Economics

Longtime bear Nouriel Roubini is out today with this bit of apocalyptic, headline grabbing prognostication. Roubini, you'll remember, predicted recession for 2006 and 2007 before claiming prescience in 2008. I wish I could write him off as a perma-bear, but there's too much actual data supporting his argument. In his latest media alert, Roubini mixes some valid (and scary) points with plausible conjecture and oddly placed policy opinions (I wish he'd leave out the last group, they detract from the compelling facts of the situation).

The facts are:

• Small banks have massive exposure to real estate (the average small bank has 67% of its assets in real estate)
• Dozens of large regional/national banks (a la IndyMac) are also bankrupt given their extreme exposure to real estate and will also go bust
• The FDIC that has already depleted 10% of its funds in the rescue of IndyMac alone
• Losses are spreading all the way up to prime mortgages and commercial real estate; to unsecured consumer credit (credit cards, student loans, auto loans); ... to corporate bonds ... to CDSs where $62 trillion of nominal protection sits on top an outstanding stock of only $6 trillion of bonds
• In a typical US recession equity prices fall by an average of 28% relative to the peak. But this is not a typical US recession; it is rather a severe one associated with a severe financial crisis

Implications of the facts:

• FDIC will run out of funds and will have to be recapitalized by Congress as its insurance premia were woefully insufficient
• The collapse of many [risk] counterparties will lead to a systemic collapse of this market. Municipalities will go bust, hundreds of small banks, some major money center banks, the entire independent broker-dealer sector will evaporate along with $1-$2 trillion of credit losses.
• Equity prices will fall by about 40% relative to their peak. So, we are only barely mid-way in the meltdown of stock markets.
• Leaving aside the risk of a collapse of the US dollar given this easier monetary policy the Fed Funds rate may end up being closer to 0% than 1% by the end of this financial disaster
• The rest of the world is in for the pain too and as a result, energy and commodity prices will fall 20 to 30% from their recent bubbly peaks.

Dire stuff indeed. The skeptic in me can't help but ask why, in a severe global recession and with the subtraction of trillions of dollars of leverage, commodities that are up 500% in a few years would only pull pack 30%.

I always appreciate Brad Inman's perspective as a consummate real estate insider who is without obligation to cheerlead (like, ahem, some) and an entrenched market leader with the cojones to embrace change. Brad nails it today with 10 predictions for the next phase of the housing bubble burst. Here's a few:

• Exotic loans of any kind will be completely out of favor, leaving many borrowers and many properties unfundable.
• Home sellers will become active lenders, but only those who have equity. Seller financing will help some transactions.
• Second homes, expensive houses and certain types of investment property will be penalized and difficult to fund.

Read the whole piece.

The other day, I highlighted the announcement from Bob Shiller's MacroMarkets to list exchange traded funds on the housing market. I've now had a chance to investigate more deeply and I'm giddy like a schoolgirl. (Albeit an incredibly geeky schoolgirl, but giddy nonetheless.)

First, some foundation as to why this matters.

In all businesses you have risks you can control and costs you can't: food, energy, interest rates, etc. For those costs, it makes sense to hedge. Successful jet fuel hedges are a big reason Southwest Airlines is the strongest in the country. Consumer products (e.g. cheaper airline tickets, wacky mortgages) get created on the foundation of these tools. (i.e. derivatives are a good thing.) Speculators can also participate - they add potential return to their portfolio where a hedger removes risk. Speculators create liquidity for the hedgers. (i.e. speculators are a good thing.) Financial derivatives, futures, options, swaps, etc. exist in nearly every asset class to solve these problems for people.

Likewise, lots of people and companies have real estate "exposure". This is a $21 trillion asset class people. You should be able to hedge. Especially now, people realize housing prices don't always go up. But before 2006, there were no financial products that let you hedge your real estate risk. And the only way to speculate was to buy investment property.

In 2006, MacroMarkets introduced, on the Chicago Merc, housing derivatives. Unfortunately it turned out that there were practical limitations on the housing futures that prevented nearly all potential "end-users" from participating. (The big banks could trade amongst themselves, but how fun is that?) Namely, you need big capital requirements, special trading accounts, most of the time you need a broker-dealer on the other side of your trade, and the payoff is not significantly leveraged. Perhaps I was a bit harsh to characterize MacroMarkets as having "dropped the ball" but, as of today, mere mortals basically still can't hedge their real estate risk. So how do you eliminate these hurdles?

Enter Exchange Traded Funds

ETFs are securities that trade like stocks on stock exchanges. You can play the oil price trends or diversified stock market positions simply buy buying a single "stock".

Here's how MacroMarkets' new ETFs ("MacroShares" as they call them) work for the housing market:

• The shares will list on the NYSE Arca. You can buy them from any brokerage account, like you would any stock.
• They're designed to follow the Case Shiller Index - specifically the CSI 10-City Composite, the national index. more on the implications of this below.
• The shares are issued in pairs: ticker symbol NYSE:UMM goes up when housing prices go up, NYSE:DMM goes up when housing prices go down.
• Like any stock, there's a market specialist so you always have price liquidity. You don't need to line up Goldman or Merril to take the other side of your bet.
• The shares have a par value of $25/share so when the market is heavily bearish the DMMs will trade at a premium to the $25.
• They have a 10-year horizon so you can play the longer term cycles of the housing market.
• The underlying assets get parked in short term US Treasuries, so the securities actually return a quarterly dividend.
• So the very easy trade is if you're bearish, simply buy the DMMs. Think you're seeing the bottom? Buy the UMMs. Ahh... simplicity.

Exercise some caution however, because there are nuances of how these things will behave. Namely:

• They trade in pairs that offset each other. This means if home prices double, the DMMs will go to zero and the security closes out. This happened in MacroMarkets oil MacroShares this year. AMEX:UCR and AMEX:DCR. (Those securities have market values in the billions now, so people are obviously adopting them as useful instruments.)
• That means also that the upside is limited to a 100% move. You can improve your return with margin leverage like any stock.
• As these things approach close (because of A. time or B.100% market moves) the pricing will exhibit optionality. They'll behave less like the market and more like an option.
  

But is the Case Shiller Index Useful?

The remaining challenges for these products are oriented around the data. It's easy to bitch about the Case Shiller Index: doesn't include condos, or new construction, or flips, etc., etc., etc. Add in local market peculiarities and a lot of people wonder if the CSI actually measures the housing market.

My take on this argument is that Case-Shiller is not useful for making a home purchase decision. But that doesn't preclude its usefulness in financial instruments. The fact is that the CSI 10-City Composite peaked in June 2006, and that's widely regarded as the national turning point for this housing market cycle.

The classic example of the localness problem came when Brad Inman asked Bob Shiller on stage and his conference in Miami, "So let's say I bought a $2 million home in Sausalito in 2005. How would I hedge that?" Ill distill Shiller's 10-minute-Yale-finance-prof reply into two words for you: "You can't."

With Given that these new securities are based on the CSI 10-City Composite, which is down strong in the last 12 months, they're not going to be helpful to hedge in Sausalito, which is doing just fine, thank you.

But if you're a reasonably diversified investor, brokerage, lender, builder, supplier, or yes, even if you're a speculator, this is a great way to measure US housing broadly. Given success in the market, there's no reason why they can't list regional funds too at some point in the future, to get a little closer to home.

Finally, of course, the backward-looking nature of all typical housing market data presents opportunities for clients of the Altos real-time real estate data. Rock on.

This is big, folks. Huge.

I don't imagine that this innovation is going to save anyone from foreclosure. But we're looking at the only effective way to manage your real estate assets without physically selling off properties. Think about that. Won't that be amazingly useful?

Look for these to get listed sometime in Q3 or Q4 2008. You can be sure that we'll be watching, and of course publishing data to help you trade.

More coverage: Here, here, and here.

A few short weeks ago there was no doubt in the press that recession was upon us. The perma-bears, who have been calling for the Big One for nearly two years now, have declared that it's finally upon us. I had a lunch with Nouriel Roubini in February gloating over his pilaf about his prescient call (the less charitable might describe it as "broken clock" prescience.)

All of a sudden, however, a recent flurry of economic news has led to speculation that we're not in recession after all. And we might even avoid one.

So who is right? Of course both side will claim victory. Are we in recession? Depends on how you define your recession.

By now, everyone is familiar with the 2-quarters-negative-growth = recession "definition" that "they" use. It turns out, though, that this definition is garbage. Woefully inadequate and misleading.

The idea originated in a 1974 New York Times article by Julius Shiskin, who provided a laundry list of recession-spotting rules of thumb, including two down quarters of GDP. Over the years the rest of his rules somehow dropped away, leaving behind only "two down quarters of GDP."

Barry Ritholtz, in his recession declaration, uses the two-quarter rule, but does his own adjustment to the data to make it illustrate negative growth.

Is there a better way to look at it? You bet. Long time readers of this blog will know that I refer to the weekly data published by ECRI, and it is to them that we turn for the clearest, most data-driven view. Economic data ebbs and flows. Some is useful for looking forward, some looks backwards. Employment levels, for example, tend to lag the economy. (It's hard to lay people off, so the jobs go only after the rest of the pain has already set in.) If you bundle up enough of the leading indicators, coincident indicators, and lagging indicators you can see when recession is coming, when it is upon us, and when we've climbed back out. Today, the picture looks like this:

The bad news: the ECRI leading indicator has never been this low for this long without hitting recession. This data leads the economy by 6 or so months.

The good news: the weekly leading indicator's negative trend hit it's nadir at the end of March and has been ticking up since.

All in all, the three bundles of data show that we're only just now about to start the recessionary vicious cycle (when the blue line starts heading negative, then the contraction forces have pervaded across the economy - the April 2008 number sits at -0.1%). If the leading indicators climb positive quickly then the pain will be short lived.

So despite a few pundits this week implying we might actually skirt a recession, don't bank on it. The data shows that the next couple of quarters are going to be rough. By the way, you can now follow this data for yourself for free at the ECRI website. I've been paying for the data for years, but it's now open to the public. Just go to BusinessCycle.com, and select the "Recession Watch" menu.

The February Existing Home Sales numbers were released yesterday by NAR. You probably saw the headlines. Home sales were, gasp, up!

Today the latest Case Shiller Index was released. In typical fashion, they're just getting around to telling us what happened in January. Guess what? It was ugly. Here, courtesy Fritz at TFS, are the 20 Case Shiller Markets vs. their market peaks.

	Peak Month	Peak CSI	Jan 08 CSI	Decline	Decline %
Atlanta	July 07	136.47	127.08	-9.39	-6.88%
Boston	Sept 05	182.48	162.59	-19.89	-10.90%
Charlotte	August 07	135.88	131.7	-4.18	-3.08%
Chicago	Septmber 06	168.6	156.47	-12.13	-7.19%
Cleveland	July 06	123.49	108.49	-15	-12.15%
Dallas	June 07	126.47	118.56	-7.91	-6.25%
Denver	August 06	140.27	128.98	-11.29	-8.05%
Detroit	December 05	127.05	100.17	-26.88	-21.16%
Los Angeles	September 06	273.94	224.41	-49.53	-18.08%
Las Vegas	August 06	234.78	186.05	-48.73	-20.76%
Miami	December 06	280.87	225.4	-55.47	-19.75%
Minneapolis	September 06	171.12	151.16	-19.96	-11.66%
New York	June 06	215.83	200.49	-15.34	-7.11%
Phoenix	June 06	227.42	180.06	-47.36	-20.82%
Portland	July 07	186.51	178.81	-7.7	-4.13%
San Diego	November 05	250.34	197.45	-52.89	-21.13%
Seattle	July 07	192.3	181.62	-10.68	-5.55%
San Francisco	May 06	218.37	183.81	-34.56	-15.83%
Tampa	July 06	238.09	194.64	-43.45	-18.25%
Washington DC	May 06	251.07	212.83	-38.24	-15.23%
10-C	June 06	226.29	196.06	-30.23	-13.36%
20-C	July 06	206.52	180.65	-25.87	-12.53%

Altos Links: For those of you with more than a passing interest in knowing thhe real estate data before these lagging indicators get published, Altos has two things for you:

1. Our monthly national real estate report publishes in real-time the housing price trends for all the markets covered by Case Shiller. CSI for January was published today. The Altos National Real Estate Report for February and March have already been published. April comes out next week.
2. Our full real estate data feeds are for institutions that make a living in the housing markets. You can now get data feeds for nearly 10,000 zip codes in over 40 metro markets around the country. We're publishing now an Altos National Composite price for the same markets as the Case Shiller 10. This is important because the derivatives trades are being done on the national index.
   

By the way, our data is highly correlated to the CSI. We'll be publishing correlations to the Existing Home Sales numbers very soon. Rock on.

Interesting report from the Anderson b-school at UCLA today. The economists there write the periodic Andersen Forecast on US and California economies. Theirs is an interesting perspective, as they've been vocal housing bubblistas for several years.

Some key points [My comments in brackets]:

• The data doesn't yet indicate recession. [This jives with my most trusted sources, which I've written about recently. Despite the obvious weaknesses in the economy, exports are strong and employment hasn't tanked. Money is cheap, if you've got good credit. But we're on the precipice.]
• The downturn in real estate related employment in California is an order of magnitude less than the manufacturing related job losses of the last two recessions. [true around the country]
• The higher conforming loan rates will not save us. [Lenders are so afraid that they're not generating anything right
  now...]
• The fact is that we've not seen an asset driven recession previously, though it could very well be coming. We're in new territory. "Stinky, but new." [ahh that new economy smell.]

ht: Inman

Back in New York this week for the Real Estate Derivatives World shindig hosted by Terrapinn. I know. Paaartay!

It's actually exciting for us as we're beta testing new data products we've designed especially for the real estate derivatives traders. Here's a quick glimpse of the Altos 25-City Composite Price, which tracks the Radar Logic 25 markets and the Altos 10-City Composite Price, which tracks housing markets covered with the Case Shiller national Index.

Full product launch and details soon. If you're interested in the housing futures markets, we should be talking.

Link: Altos Real Estate Derivatives Data

Been getting a few requests about our opinion on the various proposes economic stimulus packages in the works - including sharply reduced short term rates, and some kind of tax relief. How will they impact the housing market? Are we seeing any psychological impact already?

First things first: Are we in recession already? Is a recession inevitable?

From where we sit, the current-recession answer is, No, it doesn't appear so. Slowdown, yes. But exports are strong with the weak dollar, and there other signs of okay-ness out there. Gonna be hard to avoid one before the end of the year though.

Here's my favorite way to look at recession probability. The folks at ECRI publish a weekly leading economic indicator (WLI). In several decades they've not missed a recession call and have had no false-positives. This data is good.

What's this chart tell us? This data leads the economy by 6-9 months. ECRI looks for the Three P's of drop in its economic statistics before it calls a recession. Pronounced (check), persistent (check), pervasive (allllmost).

We're in the danger zone here, which is why immediate monetary (interest rates) and fiscal (taxes, etc) stimulus might just work.

Where does the housing market fall into all this?

We know that the real estate market is generally lousy. But really, really low mortgage rates mean that you can lock in affordability, if you have the credit. From Bloomberg:

For a long time, our worst case scenario here at Altos has been recession plus high interest rates. We've avoided that so far. As a result the pain in the housing market is most pronounced at the margins: Overstretched, with weak credit. New home construction. Here's what I mean.

So the weakness, while felt across the spectrum, is most acutely painful at the low-end of the market. That implies that a deep recession with it's job loss and income uncertainty is what it'll take to knock the final leg of the stool out from under the the rest of the market.

Conclusion: stimulate away, Uncle Sam, and do it quick.

We've had some really nice attention in the press and blogosphere the past week or so. Here's a quick summary so you can see what people are saying about Altos.

O'Reilly Radar: Tim O'Reilly highlights our real-time data products for Wall Street and the housing derivatives markets. I'll be presenting on this topic at the O'Reilly-sponsored Money:Tech conference in New York February 6-8.

In SFGate.com / San Francisco Chronicle Carol Llyod finds her friends in the market for a home in San Francisco - everyone is surprised how hot the market is. I love this kind of analysis. The data reveal so much more than the headlines can capture. Carol - have your friends email me and I'll set them up with the neighborhood level and insights that we do in our detail reporting.

Dustin thinks we're going to get acquired. And Robbie gives us a nice plug on Rain City Guide.

The bloggers at Redfin have been especially prolific lately. I like the approach Redfin uses for their blogging work. They've got a team of bloggers, each with an intelligent voice, tackling the local real estate markets they're in. None of it is too controversial, but it's solid content, targeted well for their customers.

Altos Links:

National Data for the Housing Derivatives and Case Shiller markets

San Francisco housing market

For the NAR conference this month I was a bit tardy in posting my travel schedule, and I missed some connections there as a result. So here's a heads-up for my conference travel schedule in January and February.

January 8-11 New York: Inman Connect conference. Brad Inman always throws a grand shindig. I make connections, friends, and new clients at every Inman conference. My meeting schedule is filling up fast, but I still have some time on Thursday and Friday. Give me a buzz and we'll get together. Scott will also be in attendance so we should have good coverage meeting old friends and new.

February 5-8 New York: O'Reilly Money:Tech conference. This conference is all about hacking Wall Street with new data and tools. It promises to be one of a kind. Love it. I'll be presenting on real-time real estate market analytics, plus our data that leads the Case Shiller and Radar Logic housing futures markets. We'll be demonstrating some never-before-public data goodies.

Lots of big shots presenting at Money:Tech too. Jim Cramer, Barry Ritholtz, Henry Blodgett, Bill Tancer, and more. Check it out.

As always, these trips are about meeting clients, partners, and readers. email mike at this url.com to get in touch.

Here's a fascinating development for anyone interested in the housing futures markets. Radar Logic has acquired Miller Samuel-- the eponymous home of Jonathan Miller, blogger of Matrix fame and all around good guy.

Radar Logic, in case you haven't been paying attention, has developed the second tradable index for futures and options in residential real estate. Their product, the RPX, differs from the incumbent Case Shiller Index in a few key ways. The CSI updates monthly, where the RPX is a daily update. Case Shiller tracks median price, RPX tracks price-per-square-foot. This difference is ostensibly to better align with the relative value of a property and to avoid entanglement with the changing nature of the properties themselves.

More important in this story however, is not the difference in the trading indexes (each has its own advantages) but the differences in the companies that support these indexes.

With this move, Radar Logic buys itself all kinds of benefits: revenue, diversification, and talent. Miller is arguably the most influential voice in residential property valuation markets today. He's certainly got more readers than Shiller, plus the regular CNBC gig. Radar Logic is building itself into a significant Wall Street player.

Shiller's firm MacroMarkets, on the other hand, remains a couple of introvert finance professors in Cambridge with a reputation as enormously difficult to do business with.

So place your bets. Expect the RPX to over take the CSI in trading volume very quickly. (Both are still thinly traded to date.) Radar Logic may just be making itself into the firm that can fulfill the promise of a real, liquid market in housing futures.

[Disclosures: At Altos Research, we sell data that leads the Case Shiller Index by 3 months. We have trader clients on Wall Street. We have no relationship with MacroMarkets, but wish they'd turn up the heat a bit. RPX stuff coming soon.]

I have huge respect for Jonathan. Great move by Radar Logic. Congrats to both. This is what the market needs.

They say when you age, everything slows down. There's now evidence to say that you home's value is included in that statement.

According to new research from HUD, the homes of people over 75 appreciate at 1-3% less per year than the homes owned by middle-agers.

The phenomenon appears to be determined by a few factors:

• older people = older homes = greater depreciation
• home improvement counteracts home age depreciation, but home improvement activity declines as people age

Full report here.

In case you missed it, long term interest rates are rising. In some respects this is actually good news. The yield curve, charting interest rates along their maturity duration, is no longer inverted. Recall that an inverted yield curve means short-term rates are higher than long-term rates, an awkward financial state that commonly signals a coming recession. So a positively sloped curve reflects general economic strength. That's the good news.

The yield curve first inverted nearly a year ago. It was a time of pick-your-poison for the housing market. To get "right", either we were going to see recession, where the resulting joblessness would pummel housing demand. Or we'd be faced with rising long term interest rates, making mortgages more expensive and pummeling housing demand.

Well, the economy has spoken. The bears are capitulating one by one, recognizing that the housing market downturn is not sufficient to drive the economy into a tailspin.

Instead we're faced with something much more mundane in the housing market cycle. Higher mortgage rates. Higher rates, coupled with tighter lending from the subprime cleanup. We've had such low rates for such a long time that returning to normal levels will seem like a foreign country. Every upward move in rates makes homes less affordable.

Macro shifts, a declining dollar, protectionism all seem to be lurching us out of the mortgage rate utopia and back t