Housing Bubbles: Economists ‘Cart Before The Horse’ Problem
Hugh Pavletich FDIA
Performance Urban Planning
Christchurch
New Zealand
July 6, 2009
Within this recent New York Times article Fair Game - So Many Foreclosures, So Little Logic , a report from the United
States Comptroller of the Currency, indicates that there is promising data regarding loan modification trends in the
United States.
However – research by Assistant Professor Alan M White of the Law School at Valparaiso University, of 3.5 million Sub
Prime and Alt A Wells Fargo mortgages written between 2005 and 2007, seems to paint a different picture – indicating
that modifications are declining.
The average monthly payment adjustment for modified mortgages was found to be just $173. This would suggest the loan
modifications are a “sideshow” – at best.
In June, the data show almost 32,000 liquidation sales: the average loss on those was 64.7% of the average $223,000 loan
balance – or a loss of $144,000 each – up from 56.1% loss of the loan balance last November and 63.3% in February this
year.
Belatedly – international discussion is occurring of the New Zealand and Australia housing markets and the Banking
institutions ability to cope - refer Analysis of Australian Bank Fundamentals -- Seeking Alpha
Housing bubbles are a local issue - as clearly illustrated by the Annual Demographia International Housing Affordability
Surveys (2009 5th Edition) of the 265 major urban markets of the 6 English speaking countries and the Harvard University
Median Multiple Tables.
The latest Demographia Survey illustrates that of the September Quarter last year, the Median Multiple nationally of the
major urban markets overall were – the United States 3.2; Canada 3.5; United Kingdom 5.2; Ireland 5.4 with New Zealand
5.7 and Australia 6.0.
If housing exceeds three times annual gross household income – it is in bubble territory.
For example – housing prices bubbled out to around 9 times annual household income in California (the ‘epicenter of the
Global Financial Crisis), while there were no bubbles in Texas, where housing stayed at around 2.5 times annual
household income.
To maintain market share – financial institutions mortgage lending had to reflect the Median Multiples of the housing
markets they competed in.
The size and structures of the mortgages simply had to reflect the Median Multiples (house prices divided by the
household incomes) supporting them.
To illustrate – it would appear (from this City Data - LA sample insured mortgages - refer bottom of page) that average
conventional insured mortgages in Los Angeles during 2007 was $403,000 – with refinancing mortgages around $430,000.
Indeed - Herb Greenberg in Mortgage Mess illustrates how lending in California ballooned out to 11 times annual
household earnings, where for example those with a gross annual household income of $90,000 were borrowing a million
dollars.
In contrast – let’s consider Houston (City Data - Houston – sample insured mortgages - refer bottom of page and Houston
Association of Realtors latest Monthly Report ) where it would appear that during 2007 average conventional insured
mortgages were $143,000 – and refinanced mortgages $139,000.
It appears that financial institutions in Australia are currently lending 5 to 7 times annual household earnings and in
New Zealand, in the order of 4 to 5 times annual household earnings. These are well above the historical norm and
current affordable markets, where housing does not exceed 3.0 times household earnings, requiring mortgage debt loads of
around 2.5 times annual household earnings.
To date – economists, property commentators and the media generally have failed to ask two extremely simple questions –
Firstly - why were the sizes of the mortgages in Houston substantially lower than they were in Los Angeles and other
bubble markets globally?
Secondly - what are the real costs and consequences of lending in to housing markets, where there are artificial
regulatory scarcities in place, as a necessary foundation for speculative bubble behavior to get underway?
Put simply – they could not write $400,000 mortgages on $150,000 houses in Houston.
Yet – too many economists “put the cart before the horse” in suggesting the finance sector is responsible for the
housing bubbles in certain markets globally – when this is clearly not correct. The finance sector simply provided the
debt finance “fuel” – investors and speculators the rest with often ‘bubble equity”.
Clearly - Local Government failure put in place the artificial scarcities, allowing speculative bubble behavior to get
underway.
ENDS