Felix Salmon

When it comes to economic series, any one datapoint must be taken with a pinch

of salt. And when the datapoint is such an outlier compared to previous reports

in the series, one should discount it almost entirely. Case in point: today’s

new home sales report.

There are all manner of weird numbers here: the headline rate of new home sales

was much higher than expected, at 981,000, while the median and average sales

prices were much lower than expected, at $229,100 and $299,100 respectively.

The fact that the numbers are unexpected, of course, is in and of itself reason

to believe that they might well be revised significantly in future.

It’s certainly worth noting that the 16.2% month-on-month rise in sales has

a margin of error of 13 percentage points. So I’m not drawing any conclusions

from this one report, even if Bloomberg’s Bob

Willis thinks it’s "a sign low lending rates and incentives may be

reviving demand". Especially since if you look at a graph

of mortgage rates over the past few months, it clearly shows them going up,

rather than down.

Tanta,

at Calculated Risk, makes a couple of interesting points today. The first, which

is very important and not well understood at all, is that just because subprime

mortgage default rates are at 5%, say, that does not mean that 95% of subprime

homeowners are managing to stay current on their mortgages.

A foreclosed subprime loan can represent the second, third, or nth subprime

loan that borrower has had on the same property. In this case, the last loan

in the series ended up in foreclosure; the first n loans ended up as prepayments

due to refinances, which means they count in the "successful" pile

of loans. Looking at current rates of delinquency or foreclosure cannot tell

you anything about cumulative numbers, and it does not track one borrower

all the way through all the refis until the end game. It is perfectly possible,

at least hypothetically, to have a situation in which 40% of subprime homeowners

eventually end up in foreclosure or short sale or jingle mail, but only after

three or four loans, so that on any given month, on the current total book

of outstanding subprime loans, "only" 4% are currently in foreclosure.

The point here is that we simply do not know what percentage of subprime borrowers

are ending up in default or foreclosure. It’s conceivable that the ratings agencies

or someone else might be able to do the math, but it seems that no one has done

it, as of yet.

Tanta then goes on, however, to quote Carola

Katz Reid, and this is where she loses me:

The dramatic finding is that for low income minorities, low-income whites,

and middle-income minorities, the financial returns to homeownership over

even 10 or more years of owning a home are extremely small. Indeed, for low-income

minority homeowners, the average value of their housing only increased from

$50,000 to $65,000—roughly a 30 percent increase over a 10 year period.

While this does represent an increase in house value, this rate of return

is less than the “riskless” return on Treasury bills.

This is, in a word, bullshit. Low income minorities don’t tend to have $50,000

in cash lying around to spend either on housing or on Treasury bills. In fact,

their net worth is normally just about zero. That doesn’t mean they can’t get

a mortgage, however, and if you can manage to find say $10,000 for a downpayment,

you can borrow the other $40,000 for a step on the bottom rung of the property

ladder.

Ten years later, you’ve probably paid down half the mortgage, and your house

is worth $65,000. Which means your net worth has gone up from the $10,000 you

scrounged for the downpayment to $45,000 — an increase not of 30% but of 350%.

Try getting that from Treasury bills.

Now, with high returns comes high risk, and there surely is a reasonably significant

probability that our low-income homeowner will end up losing the $10,000 as

her home goes into foreclosure. (On the other hand, if that $10,000 was invested

elsewhere, for instance in a small business, it might just as easily be lost

there, too.) As we saw initially, we don’t know what the real probability of

foreclosure is. But to say that "the financial returns to homeownership

are extremely small" is simply wrong.

It seems there’s academic backup for my thesis

that New York City property is only going up: a paper

called "Superstar Cities" by Joseph Gyourko, Christopher

Mayer, and Todd Sinai. Their thesis is simple: the

number of very rich people living in cities is skyrocketing, while the supply

of housing in those cities is rising much more slowly. Result: large price appreciation.

It’s a dynamic which has played out around the world, from San Francisco to

Shanghai. But Robert Shiller, the well-known housing bear,

isn’t

convinced.

For one thing, Shiller doesn’t believe that the supply of new land is really

constrained, especially when you take into account the ability of new cities

to be built. He gives a few examples, but unfortunately for him he gives them

in alphabetical order, which means he’s forced to start his list with Brasilia

and Canberra. Neither of which is anybody’s idea of a superstar city. Proof?

Ask anyone in Brasilia whether they’d rather live in Sao Paulo or Rio de Janeiro;

ask anyone in Canberra whether they’d rather live in Sydney or Melbourne. Now

repeat the exercise the other way around.

The fact is that you can’t build a superstar city by decree. No one really

understands the factors which go into creating one: no one knows why New York

is the superstar rather than, say, Baltimore. But it is, and there’s nothing

that Baltimore can do about it. The one thing we do know is that it has nothing

to do with the city being "well-planned," as Shiller seems to think:

there are lots of well-planned non-superstar cities, and lots of superstar cities

which seem to have no planning at all. (Sao Paulo springs to mind as a prime

example.)

But Shiller isn’t giving up. "New cities are constantly ripening like

so many cherries on a tree, drawing people away from older, original cities,"

he says — but neglects to give any examples. To be sure, the number of cities,

and the number of superstar cities, is growing, and there are also some older,

original cities which are fading. Las Vegas is on its way up; Detroit is on

its way down. But Shiller’s specifically talking about new cities "within

an hour’s commute" of the old one, and I can’t see that dynamic anywhere.

Shiller concludes that superstar cities, with their low rent-to-price ratios,

are an unattractive place for property investors, which is something of a hard

sell given what’s happened to property prices in these cities worldwide. But

I do think it’s reasonable to think that property in a superstar city is a safer

investment than property elsewhere. There’s a constant and growing demand for

property in unique cities, which helps to support prices. And you can’t say

that about suburban McMansions.

(Via Thoma)