What we “know”

we know what we know is an arcane epistemological question, but one that now may be a matter of national economic security, at least with regard to real estate markets. Our entire financial system’s survival may depend on how we “know” what we “know” about real estate markets.
What we “know” is that day after day the headlines tell us that the real estate markets in America are falling out of bed. Because the value homes are presumably falling in value, the mortgage markets have seized up and institutions are reluctant to lend against an asset declining in value.
The financial market’s reluctance to lend against this declining asset and the public’s reluctance to buy it, fuels a self-fulfilling cycle of falling prices that today threatens the very Wall Street firms who securitized and internationalized the once sleepy, local mortgage market. The failure of one or more of those firms could have a domino effect on our entire financial infrastructure and cause further panic in financial and real estate markets of epic proportions.
But what if the headlines are not quite accurate? What if what we know about the real estate markets is distorted and being sensationalized?
Given the importance of the outcome, now might be a good time to ask how we know what we know before fiction becomes reality.
What we know today is largely courtesy of the S &P Case Shiller Index. This index has replaced older indexes on the front page of American newspapers. Older indexes came from two sources. One was the National Association of Realtors’ monthly price index and the other is the OFHEO index (Office of Federal Housing Economic Oversight). The latter two use rather different methodologies but over the years have reached remarkably similar conclusions about prices of homes in America. When different methodologies yield similar results, that means you have a good handle on reality.
Today we don’t hear much about either index. Instead, the Case Shiller index is everywhere and its ominous message is clear: Bloomberg News recently said that according to Case Shiller “prices fell 7.7 % from a year earlier after dropping 6.1% in October.” This suggests to any reader that prices are in a free fall and are even dropping 6% in one month ! The index talks about a 15% price decline in Miami and 4.8% for the year in New York. Bloomberg quotes Shiller: “We are in an historic housing bust right now.”
Two weekends ago I opened my AOL account and saw a bold headline that home prices in 20 markets were falling rapidly with quotes from Mr. Shiller that prices nationally finished down 8.9%. “Wherever you look things look bleak” Mr. Shiller said.
The Wall Street Journal runs a headline “Home Prices Decline at Record Rates” quoting Mr. Shiller yet again.
Is Mr. Shiller right? The importance of the question forces us to look at the market through the other available lenses, NAR and OFHEO.
OFHEO has been keeping a national index for years and publishes monthly a one inch thick book on housing prices. It says that in 2007 the average price in America was down .3% . Yes, that is three tenths of one percent, not Mr. Shiller’s 8.9%. Compared to OFHEO Mr Shiller’s index overstates the decline by 29 times or 2900%, not a small amount.
The National Association of Realtors index showed a median 1.4% decline nationally after 64 years of uninterrupted gains. Compared to NAR’s 1.4% median price decline, Shiller overstates the “freefall” by 6.3 times or over 600%.
When I pondered the 2007 OFHEO and NAR numbers a blasphemous thought came to mind, one contrary to today’s media dogma: that the numbers showed not weakness in the real estate markets, but rather resiliency. But that is just my musing. Interpret the data as you will.
Recently, another report came out that was greatly at odds with Shiller’s shrillness. It came from the 2007 results for Realogy, the largest real estate brokerage company in the world that owns the Century 21, Coldwell Banker, Coldwell Banker Commercial, Sotheby’s, ERA and Better Homes and Gardens brands, among others. They have over 300,000 agents under their franchised brands, or about one-fourth of the members of the National Association of Realtors. So these are real people doing real business everyday in the real marketplace, not in a Yale think tank. What do their numbers say?
While the drop in sales volume has led that company to lose money Realogy reported that their average price in 2007 was down 1%, right in line with the NAR and OFHEO data. Again this is from a real real estate firm operating in the real world daily. This makes three out of four indexes point in one way and Shiller alone pointing to much more calamitous and foreboding results. Is there a reason why?
Some think it may have to do with methodology. Shiller and OFHEO’s are both repeat sales indexes whereas NAR’s data and that of Realogy take all sales volume and divide it by unit sales to get an average price and then figure out the median. Still three out of four, even using different methodologies, give one clear answer, that prices have fallen about 1% while Shiller points to a 9 times greater fall.
A couple of notes about the discussion that should be taking place. Shiller issues national press releases monthly but his index is anything but national unlike OFHEO, NAR and Realogy’s data. He covers only 8 states out of 50 and those eight states are among the weakest in the nation, leading the Wall Street Journal several weeks ago to say that Shiller’s index may be negatively biased.
Shiller claims to cover 20 markets (some are in the same states and hence 20 markets but only 8 states are fully covered) . He labels those markets with the names of cities, not states. Hence New York, Miami, Seattle, etc. This gives the impression that the markets he is reporting on are in fact cities (what else would one think?)
In fact Shiller does not report on cities but on MSA’s, short for Metropolitan Statistical areas. This leads to some remarkable absurdities. For instance, Shiller claims New York prices fell 5.6% in 2007 versus an index created by Manhattan based Miller Samuel that says the average Manhattan price rose 17.6%. Unlike Miller Samuel that tracks coop and condo sales in Manhattan, Shiller’s index, expressly excludes condominiums and coops which account for 1/3 of New York sales and 99% of Manhattan sales. Manhattan is the high profile part of the New York market and the one most associated with New York City. Thus Shiller claims to report on what is happening in a city where he does not cover 99% of the sales in its most high profile borough.
Even more perversely, Schiller’s MSA for “New York” tracks sales in Putnam County, two hours north , and single family home sales in Bergen County, New Jersey and home prices out on Long Island. Trailer park sales in Putnam county could be included in his “New York” index.
Criticisms of Shiller’s inaccuracies are finally surfacing. RealTrends, a national industry monthly, ran its January headline “Cash Shiller Index Exposed” and ran a synopsis of a paper done by Andre Leventis of OFHEO in which it chronicles the “flaws in Case-Shiller that are traceable and have a huge impact on the variance between their reports and those of so many other reports, including NAR’s and our own.”
Lawrence Yun of the National Associations of Realtors (who was named by USA Today as one of the top ten economic forecasters for his accuracy) has ratcheted up his criticism of Shiller. Yun calls Shiller’s index a “total distortion of market conditions based upon a small selection of falling local metro coverage.”
OFHEO has also chimed in by indicating that 70% of markets nationwide are not falling but actually rising, a far cry from what Shiller is peddling to the press.
But something more sinister is coming to the fore which a responsible press cannot ignore. Shiller shrillness may be due to self interest and private gain. The gospel according to Shiller is that national homes prices are in a freefall of epic proportions and that 20% to 30% price drops are in order. How could that possibly help Mr. Shiller?
Yun suggests that Mr. Shiller profits from creating fear. He creates fear so that people will want to hedge themselves against price declines by buying insurance against a free fall in prices. Where is such insurance available? Answer: on the S & P Case Shiller index traded on the Chicago Mercantile Exchange. According to Yun, Shiller has a “side business in Chicago. His index is used at the Chicago Mercantile Exchange for hedging housing futures values. The more hedging of bets that occur, the more profits go into Dr. Shiller’s bank account. And more hedging of the bets will take place if people believe there will be a crash in housing values. So naturally he has a financial incentive to ‘scare’ the market.”
I have no direct knowledge that he does so for profit although anecdotally I have been told this is true. I suggest it is time for the media to find out.
If the media does not look more deeply into the methodology being used today, Shiller may indeed scare America into depression or a Depression.
So while asking for Shiller’s self interest to be fully disclosed, allow me to disclose mine. I am indeed a Realtor and make a better living when real estate markets are healthy than when they are sick. But in addition as a Realtor I subscribe to something made clear in our Code of Ethics: we believe that upon “widely allocated ownership [of real estate] depend the survival and growth of free institutions and of our civilization.” No small thing. We also believe that this interest imposes on us “obligations beyond those of ordinary commerce.”
Today the commerce of real estate is being distorted possibly for private gain and threatens widely allocated ownership and possibly the survival and growth of our free institutions. In addition, most Realtors actually enjoy the housing business because while ostensibly it seems to be about homes, it really is about the American Dream, which consists of owning a home. We sell dreams and we take some satisfaction out of trying to make sure as many people as possible can own them. We even think that owning a home helps our country by fostering better citizens who by owning a piece of America will want to take greater care of it.
So we feel there is a lot at stake here, both for Realtors like me, as well as the rest of America. Is it not time to start some background checks?