The stocks-housing disconnect

By Felix Salmon
May 31, 2011
double dip in the housing market -- with house prices nationally now back to their 2002 levels -- stands in stark contrast to what's going on in the stock market, and a lot of people, myself, included, are puzzling over why that might be.

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The double dip in the housing market — with house prices nationally now back to their 2002 levels — stands in stark contrast to what’s going on in the stock market, and a lot of people, myself, included, are puzzling over why that might be.

A few charts would seem to be in order here. First of all, the Case-Shiller house-price index, the blue line on this chart:

Case-shiller-mar.gif

It’s pretty clear from this chart that house prices are going down rather than up, and have been doing so for a good five years at this point.

Next there’s houses priced in stocks:

20110604_WOC820_0.gif

This is particularly interesting because it dates the big decline in housing as a worthwhile asset class all the way back to the early 1980s. You can see the housing bubble and bust in the spike at the end of the chart, but you can also see that this is a very volatile series, and that houses can and probably will become much cheaper still, relative to stocks.

Cullen Roche, looking at these charts, concludes:

Despite all the attempts to manipulate the real estate market, the government has largely failed in attempting to stabilize prices. In other words, it’s undergone a much more natural price discovery process. The equity market, of course, has been intervened in at every step of the way and the government has undoubtedly succeeded in propping up this market.

I don’t agree here at all. The government has done much more to intervene in the housing market than it has in the equity market, to the point at which the government at this point guarantees the overwhelming majority of mortgages. There’s nothing natural about the housing market price discovery process, and there won’t be anything natural about it for the foreseeable future, unless and until banks start taking mortgage risk again. And the large number of houses which have been sitting on the market for well over a year now is proof that this market isn’t clearing and that a lot of homeowners are still pretty delusional when it comes to what they think their home is worth.

But still the question refuses to go away: why is there such a difference between the housing market and the stock market? It’s something to do with investability, I think, because if you look at ways to invest in the housing market, they turn out to behave pretty much like stocks, rather than like houses. Here’s the Vanguard REIT ETF, overlaid with the S&P 500:

vnq.tiff

The point here is that houses are largely insulated from the kind of capital flows which drive everything from the stock market to the price of gold. There was a brief speculative bubble in housing from about 2000 to 2006, but even then the capital being deployed was largely borrowed rather than invested. Real estate is and always will be a game of debt: it’s almost unheard-of for people to buy up investment properties for cash.

The other weird thing about the housing-stocks disconnect is that it seems to be peculiarly American. There have been gruesome property-market crashes in other countries too, of course — look at commercial property in Ireland, or speculative beach resorts in Spain. But in general, countries with much larger property bubbles than we saw in the U.S. have seen property prices fall much less during the bust. And indeed there are brand-new property bubbles popping up all over the Pacific Rim: what is it that’s causing huge demand in Sydney and Hong Kong and Shanghai and Vancouver which doesn’t seem to have any effect on San Francisco?

I don’t have any good answers here, except to say that if housing is getting cheaper, in many ways that’s a good thing. Sure, it’s bad for banks, and it’s unpleasant for anybody who bought a house as an investment. But in general, the less money we Americans spend on housing every month, the more money we have to spend on more productive sectors of the economy, and the higher our disposable incomes. Falling house prices don’t make people richer. But they can make you feel richer than if you were spending hundreds of dollars more per month on a mortgage.

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