Shiller: Why the Housing Optimism?

Yale Economist and housing market guru Robert Shiller published a piece in the New York Times on Sunday pondering why so many are bullish on the U.S. housing market. He notes that home prices have improved recently, but doesn't find much reason to assume that they'll continue to do so. Indeed, major obstacles stand in the way of stable home price appreciation going forward.

Shiller points to a few indicators to support his fear that home prices could stop rising or even begin to fall again. One is the National Association of Home Builders index for prospective home buyers, which he says suggests home prices will decline. He also believes consumer psychology is very different now compared to 2006 regarding the resilience of the housing market.

He continues by noting that the recession appears to be over and the government is pulling back its emergency measures. He then asserts:

Recent polls show that economic forecasters are largely bullish about the housing market for the next year or two. But one wonders about the basis for such a positive forecast.

Momentum may be on the forecasts' side. But until there is evidence that the fundamental thinking about housing has shifted in an optimistic direction, we cannot trust that momentum to continue.

Shiller is right to be worried about the market's awakening. Much of it isn't the kind of buying you want to see in a stable environment. Some reports indicate that speculative home buying has begun to heat up again. For example, house flipping is said to be regaining popularity. Even though home prices haven't begun rocketing upward, this might indicate that they would be even lower in some regions were it not for investors making speculative bets on real estate.

Like stocks, housing prices are based on expectations. But also like stocks, fundamentals must eventually catch up to forecasts. Those indicators remain mixed at best.

Foreclosures are still increasing. Americans continue to lose their homes in troubling numbers, some due to unemployment, others willingly through "strategic defaults," and some due to the subprime mortgage products that started the mess in the first place. If interest rates do increase in the months to come that could also put pressure on adjustable-rate mortgages, which have benefitted from the ultra-low rates the market has experienced over the past year.

The Obama administration's mortgage modification program has slowed foreclosures, but has failed to permanently prevent most. In fact, some of its meager success may turn out to be fleeting if re-defaults ramp up. Since most of the permanent modifications through March were done by temporarily lowering interest rates instead of principal, it's pretty likely we'll see many of those ultimately fail.

Then, there's the shadow foreclosure inventory. Most of the published foreclosure data is only part of the story: banks continue to hold back properties in an attempt to stabilize the market. If all severely delinquent and defaulted homes were suddenly listed for sale, prices might quickly reverse their positive trend.

Finally, no one has any idea what will happen come May. At that time, the home buyer credit will be gone and the Federal Reserve will not have purchased any mortgage securities for several months. By then, the only government support the housing market will be left with will really be the Treasury's foreclosure prevention program. As mentioned, through March, the effort's results have been weak. So unless consumer buying sentiment improves significantly without any government incentive, it's hard to see how housing inventory won't increase quite a bit at that time. If it does that would consequently put pressure on prices and prove Shiller's point.