What Are House Prices Telling Us? Karl E. Case February, 2009

Why do home prices matter? Houses are collateral for mortgage debt If prices continue to fall, the 2008 and 2009 books could be unprofitable Some $4 trillion has been lost form household balance sheets – household spending has fallen: - Equity can’t be withdrawn - General drop in consumption

Housing Starts (Census Bureau SAAR) January 2006 (Peak)2.273 million units December ,000 units Down1.723 million units Average Fixed Investment Per Unit (ex: Land) $250,000 Total Annual Direct Lost Production $431 billion Total Lost Production (multiplier: 1.4) 1.4 x $431 b= $603 billion Annual Lost Production As Percentage of GDP 4.2% of GDP Effect on GDP

House prices are hard to measure and interpret Asset values in “normal times” must be based on actual arms length closed transactions between willing buyers and sellers, Relatively few units are sold in a year, Housing is heterogeneous: a house is really a bundle of structural and neighborhood characteristics, Markets are sometimes “illiquid” Housing is fixed in location: arbitrage difficult.

Two Market Clearing Processes Normal times: Sellers resist, buyers lowball, “sticky prices,” inventories high, production falls…

Two Market Clearing Processes Normal times: Sellers resist, buyers lowball, sticky prices, inventories high, production falls Foreclosure auctions: prices less sticky, distressed sales

What are the S&P Case-Shiller Indexes? What are they telling us?

Table 3 S & P Case-Shiller Index -- Through October 2008 Released December 30, 2008 Metro AreaPeak% ∆ Since Peak% ∆ Last Year %∆ from August to September %∆ from September to October %∆2000 to October 2008 PhoenixJune %-32.7%-3.5%-3.3%+35.2 Las VegasAug %-31.7%-2.6%-2.7%+42.6 MiamiDec %-29.0%-2.6%-3.0%+73.4 San DiegoNov %-26.7%-2.4%-3.0%+51.1 Los AngelesSept %-27.9%-2.5%-2.6%+79.8 DetroitDec %-20.4%-2.5%-4.5%-13.9 San FranciscoMay %-31.0%-3.9%-4.2%+39.4 TampaJuly %-19.8%-1.8%-3.1%+65.4 Washington D.C. May %-18.7%-2.2%-2.7%+84.9 MinneapolisSept %-16.3%-1.0%-3.4%+35.7 ClevelandAug %-6.2%-0.6%-1.0%+8.8 BostonSept %-6.0%-1.1% ChicagoSept %-10.8%-1.1%-1.6%+45.5 New YorkJune %-7.5%-1.0%-0.9%+90.0 AtlantaAug %-10.5%-1.3%-2.4%+19.8 SeattleJuly %-10.2%-1.4% DenverAug %-5.2%-1.3%-1.5%+29.1 PortlandJuly %-10.1%-1.3%-1.9%+66.4 DallasJune %-3.0%-0.8%-1.1%+20.6 CharlotteAug %-4.4%-1.3%-1.8%+28.0 Composite 10June %-19.1%-1.9%-2.1%+69.8 Composite 20July %-18.0%-1.8%-2.2%+58.2

How Did this Happen? 35 Years of rising prices The recession of 2001 Fed’s preemptive strike in late 2000 Highly “exuberant” consumer Boomers armed with equity.com bubble bursts: real assets look good Low rates and Fed expansion continues Mortgage rates spike in 2003:2 Underwriting quants did loan level analysis Sub-prime! Low rates led many into homeownership Provided a big pool of first time buyers Boomers could move up

Fierce competition among originators, agencies, Wall Street, Banks and Insurers Underwriting, quants and risk based pricing Housing skipped the 2001 recession Fraud Increasingly exotic A- paper: stated income…. World wide liquidity: the DarkMatter story Pure speculative bubble in 4 states: P&Q Huge run-up in the lower tier Immigration Foreign Demand Government encouragement of homeownership: tax law and CRA Leverage

Auctions in November, 2008 U.S. and Top Four States* (Foreclosure auctions by state in hundreds) Number of % of Total Auctions Existing Sales The U.S. 87,700 21% Top 4 (54%) 47,300 60% Arizona 8,100 87% Nevada 3,100 62% California 24,100 58% Florida 11,400 52% Bottom 47 (46%) 40,400 12%

House Price Changes Case-Shiller Zip Codes Boston 2008-Q1 Percent Change CityOne-YearFive-YearTen-YearMedian Brockton $230,000 Lawrence $165,000 Worcester $230,000 Lynn $250,500 North Dartmouth $258,000 Northborough $372,000 North Andover $500,000 Westborough $350,000 Andover $519,000 Lynnfield $494,000 Southborough $533,000 Springfield $159,000 Weymouth $285,000 Gloucester $385,000 North Adams $127,000 Walpole $402,500 Billerica $326,000 Weston $1,202,500 Lexington $839,000 Wellesley Hills $1,210,000 Lincoln $1,045,000 Dover $932,500 Needham $716,500 Belmont $722,500 Waltham $389,000 Newton $895,500 Cambridge $590,000