What happened in 2001:1 ?

What happened in the first quarter of 2001 that would cause BOTH:

1. A US house price bubble?

AND

2. A structural change in relative prices between high-end and low-end US houses?

It's hard to date precisely the beginning of the US house price bubble. House prices rose gradually at first. But looking at the graph in this post on Calculated Risk, there seems to be a very clear structural break in Case-Shiller data on relative house prices beginning early 2001. Low-end house prices began increasing relative to high-end house prices. (January 2000 is the base period, so all prices are the same 100 then by construction, but the divergence of relative prices beginning in early 2001 does not seem to be an artefact, since they tracked closely together until that date.)

[Update: Oops! I just noticed the CR graph is for San Fransisco, not the whole US. But eyeballing the data for other US bubble cities like LA and Miami seems to give the same story.]

My inner Occam demands a single explanation for both phenomena. What caused both?

I remember a neighbour, having lost his job (and possibly some of his savings) at Nortel, decided to invest in rental properties. He was probably not alone. The solid tangibility of bricks and mortar was a tempting contrast to dot.com esoterica. Rental units tend to be low-end, I think.

The Fed funds rate started falling in January 2001, but fell slowly until reaching a low in 2003. There was no discontinuous drop in early 2001. And I can't see why that should affect relative house prices in any particular direction anyway.

What else, apart from the tech-wreck, happened around the same time?

It's a pity that the Canadian equivalent, the Teranet/National Bank index, does not give tiered data.

Comments

[baboinga]

The obvious suspect is Greenspan and the prolonged period of negative real interest rates. I remember on 9/11 thinking --"man, this could be the start of the next great depression". Instead, we got a bubble and the economic pain that should have been triggered by the dot com bust was forestalled by the next, bigger bubble. Until last fall, of course.

[Nick Rowe]

But that was 9/11/2001. And the really low interest rates followed after that, in 2003. It's too late. If it were 9/11/2000, I could believe it, since it takes a few months for people to check out which house they want to buy, and for the increased demand to reduce inventory, and for the reduced inventory to start to push up prices.

[Nick Rowe]

And also (sorry, because I was adding this to the post while you were commenting), why should low interest rates increase the low-end house prices relative to high-end?

[reason]

The Euro?

(The end of the tech boom was a lot about a lot of the IT resources needed for the Euro introduction and Y2K no longer being required). The fall in IT salaries may have slowed the rise of high end housing prices (depending on how high end you mean).

[Chris S]

Given that subprime mortgages tended to be for people with less money, I can see that if something loosens the reins on subprime at that date, the effect would be to drive up the pricing on lower priced homes.

Interestingly, mid-2000 to early 2001 is the time frame when David X. Li produced the paper on copula functions, which provided a mechanism to price CDOs -- essentially opening a tap that let subprime mortgages run out. Shortly after that, the mortgage market would sense that subprimes had become valuable, and act to run up the number that they brought in.

[Chris S]

Oh, and by the way ... the following two items appear suggest that the month before, the CFMA passed, ensuring that CDOs would be free of regulation. Next month - CDOs out one door, have to keep pumping mortgages in the other.

2000 December 13: The U.S. Commodities Futures Modernization Act, which allows banks to continue to self-regulate derivatives, is passed.

(*: http://www.thefreelibrary.com/The+dominoes+fall:+a+timeline+of+the+squeeze+and+crash+...-a0192897652 )

The Commodity Futures Modernization Act of 2000 or CFMA (H.R. 5660 and S. 3283) is United States federal legislation which repealed the Shad-Johnson jurisdictional accord, which had banned single-stock futures in 1982. The legislation also provided certainty that products offered by banking institutions would not be regulated as futures contracts.

(*: http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000 )

[Nick Rowe]

Hmmm. I'm now leaning towards Chris S.'s subprime story as explaining both.

But if anyone is handy with graphs in Excel (I'm not at all), they might want to have a quick look at the Case-Shiller tiered data for other cities, just to check what my eyeballs are telling me. (I'm not to be trusted with numbers and empirical stuff). http://www2.standardandpoors.com/spf/pdf/index/SA_cs_tieredprices_042841.xls

[asp]

In Canada, CMHC helped inflate the bubble by insuring 40 year, 0-5% down payment mortgages. Rather then making housing more affordable, as is its mandate, this caused house prices to rapidly overinflate.

But it was not just in the US and Canada that housing bubbles occurred, it was throughout Europe as well. From what I have been reading, this was due to the credit bubble, whose bursting is causing this little credit crisis we find ourselves in.

[Chris S]

Comments...

1) I did the graphs for Atlanta, Las Vegas, Miami, Portland and DC. *Radically* different results.
- Miami fairly explodes - peak nears 340, and shows the breakout trend.
- La Vegas is completely different - the three track together until mid 2003 (two and a half years), but low tier doesn't dominate until January 2006, and only barely then.
- Atlanta barely moves at all - the peak never reaches 140.
- Portland looks like a slightly stronger Atlanta.
- WashingtonDC looks like a weaker Miami.
(Sorry, no good way to post. I'll save the sheet just in case.)

2) I know from previous reading that there are important state-by-state differences in the subprime meltdown. California, Nevada, and Florida all have very high foreclosure rates. Georgia is not as high, but was still top 10 in many listings. I couldn't find any foreclosure stats for all states (everyone wants to do top 10) and this dataset doesn't have all cities anyway.

3) I don't think I disproved a corelation between sudden bubbles and subprime. Interesting, though, that some places really haven't had a bubble! But this dataset is a good step towards being able to do that.

P.S. Will someone please save me from dumb spreadsheet dumps. Year and Month should be ONE FIELD, formatted to show YYYY-MM. As it is right now, it is very hard to do X-Y lines (which is what the chart is) with the X being the date, because the date is split between two columns. Most of the time for each city was spent doing a build of a single date column (insert working column, build single date field, copy single date values back over year, reformat year to yyyy-mm, remove working column). If this had been 'proper', it would have been straight forward to add a single sheet/chart that where you could just fill in the city name and see that chart. Grrr.

[Chris S]

And NOW I find it...

http://www.realtytrac.com/foreclosure/foreclosure-rates.html

It appears that Georgia is showing a year-over-year *decrease* in foreclosure rates; this would be consistent with the price dataset, in that there's no big deal involved in unwinding a bubble you never had.

I still think it's likely that subprime would inflate lower-priced homes more than high priced homes. But I think I would be very careful about making any serious pronouncements on the basis of this data.

[Nick Rowe]

Chris: so bubbles and relative price divergences tend to start at the same time as each other (if they start at all), but different cities start at different times?

If so, I expect looking for a single national event on a particular date that caused the whole thing is a hopeless task. Which would be a pity. Because one always likes to give Occam first slash with the razor, to see what he can do.

[anne]

http://economistsview.typepad.com/economistsview/2009/04/the-twentyfirst-century-will-be-the-age-of-inductive-economics.html?cid=6a00d83451b33869e20115705ecb17970b#comment-6a00d83451b33869e20115705ecb17970b

Please notice that I used this fine post as a support to an argument I have been making separately on Mark Thoma's thread. I only found your fine post a few moments ago, and never used data from Calculated Risk.

[Leo Petr]

Not necessarily related, but the Bush inauguration immediately comes to mind as something that happenned in 2001Q1.

[Chris S]

The sudden change in several areas is compelling - but my preference has grown to call on Occam to help me pick between two items that are in other respects the same. One driver for two simultaneous events may be fewer, but if an alternative 'two drivers' explanation has a more reasonable driver for each individual event, then I'd want to be very careful about deciding in favour of the 'one driver' idea just because I wanted to always count fewer as better

My big concern is that it's not clear that there is one "whole thing" to be caused. If we look at only some areas, there certainly is a thing, though. But some areas clear never went though an upswing big enough to be called a bubble. And in fact, there are many more areas in the U.S. that are not in this dataset (Vermont? Wisconsin?) where the local contraction is not as serious. (They still get clobbered with spillover from national problems.)

I would be fairly comfortable with the idea that some states had the economic fundamentals to support a bubble - and that finance technology (copula functions) and legislative changes (CFMA) opened the bubble door wide, via the subprime mortgage connection. A subprime driven bubble seems likely to drive the low tier harder than the high tier.

But there may be local conditions, such as a relatively poor economic climate, or possibly a strong regional bank that has a more risk averse profile, that hold back the bubble locally. Moreover, some regions - just like in Canada - are strong with industries such as agriculture which will not ramp up rapidly in support of a boom cycle. They often won't be as risky during a downturn, either. (Risk/reward - two sides of one coin.)

If I had way more time and data, I'd look for an independent metric to assign "bubblability" to each city (or whatever region we are considering). Then I would ask if those 'bubble likely regions' showed the break in pricing between low tier and high tier prices.

[Jon]

Nick,

I have to disagree. The Housing boom started in the mid-90s. House prices match very closely with the greatly accelerated broad money growth that followed the (effective) suspension of reserve requirements in the US.

Booms in Spain and Ireland can be traced to the euro introduction and a sudden reduction of the reserve ratios there. Similar scenarios played out in other countries after US suspension secured the repute of low (or zero reserve ratios).

Thus the coordinated boom/bust across the world.

[jp]

Freddie Mac introduced its first 100% mortgage product in December 2000 and also an Alternative Stated Income product that month. Fannie followed with the its own 100% product in 2001 and its first interest only product.

[Nick Rowe]

When you have several competing explanations for one set of facts, a good way to proceed is to try to bring in an additional set of facts, and see which of the competing explanations fits both. That's what I was trying to do here, by looking at relative price changes. The relative price changes seemed to be part of the same thing phenomenon, because (judging from looking at the graph on Calculated Risk), the relative price movements seemed to follow the same trajectory as the average price movements.

It's like when we try to explain business cycles. We don't just try to explain the ups and downs of GDP; we try to build a theory that can also explain all the other co-movements -- the prices and quantities that rise and fall along with GDP. And it's only because all these other things tend to co-move with a familiar pattern that we can talk about "business cycles" as a unified, repeating phenomenon. That was Lucas' point, in "Understanding Business Cycles" (1975?). "All business cycles are alike" was his methodological premise (even though we know that in some ways they all differ).

Occam's Razor is, I think, another way of saying the same thing.

But Jon's point is correct, and exactly in line with my way of thinking, methodologically. He introduces another set of facts, the house price bubbles in many other countries, and asks which single cause can explain all countries. (It was the same way of thinking that, in the Fall, lead me to reject purely US-specific explanations of the bubble, like CRA, etc., because no other country (to my knowledge) had anything similar, but many had bubbles.

The "low real interest rate" explanation can fit the facts better globally. But can it also fit the "fact" (if it is a fact outside some cities in the US) of the relative price changes I pointed to?

As Chris S. says, we could have a theory with "one big cause of everything", but mediated by local conditions (like different elasticities of supply in different cities, depending on whether they are hemmed in by oceans, mountains, or planning restrictions). But I don't think Occam could reasonably object, provided we do have some independent way of observing those local conditions. ("Yes, Vancouver is indeed hemmed in by sea and mountains, I can see them, so the elasticity of supply of new housing will be lower, and so increases in demand will impact price not quantity, and I'm not just making this up to get the theory to fit the facts.")

[Phillip Huggan]

What was the capitalization of the tech-bubble? I went tree-planting in early Spring 2000 and the bubble was still there. By summer it was gone. So a year too late to explain any 01/2001 pop.
Maybe a mini flight-to-quality in the interim? The tech bubble deflated 1st-2nd quarters 2000 (the Biochem part of my Monopoly money portfolio broke me even for cot.com "bargain hunting"), maybe for defensive psychological reasoning or tax reasons the money was parked somewhere for 3 quarters? Any evidence of a dot.com sized increase in safe bond and bills or currencies at the time in between dot.com exhale and your 01/2001 runup?

[Scott Sumner]

The Fed rate cut of January 2001 was the first of many, but to me the most interesting aspect of it was the way it shifted expectations. The 1/2 point cut was larger than expected. Short term rates fell, but only slightly. Long term bond yields soared (I forgot how much, but I know the price of 27-28 year T-bonds fell more than two full points right after the Fed announcement.) Thus the more expansionary than expected announcement had an unusually powerful impact on inflation expectations. Obviously that alone could not cause the housing boom, but that and another series of further easing steps might have. My point is that January 2001 is more interesting than many people imagine. For the last 8 years I have spent (in my money classes) almost a full class period on the Fed announcement of January 2001, so naturally I was interested when I saw your post.

For the low price/high price issue, I would look to lending practices. I actually think the Fed was correct to adopt a policy that boosted the housing market, my problem is with the high risk mortgages that were dished out like candy. I suppose those went disproportionately to the low end of the market. I know many others have made this point.

[Nick Rowe]

Phillip: (You are a brave and tough guy to survive a season of tree planting. My daughter survived two seasons. From what she told me, I don't think I would survive a week, even in my younger days.)

Yes, I'm really not sure the timing fits exactly for the tech-wreck theory, or whether it's big enough. I'm not at all wedded to the tech-wreck theory, and I'm not even sure I would even really call it a theory. I just sort of threw it out there, as an example.

Scott: that's interesting. If you have been spending a whole class on January 2001 monetary policy for the last 8 years, (and 8 years means it easily pre-dates the bursting of the house bubble, so you are not cooking up an explanation after the fact, like me and everyone else), it must have been a bigger event than I thought.

But if expectations of inflation went up, (ooops! I was about to say "...how come yields on long bonds fell?", then I re-read your comment, and saw they rose!)

So house price started rising because houses are real assets and so an inflation hedge? Makes sense.

But then was it just a coincidence that lending practices changed and caused the relative price change at the same time? Why would a perceived change in long-term Fed behaviour cause a qualitative change in lending practices, rather than just a fall in rates?

[Richard H. Serlin]

I think the same basic thing as Chris. There was a huge change in the U.S. mortgage business that really picked up speed about this time. It allowed many poor and middle class people to get mortgages who couldn't in the traditional mortgage business, which was much more regulated and conservative. In addition, the poor and middle class were able to take out much larger mortgages with the rise of low-down and no-down mortgages, low intro-teaser rates, interest only, and even negative amortization mortgages, etc. This added great fuel to the bidding on less expensive and middle expensive homes, but it was much less of an issue for the really expensive homes where bidders were much less liquidity constrained, although there was some domino or cascade effect from rises in the less expensive homes to rises in the more expensive homes.

Also, whatever the initial reason for a strong price rise, it can easily cause a Minsky psychology and bubble. About this time Minsky psychology was starting to really take hold in the general middle class public.

[Phillip Huggan]

...my favourite anecdote is walking a trail alone on the way to replenish tree bag and feeling a wave of adrenaline sweep through me. A few seconds later a tree in front of me started shaking too violently to assume a raccoon or squirrel was the cause. Then about 5 or 6 squirrels lept towards me and I was relieved. Later I was asked, "what was behind the squirrels?". 2nd place to rolling over from my air mattress into a tent filled with a foot of water one morning. I have an artist friend who drew dozens of horror sketches; was probably still traumatized decades after the fact.

[Scott Sumner]

Nick, I forgot to get back to this one. To answer your question, I think the lending practices were unrelated. I tend to expect (a priori) any huge macro event to have multiple causes--the "perfect storm" analogy. That was true of the Great Depression, and probably also of the U.S. sub-prime fiasco. I view monetary policy as being a separate issue from regulations, and both of those as being separate from poor banking decisions. I am skeptical of any monocausal explanation for a macro event of unprecedented size. Someday I might do a post about monetary policy in January 2001, there was a very interesting market reaction--similar to September 2007.

Perhaps previous commenters mentioned this--but falling stock prices tend to hurt high end homes.

[valuethinker]

Nick

The obvious change is a political one: Republican majorities in both Houses plus a Republican president.

My guess is that the regulators were told 'hands off' in that period re lending in the subprime/ low credit rating customer segment.

Simply unsubtle pressure from the White House can change the way regulatory agencies work: this noticeably happened at the EPA.

Usually when you hit a structural break like that one needs to look at legislation or change in who is running the policy mechanism.