The Housing Chronicles Blog: The Science of Guesstonomics

Saturday, December 29, 2007

The Science of Guesstonomics

Remember a year ago when many economists were predicting flat or very weak growth in the housing market? This was well before the mortgage issue arose, so most were looking just at inventory and sales numbers.

So why should anyone believe their forecasts for 2008? I'd argue that it depends on the performance of their previous predictions, and CNNMoney's Chris Isidore provides a summary. Some highlights:

Greenspan & Bernanke:

Former Federal Reserve Chairman Alan Greenspan and his successor Ben Bernanke, after reviewing home sales and mortgage rates in fall 2006, were hopeful that the market had bottomed out.

"It may be too soon to say that it's over. It may not be too soon to say that the worst is over," said Greenspan in an October 2006 speech in Richmond, according to press reports.

In a November 2006 speech, Bernanke said he saw some "encouraging" signs in recent housing reports.

Many commentators think that Greenspan ignored the ultimate consequences of a housing bubble with increasingly lower short-term interest rates and that Bernanke has not seemed concerned enough about the market's meltdown.

Lawrence Yun, NAR (thank God they got rid of former Chief Economist David Lereah, who in February 2006 published
Why the Real Estate Boom Will Not Bust—And How You Can Profit from It.). Thanks to him, numbers from all trade groups are now suspect:

The National Association of Realtors made a forecast a year ago that was far more optimistic than those by Wyss and many other economists. The Realtors expected only a 1 percent drop in the pace of existing home sales, and a 1 percent gain in median prices. Instead, 2007 will likely end with a 12.5 percent plunge in the pace of sales, and nearly a 2 percent drop in prices, the first such decline on record.

The group's current forecast for 2008 calls for a 0.5 percent increase in the pace of sales, and a 0.3 percent rebound in prices. But Lawrence Yun, chief economist for the trade group, said that making forecasts is even tougher this year than it was a year ago.

Yun forecasts essentially flat prices in 2008. Yet, he also believes there's at least a one in four chance that prices will fall more than they did this year, and about the same chance that prices could rebound by 3 percent or more.

"I would not be surprised if home sales improves in 2008," he said. "At the same time I can also foresee a circumstance where buyers continue to pull back, the inventory sitting on the market continues to build and it causes prices to go down further."

I think Mr. Yun is flailing a bit, but he's right that economic forecasts are always tricky. Of course I also remember when CAR's Leslie Appleton-Young said she needed more time to come up with an appropriate term when the market peaked and started trending downward, thus suggesting she was caught unawares.

Robert Shiller (co-founder of the Case-Shiller index):

Robert Shiller, a Yale economist who had argued for years that a bubble was forming in real estate prices, points out that one group was on target about where prices would go - investors in a real estate futures market that he helped set up on the Chicago Mercantile Exchange.

Starting in May 2006, the CME set up futures contracts for 10 metropolitan real estate markets, allowing investors to bet whether prices would go up or down and by how much.

By the end of 2006 those futures were pointing to real estate price declines between 5 percent and 7 percent in those markets, Shiller said. That ended up in line with the 6.7 percent annual decline in the October reading of S&P/Case-Shiller home price index, which was the largest drop recorded in that 20-year-old price measure.

"I'm not normally an advocate of market efficiency, but there's something to be said when you're putting money on the line with your prediction, rather than just talking," he said.

Those futures today are far more bearish about future housing prices than most current economists - foreseeing an additional 4 percent to 14 percent drop in prices over the next year.

Although the Case-Shiller index doesn't track all cities, its strength is its focus on matching sales of the same properties. Plus Dr. Shiller has a good point when he says, "there's something to be said when you're putting money on the line with your prediction, rather than just talking."

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