....

Deflation is great for the consumer until he loses his job and has no money to take advantage of the lower prices.

While deflation makes everything cheaper in nominal terms, the real costs do not decline by the mere strengthening of the currency. If deflation is very small (under 1%) it can be tolerated without much adverse effect on the economy. However, meaningful deflation creates an environment where investors are better off holding their cash idle - rather than investing it to receive fewer dollars later. Job growth and output growth then grind to a halt, and this puts further downward pressure on prices. Prices will decline faster than wages, and profit margins disappear, leading to layoffs and shutting of production to escape the cost squeeze, and to conserve cash. Economic decline continues as the deflationary spiral accelerates, and people hoard cash rather than invest in growth.

Periods of mild deflation can be somewhat prosperous, but not as prosperous as they would have been without deflation. The second half of the 1800s was such a period. It did have many years of economic difficulty, but also had prosperity with mild deflation. Technology lowers real costs and this enable virtuous deflation. However, deflation reduces the benefit of investing, and eliminates the imperative to keep the money working. This negative effect overpowers the system and undermines the economy.

Going back to the Shiller graph discussion… I don’t like log-normal scales. I prefer linear graphs. They are more intuitive. Log-normal graphs flatten everything, but the problem is that it is already too flat for the years prior to 1990. It’s a data issue – not the scale.

"Here’s the problem: The Fed/government doesn’t share that view..."

As you imply, inflation is their meal ticket. I was just pointing out the popular misconceptions about deflation. And boy, are they popular! It's amazing how well their propaganda machine has worked over the decades.

If you are saying that it will never happen, you are in good company. Still, I wonder about Japan. ;-)

HARM, On some of your earlier points:

The GDP deflator is a more stable and broader measure of the monetary phenomena of inflation. The CPI is intended to measure the impact on consumers only. Because it only includes consumer goods it is not really a true measure of the general price level.

As for the old years, the data is sparse and I agree that using a better deflator is of little significance. As you said, garbage in, garbage out.

There are pockets of good data out there for the old years for selected localities, but not on a consistent basis with each other, and privately held or proprietary. In other words, not generally available.

Thirty years ago I conducted a study of real estate prices using some pretty good data spanning the 50 years from 1920 through 1970. It was actual same home type data by year, by neighborhood, for about 40 distinct neighborhoods in a major SMA. This home price data was very proprietary to its source, but they allowed me to use a derivative of the data (indexed values, not the raw prices). This was actually just as useful because I was measuring the changes over time and differences between neighborhoods. In addition, I already knew the latest data points, so I was able to calculate all of the actual values anyway.

I was exploring and measuring the determinants of value and the determinants of changes in value. I was testing various common ideas and seeking new ones. I had lots of data. I also had several economics students assisting me in running hundreds of regression scenarios with all manner of data combinations that we could think of and obtain (incomes, interest rates, distance to employment, etc).

The purpose of the study was to evaluate the market realities for the benefit of improving residential investment strategy. After finishing the study I decided that I did not want to share what I had learned with anyone. Selfish, for sure - but I saw a competitive advantage that would be worth more to me than any recognition that could come from publishing the results. What I learned has helped me tremendously as an investor.

And I am not interested in selling books. When you sell books you don’t have to be right – you just have to sound right. You must be persuasive. As an investor being persuasive is not important, I have to actually be right.

If you are saying that it will never happen, you are in good company. Still, I wonder about Japan.

Not saying it can't happen, frank, just that ol' Ben & Co. will do everything in their power to prevent to try to stop it. How successful they will be remains to be seen.

deflation is no worse than inflation..........if we do have severe inflation, the ones who will get squeezed the most will be those who overleveraged themselves with debt. Companies will not pay their workers more, they are already cutting costs by outsourcing.... Inflation will only cause more people to default on credit........deflation on the other hand will put more money in the pockets of those who are indebted, not that they'll be smart enough to pay off their debts, but may give them a chance......either way, the outcome will not be pretty........but if you ask me, I have to say that deflation would be a better outcome.......let everything else deflate along with house prices.

What will happen to the homes of people who are foreclosed on? The same thing that happens to the homes of people who die. Someone else buys it. And death is more prevalent than foreclosure.

Allah, A brief study of economic history would show you that deflation is far worse than inflation. Even if you do not understand the theory, you should be able to see the difference in the results.

What will happen to the homes of people who are foreclosed on? The same thing that happens to the homes of people who die. Someone else buys it.

Someone else does buy it, but usually for a much cheaper price.

Allah, A brief study of economic history would show you that deflation is far worse than inflation.

You cannot always use history as a guide....during the great depression, things were alot different than they are today. I am not an economist, but I do know that it would take higher income to support high inflation and the companies in this great country of ours will not pay the price for american workers. Sure....deflation is not good for companies, but do you think inflation is? If people cannot afford to support themselves, they will have to find another job and/or move to a community that has cheaper living expenses. Also, people will cut back on spending and that can't be too good for companies either.

Thirty years ago I conducted a study of real estate prices using some pretty good data spanning the 50 years from 1920 through 1970. It was actual same home type data by year, by neighborhood, for about 40 distinct neighborhoods in a major SMA. This home price data was very proprietary to its source, but they allowed me to use a derivative of the data (indexed values, not the raw prices).

...The purpose of the study was to evaluate the market realities for the benefit of improving residential investment strategy. After finishing the study I decided that I did not want to share what I had learned with anyone. Selfish, for sure - but I saw a competitive advantage that would be worth more to me than any recognition that could come from publishing the results.

Zephyr,

As far as the GDP being a better/broader measure of inflation, you may or may not be correct, although some believe it overrelies on substitution and thereby understates the impact of real price hikes on the consumer.

I certainly understand not wanting to reveal valuable proprietary research you're currently using. But without knowing what it reveals, it's hard to debate you over it's merits relative to Shiller's methods & data.

How about this: if you were to re-plot Shiller's RE price graph using the GDP deflator as an index, and substituting your own price data, what would be the approximate result?

Zephyr writes:

“Deflation is great for the consumer until he loses his job and has no money to take advantage of the lower prices.”

Deflation, to the extent that it is a corrective process, will temporarily bring higher unemployment rates as factors shift from mal-investments to more efficient allocation of resources (e.g. who needs all those Real estate agents!). The new jobs created will be more permanent because they are not the result of some inflation-induced bubble.

“While deflation makes everything cheaper in nominal terms, the real costs do not decline by the mere strengthening of the currency.”

Real costs do not decline by the mere strengthening of the currency, but because of the more efficient allocation of resources (i.e. more efficient production) - something that under a price targeting, inflationist economy has historically been proved impossible to achieve (repeatedly).

“…deflation creates an environment where investors are better off holding their cash idle”

I think I sufficiently covered this in my prior post. Let us just agree to disagree, then :-).

“…deflation reduces the benefit of investing, and eliminates the imperative to keep the money working”

Huh? You are assuming that there are no good investments in a deflationary period? That is not historically supported, and seems counter-intuitive. An economy that is good for both consumers and businesses, after all, has to be a good place to invest.

"But it strikes me that even the most stupid sheeple will look at the fact that that shiny new car or toy ( like the bike ) keeps getting cheaper then it’s best to wait"

It depends on individual circumstances, but if this were a general rule then I would never own a computer, iPod, Palm pilot, digital camera, TV, bike, or one of a dozen other toys that become continuously cheaper over time.

Necessity is only one factor. I think you grossly underestimate the desire to consume now as opposed to later. We all want to enjoy the fruits of our labors at some point. It is ridiculous to think that in a deflationary environment, everyone will take their money to the grave with them ;-).

The value of looking at price data such as the Shiller graph is to show how the real price has changed over time. It would be better to look at the total cost of ownership rather than the price. However, that is not as easily portrayed. Working with price data we can take the analysis to a more refined level than mere price. Mere price ignores changes in the average house. How much house do you get for your money?

Over the last 50 years the average home has increased in size dramatically. This size growth is an important factor in considering housing price changes over time. In addition, homes built or remodeled today include a much higher level of luxury finishes and features. It is hard to calculate the value of these upgrades with confidence. However, we can calculate the cost per square foot to see how housing costs have changed over time on an apples to apples basis relative to size.

I have done a rough calculation of the inflation-adjusted median home price per square foot. I used the U.S.A. median prices, median home sizes and the GDP deflator for the last 40 years. I have stated the values as an index where 1965 equals 100%. Here is the result:

1965 100%
1970 135%
1975 118%
1980 134%
1985 131%
1990 157%
1995 127%
2000 152%
2005 197%

Housing prices per square foot have roughly doubled. It is interesting to note that inflation-adjusted household incomes have also roughly doubled since 1965. Interest rates were rising or high during the 1970s and 1980s suppressing price appreciation, and the declining and more favorable interest rate environment of the last 20 years has accelerated housing prices. Interest rates today are comparable to what they were in 1965. The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years. Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years. Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

Housing is not more affordable...........the only reason it seems that way is because of the looseness in credit standards and the crazy types of mortgages that are available. If we didn't have these two elements, it would be no more affordable than it was back then....and there would not be a bubble.

the percentage of households that own the home they live in is now at an all-time high.

...another thing,.......the percentage of ownership statistic is totally flawed. Someone who took out a 0% down, IO ARM cannot reasonably be called a homeowner........and I know when this crash plays out, the percentage of homeowners(as they like to call it) will drop lower than it was before the boom due to cash out refi's and spending on investment properties.

R. Patrick, You are spot on with your comment that deflation would cause some deferral of purchases. They would not fully stop. That is not possible, but it is a well established fact that consumers react to expectations about future prices. When prices are expected to rise significantly consumers rush to purchase if they can. This is in fact one of the symptoms and a contributing cause of bubbles. They (we) also tend to wait on some purchases when we expect prices to fall. Many on this board are in fact advocating that very behavior regarding home purchases.

It is certainly true that not all purchases can be deferred or accelerated. But for those that can be consumers do respond to expectations of future price changes.

You are right that even the most stupid sheeple will see the benefit of this strategy and act on it to some extent.

Allah, You say that easy money is the reason for people being able to buy. OK, I am only saying that it is more affordable, not why. You are correct in observing that easy money is a factor in making housing more affordable. Take away the easy money and the affordability declines.

As for financing, whether you have no debt or 100% debt you do own the house. You may have only a small stake in the house but it’s yours. This does raise questions about risk factors and distribution of risk.

As for financing, whether you have no debt or 100% debt you do own the house. You may have only a small stake in the house but it’s yours.

That stake may be below zero....in which case the house owns you.

The value of looking at price data such as the Shiller graph is to show how the real price has changed over time. It would be better to look at the total cost of ownership rather than the price. However, that is not as easily portrayed. Working with price data we can take the analysis to a more refined level than mere price. Mere price ignores changes in the average house. How much house do you get for your money?

...Housing prices per square foot have roughly doubled. It is interesting to note that inflation-adjusted household incomes have also roughly doubled since 1965.

Hmmm... I smell a 'hedonic' adjustment coming.

Over the last 50 years the average home has increased in size dramatically. This size growth is an important factor in considering housing price changes over time. In addition, homes built or remodeled today include a much higher level of luxury finishes and features. It is hard to calculate the value of these upgrades with confidence. However, we can calculate the cost per square foot to see how housing costs have changed over time on an apples to apples basis relative to size.

Not so sure about that "much higher level luxury finishes and features" being the primary reason for driving up prices, though you have a point about homes being about 50% larger on average than they were 40 years ago.

Even so, here's the problem with this logic:

1. I don't see how/where you're arriving at the conclusion that HH incomes have gone up at roughly the same rate as housing prices, especially in the coastal states. Every reliable measure of HH incomes and prices says otherwise, even the BLS (who have reasons to want to show income growth). If switching from the CPI to GDP deflator is alone responsible for this result, then this convinces me that the GDP deflator is an even WORSE method of measuring inflation. Clearly, incomes are lagging behind RE prices, or affordability rates (even with exotic financing available) would not be so low, nor would record numbers of households devoting record high %s of incomes to service mortgage debt.

2. Newer houses being built are significantly larger than they used to be, yes. This still doesn't explain why resale prices on older existing homes (with less square footage) have also gone up far faster that rents, inflation and HH incomes in recent years.

3. People may be buying bigger houses than before, and they may or may not have more "features" (whatever that means), but such hedonic "quality improvements" don't in themselves explain why prices have risen so high so quickly. Today, my computer has tons more "features", more RAM, CPU, storage capacity, speed, etc. than it used to 5 years ago, but it hasn't doubled or tripled in price. Housing, like practically all consumer commodities, gradually improves over time, but that alone doesn't lead to higher prices.

The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years.

Right. Except that even CAR/NAR admit housing affordability is actually at its LOWEST level in 18 years.

Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

With median home equity per household (a better measure of "homeownership" than how many people have taken out an NAAVLP special) at historic lows of around 55%, this conclusion is highly questionable, if not flat out wrong. Let's rephrase it for better accuracy:

Not surprisingly the percentage of households that owe record levels of mortgage debt is now at an all-time high.

Frank, The key to evaluating the impact of deflation is the magnitude of the deflation. Mild deflation (under 1%) will work fine, but anything much higher leads to a deflationary contraction, under-investment and rising unemployment. Those who keep their incomes will benefit as prices fall faster than incomes. However, in the aggregate, real incomes will decline if deflation is more than mild.

Falling incomes lead to falling sales, and further unemployment… A death spiral.

Extreme inflation can also cause severe problems. However deflation of 5% annually is more destructive than inflation of 10% annually.

In other news, a recent AOL survey concluded that only 30% of participants think we’re in a bubble.

Well that only proves my theory that at least 70% of AOL users are ignorant.

It's funny how they say the ownership rate is about 70%

HARM, You disagree with the notion that higher luxury features are the primary reason for higher prices. I do too. And I did not say they were. I did NOT include them in my calculations. I only noted them because they are a real (and perhaps material) consideration left out of my calculations. There are no hedonic adjustments in my data.

As for the average household income, compare the prices per square foot to whatever income measure you like. You will get substantially the same result if you do so correctly. We can debate the precision of the income and inflation calculations, but that will only yield minor adjustments.

You suggest that inflation has been higher than I used, and that inflation-incomes have grown less. OK. Higher inflation factors will make the old years look more expensive per square foot, but will be offset by higher inflation-adjusted incomes back then. So the relationship will barely change. It doesn’t really matter what inflation index you use as long as you apply the same index to the numerator and the denominator (prices and iIncomes).

Allah, You said "Well that only proves my theory that at least 70% of AOL users are ignorant."

At 70% AOL users compare favorably to 95% among the general public.

HARM, Size of home is not a hedonic measure. It is a quantity of the good, like two gallons instead of one gallon. Do you really think that in the same housing development you can buy a 3,000 square foot home for the same price as a 1,500 square foot home of the same quality and features under normal conditions? I know from your prior posts that you are smarter than that.

Home prices in California have gone up by much more than the national average. Incomes in CA have not.

Like all assets, some appreciate more than others. Compare Toyota stock to GM stock…