San Francisco Real Estate

San Francisco is the real estate market that couldn't fall. It has now fallen 45% from its peak in 2006. Here's a graphic that compares the three California cities in the Case Shiller Index to the housing market in SF if it had followed the increases in the Consumer Price Index. The reasoning here is that housing prices should roughly follow the growth in other prices, given no new technological changes in the cost of producing houses, as well as no unusual changes in demand.

Of course, weakened lending standards did lead to an unusual surge in demand, because millions of people who would not have qualified for mortgages under the old standards suddenly did, and they bought houses, bidding up prices.

The graph shows that despite spectacular carnage in the SF real estate market, prices still have not converged to the CPI. To consider another measure, prices have not reached the level of historical affordability either.

The median income in SF was $68,023 in 2007, while the median home (or condo) price was a staggering $830,700. The median home price to median income ratio was therefore 12.8, as compared to a historical ratio of about 4.5 to 5, (according to the Metro Affordability Study) which is already much greater than the national historical ratio of between 2.5 to 3. (This ratio gives rise to the old banker's rule that you never give someone a mortgage that is more than about 3 times their income.)

(Check out the Calculated Risk blog for some good analysis.)

Imagine what SF real estate would look like if median home prices here fell to their historical relationship. That would mean that the median home price would be $280k to $350k. That would be good news for people who don't want to leverage themselves into mortgage oblivion, creating an odd state of poverty by overconsuming housing.

The 2008 Cost of Living index for SF was 180.3, compared to a nationwide average of 100. This means it's about 80% more expensive to live in SF as compared to a place that tracked the national average (like Mongomery, AL, which has an index value of 97.3).

It seems logical to me that in the boom years, cities do extremely well. Wages and incomes rise, along with real estate and asset prices. But in the bust years, the situation changes. I have an anecdotal sense that SF is losing young people. I hear about them moving to places like Portland, or less dramatically, moving across the bridge to Oakland.

Will SF go through an abrupt reversal, seeing declines in the cost of living that are far sharper than declines elsewhere? We'll see.

Karl Case on Real Estate (and Banking)

On 3/31/09, me and a few dozen of my economics professor colleagues tuned in to a webcast by Karl Case, co-creator of the Case-Shiller Home Price Index. He told an interesting story of how the housing market came to be constructed, how home prices became collateral for all kinds of other assets, and how the smartest statisticians on earth could have been wrong about default rates on subprime mortgages, since they were deceived by a 30-year long real estate boom. I liked his story of the real estate bubble, though I think he missed the primary cause, the only logical reason why housing could become hideously overvalued: money creation.

I questioned him on the connection between fractional reserve banking and the housing bubble. His response showed how little he had thought about banking. "There's no need to destroy the entire credit system and bring lending to a halt," he replied.

I understand that response, for I thought much the same a few years ago, before I began to research the issue. Banks are a major conduit through which savings become investment. It is an economic necessity that such a conduit exists, but it is far from the only one. When corporations issue stocks or bonds, for example, savings become investment. (Assuming the corporation uses the money it raises for investment and not some other purpose.)

If we insist that banks are honest and do not permit them to engage in fraud, it does not mean that there will be no credit system and no lending. It simply means that lending will be done on a basis that is absolutely solid and does not involve the fraud and instability of the fractional reserve system.

The great American economist Irving Fisher showed this quite clearly in his 1935 book 100% Money. Murray Rothbard argues for the same thing in his article The Case for the 100% Gold Dollar. A full reserve system would not destroy banking, nor would it end credit. Banks would be restricted to lending only from bonds they would issue specifically for the purpose of investment. People who bought such bonds would know that they are taking a risk, sacrificing liquidity for a return. No lending from demand deposits (checking and savings accounts) would take place.

Full reserve banking would not end credit, it would simply make the credit system rational, functional, and morally sound.

Webcast with Karl Case "The Economy and the Housing Crisis"

I got an invitation from Pearson, one of the textbook publishers that is always trying to sell me their texts, to participate in a live webcast with Karl E. Case, Professor of Economics at Wellesley College and founding partner of the real estate research firm Fiserv Case Shiller Weiss, which produces the S&P Case Shiller Index. The Case Shiller Index is, in my view, the best of the real estate indices.

If you want to check it out, it's March 31st, 12-1 EST.

Go to: www2.eventsvc.com/pearson

They want you to register first.

I'm interested because Karl Case has said housing has hit bottom, and I'd like to know his reasons. There will be a Q&A after the talk, so I'll report back on it.