Tuesday, February 28, 2012

Checkmate: The New York Fed as Totally Missing the Housing Bubble

In November of 2011, I wrote a letter to  Simon Potter, Executive Vice President and Director of Economic Research Federal Reserve Bank of New York. It said in part:

I must commend you on your very honest report on the failure of the New York Federal Reserve to detect the housing crisis and Great Recession. However, I find it curious that you singled out Nouriel Roubini for warning about the dire economy, but that you did not mention the Austrian School of economics, which seems to have been out front as far as warning about the crisis. 
More specifically, my warnings, about the housing market and the Great Recession, I believe can be matched up against any other forecaster. I provide a link to my response to your post, which outlines my reason for this belief: http://www.economicpolicyjournal.com/2011/11/federal-reserve-admits-it-was-complete.html.....

Mr. Potter responded:
 Mr. Wenzel:Thanks for the link. I will take a look. Simon Potter    FRBNY

Mr. Potter apparently forwarded my email to Richard Peach,  Senior Vice President Macroeconomic and Monetary Studies Function Federal Reserve Bank of New York. I specifically called out Peach and co-author Jonathan McCarthy in 2004 at the time they wrote a paper, “Are Home Prices the Next “Bubble”? They concluded there was no housing bubble.

In part, after detailed analysis of their errors, I wrote at the time of the McCarthy-Peach paper:
The faulty analysis by Federal Reserve economists McCarthy and Peach may go down in financial history as the greatest forecasting error since Irving Fisher declared in 1929, just prior to the stock market crash, that stocks prices looked to be at a permanently high plateau.
On November 30, 2011, Mr. Peach responded to me after receiving the forwarded email from Mr. Potter:

Dear Mr. Wenzel,  
Simon Potter forwarded to me your comment on his recent post on the Liberty Street Economics blog. As you refer to my paper with Jonathan McCarthy quite extensively in your comment, I wanted to take a moment to respond.  
If I understand your comments correctly, you indicated that you warned that there was a housing bubble in 2004 and 2005 under a pen name, and then again in 2008.  This suggests that you thought the 2004 level of prices were in bubble territory, whereas we though they were supported by fundamentals.  We did not conclude in our paper that home prices could rise another 35% to 40%, which they did, and still be supported by fundamentals.  
I would like to refer you to the following chart which plots the average FHFA home price by state for 2004 versus the level of 2011Q2.  You will note that in most states, as well as for the nation as a whole, recent levels of home prices remain equal to or slightly above the 2004 average level. There are some notable exceptions, in particular Florida, Nevada, California, and Arizona.  
Of course, prices may fall further.  But as it stands at the moment, your call in 2004 that the level of home prices was in bubble territory does not appear to have been correct.  
Dick Peach 
This morning, I sent him the below email:
 Dear Mr. Peach, 
I have other questions with regard to your ingenious argument that calls  Florida, Nevada, California, and Arizona "exceptions". California? Florida? 
However, you yourself seem to draw the line at the 2004 national price level. The Standard & Poor's/Case-Shiller home-price index out this morning now shows that prices are, at best, at 2002 levels. 
I quote AP on the Schiller report:
"Prices have fallen 34 percent nationwide since the housing bust, back to 2002 levels." 
Are you at this point willing to concede that I was correct about my [housing forecast]? 
Bob Wenzel

UPDATE: Dick Peach has responded:
 You are correct that several national home price indices have declined to 2002/early 2003 levels.  Do you think it is possible that home prices are overshooting to the downside?  
Also, I was wondering what metric you used to conclude that home prices were overvalued in 2004 and 2005. 
Richard W. Peach


    1. I believe that those numbers are nominal values. If you factor in currency devaluation (even using the bogus CPI numbers) the story is much worse. Am I wrong in my assumption that the values are not adjusted for inflation?

    2. "Also, I was wondering what metric you used to conclude that home prices were overvalued in 2004 and 2005."

      The telltale sign of an econometrician.

    3. @graham dugas

      Factoring in purchasing power parity would likely illustrate a massive devalution of housing.

      Measuring houses in terms of Gold would be even worse (for the Fed's position).

      Using the following data gathered from Wolfram Alpha charts and Kitco:

      2001 Jan. Avg home price: 156,600
      2011 Q3 Avg home price: 170,000

      2001 Jan. Gold price per oz: 272
      2011 Q3 Gold price per oz: 1620

      Cost of home in gold in 2001: 575.7oz of gold to buy a house.
      Cost of home in gold in 2011 Q2: 104.9oz of gold to buy a house.

      I used 2001 as the base to get a pre-bubble number but post-nasdaq burst.

    4. "Also, I was wondering what metric you used to conclude that home prices were overvalued in 2004 and 2005."

      I suppose the metric of "common sense" is not the one he is looking for...lol

      Anyway, that being most likely the case I love Anon @ 9:08AM's use of gold.

      Gold is the ultimate long term BS eliminator in stuff like this...which is why I liked it the first time I saw Peter Schiff using it for the DOW in 06' when I was just beginning to wake up. Thankfully I moved my and my wife's entire 401k into gold in 06'....

    5. It may not be Austrian, but it is what I used back in '04 to determine that we were in a housing bubble, and that my family should rent and not rebuy.

      Historical home price to rent ratio: 9 to 11
      Actual home price to rent ratio over 2001-2004:
      '01 -- 14
      '02 -- 16
      '03 -- 18
      '04 -- 21

    6. It'll be fun to see your response to the "what metric" question.

    7. To paraphrase the Mel Brooks film "Spaceballs" just before Dark Helmet is going to ludicrious speed.

      "Sir, shouldn't you use econometrics?"

      Dark Helmet: "Econometrics this!"