Tuesday, March 13, 2012

How Far Have Home Prices "Really" Fallen? HPI Upcoming Changes; HPI and the CPI

Various charts show home prices are now back to levels last seen in September-October 2002. I posted such a chart constructed from the LPS Home Price Index (HPI) in LPS Home Price Index Shows U.S. Home Prices Accelerated Decline.

Real vs. Nominal Prices

Nominal prices are arguably not the best way of looking at things. I asked Doug Short at Advisor Perspectives if he would chart "Real" home prices. His answer was "In a heartbeat, if I can get the data".

"Real" in this case means "Inflation Adjusted" price, nominal simply means the "Current Price".

After receiving an Excel spreadsheet of the HPI data from LPI, I passed the spreadsheet on to Doug Short. I suspect he did not know what he was getting into, because once I supplied the data, I started asking for all kinds of charts.

I asked Doug for help for the simple reason his charts and the charts by Calculated Risk are in a class of their own. Advisor Perspectives frequently uses my articles so I went that route.

Note that "Inflation Adjusted" itself can mean many things, and indeed this post will take a look at "Real" home prices from several angles.

HPI Nominal Price, PCE Adjusted, and CPI Adjusted

click on any chart for sharper image

The two most common ways to adjust for price inflation are the CPI (consumer price index) and the PCE (personal consumption expenditures index). We use the CPI in the rest of the charts below because individual components' percentage weights are readily available.

HPI Comparison

  • Nominal prices have fallen to a level first surpassed in August 2002
  • PCE adjusted prices have fallen to a level first surpassed in March 1999
  • CPI adjusted prices have fallen to a level first surpassed in March 1998

That sounds pretty dramatic and it is. However, I propose the bubble is bigger and the crash worse than using the CPI deflator straight up.

CPI Flaws

One of the biggest flaws in the CPI is its measure of home prices. The CPI does not track hope prices per se, rather the BLS uses a concept called "Owners' Equivalent Rent" (OER) as a proxy for home prices.

The BLS determines OER by asking the question “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?

If you find that preposterous, I am sure you are not the only one. Regardless, rental prices are simply not a valid measure of home prices.

Indeed, home prices rose three standard deviations from rental prices, a sure sign of a a housing bubble, and the Fed ignored it every step of the way.

I propose home prices straight up do belong in the CPI. Homes may have a longer lifetime than other consumables, but homes (not the land they are sitting on), are indeed consumed. Without maintenance, painting, upkeep, air conditioning, heat, etc., homes will slowly but surely rot away.

Whether or not one holds that view, it is absurd for the Fed to have ignored (more precisely cheered) the housing boom every step of the way.

Please check out the following graph of OER compared to the HPI.


To the Fed, everything looked "hunky-dory" in the face of the biggest housing bubble in history because they paid attention to OER rather than actual prices.

OER Weighting in CPI

OER has the single largest weight of any component in the CPI, at 23.957%.

Let's play "What If?" Specifically, "What if the BLS used actual home prices instead of OER in calculating the CPI?"

I asked Doug Short to graph that concept. By the way, I did this once before using Case-Shiller data with help of a friend "TC" who also put together some fine charts made by substituting the Case-Shiller index for OER in the CPI.

I called that result Case-Shiller CPI. See CPI and CS-CPI vs. Fed Funds Rate from November, 2008 for a description of Case-Shiller CPI.

Let's call these results HPI-CPI.


The Fed kept interest rates at historic lows between 2002 and mid-2004. The last two rate cuts by Alan Greenspan were not justified at all, by any measure, and downright absurd considering the bubble brewing in housing prices vs. rent.

Allegedly the Fed held interest rates low to prevent "deflation". Instead it exacerbated "price deflation".

Clearly the Fed had no idea what it was doing, and still doesn't, (unless of course you believe this is a Fed conspiracy to deliberately screw the middle class). The result is bubbles and crashes of ever-increasing amplitude as the Fed chases its own tail. New bubbles have formed in the stock market and commodities right now.

HPI Upcoming Changes

Changes are coming up next month in the calculation of the HPI index. Here is a relevant snip from LPS via email.
"Beginning next month, LPS will be basing its findings on an updated view of market structure to more accurately reflect the dramatically increased proportion of short sales transactions as compared to historical norms," said Raj Dosaj, who leads the HPI team for LPS Applied Analytics. "Starting with January 2012 transactions, the base HPI will shift, as short sales are excluded; though given the fact that there were few short sales prior to 2007, the impact will be most pronounced on data from that point forward."
Fed Policies Devastated the Middle Class

Inflation benefits those with first access to money, namely the banks and the already wealthy. In the case of housing, by the time money was made available to those lowest on the totem pole, a housing crash was baked into the cake.

In that manner, Fed policies have devastated the middle class, complete with bank bailouts at taxpayer expense, Fannie Mae and Freddie Mac bailouts at taxpayer expense, and the robbing by inflation of those on fixed income struggling to get by on 0% interest rates on their savings while the Fed holds interest rates at zero.

This concludes part one of two-part series on HPI data, the CPI, and interest rates. Still more charts and an analysis of treasury rates are coming up shortly.

Mike "Mish" Shedlock
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