Not Nonsense (House Prices)

Remember this graph?

Figure 1.7: from IMF’s September Global Financial Stability Report.At the time (October 21, 2007), some observers were arguing that (i) the mortgage crisis was containable, and (ii) unlikely to cause a recession.
One comment, responding to another reader’s predictions, went as follows: “In other words, you are predicting a fall of 50% in value [in valuations of residential housing]…Nonsense.”

Well, it’s now time to flash forward 16 months, and look back at what has happened in the intervening time, and to see what the markets are predicting.

caseshiller0.gif Figure 2: Case-Shiller 10 city price index, (red triangles), CME futures prices, 21 Sep 08 (green circle), and CME futures prices, 25 Feb 09. Source: Standard and Poors’ [xls],, St. Louis FRED II, NBER, and author’s calculations.As of December, the CS 10 city index is 33.3% below peak (2006M06) in log terms. Taking into account inflation (CPI-all), the CS 10 index is 38% below peak.

CME futures indicate 46.6% decline relative to peak by 2010M11 (in logs, nominal). Pretty close to 50% in my book.

Hence, in considering whether to intervene to modify mortgages, it seems to me that one has to trade off concerns of moral hazard against the collateral damage on the financial sector, taking into account the dire straits the housing market is in [1], and how many asset backed securities depend on housing values.

The observant reader will note that the trajectory of house prices implied by futures has shifted downward since September 2008, in Figure 2. My guess is that if expectations about unemployment rates in the future prove too optimistic, we might see further downward revisions in expected (by the futures markets) house prices, putting further stress on the financial sector.

Originally published at Econbrowser and reproduced here with the author’s permission.