IMF Paper: US Housing Overvalued by 14%, Likely to Overshoot on Downside

Research by an IMF economist concludes that US residential real estate was overvalued by 14% as of the first quarter of 2008. The paper seeks to define an equilibrium price and also anticipates that the housing market will fall markedly below that level.

From Reuters (hat tip Michael Panzner):

The downward spiral of U.S. housing prices still has a way to go and homes were overvalued by between 8 percent to 20 percent in the first quarter of this year, according to research by an International Monetary Fund economist published on Friday.

In his report “What goes up must come down? House price dynamics in the United States,” IMF economist Vladimir Klyuev used several economic techniques to determine by how much U.S. home prices are overvalued.

Klyuev drew from a government study of single-family home prices to conclude that values were “around 14 percent above equilibrium in the first quarter of 2008, with a plausible range of 8 to 20 percent.”

His research showed that home prices became considerably overvalued from 2001 and while the housing market has started to correct itself, there is still a long way to go…..

The report also said that it is likely home prices will swing well below their equilibrium level before they start to recover.

Klyuev’s research included data gathered by the U.S. Office of Federal Housing Enterprise Oversight which regulates mortgage-finance companies Fannie Mae and Freddie Mac and collects purchase price data.

Klyuev analyzed the dynamics of home prices and found the inventory-to-sales ratio the most important driver of changes in property values in the short run.

“Starts in foreclosures, which obviously add to inventory, seem to also exert additional downward pressure on prices,” he added.

According to the research the bloated inventory-to-sales ratio, high foreclosure rates, and inertia in housing markets imply that recent price declines are likely to continue.

The research also considered whether the current fall in U.S. housing prices represented a nationwide bust.

“While the national price level is falling on every measure, there is an opinion that this decline might reflect oversized drops in a few isolated markets rather than a countrywide phenomenon,” it said.

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  1. Rick

    Is there a link to the actual article?

    The generic "X% drop in US home prices" is fairly meaningless, except in continuing to inflame anxieties and additional generic statements. The average home price may be meaningful, but so might the median home price. So might the ratio of houses under contract to listings, and days to sale, etc etc. Maybe the article does discuss all of this…

    Since all real estate is about location (location location), to either a homeowner or a mortgage creditor (other than the US govt) the relevant data is that which is local and specific.

    For example, in "Silicon Valley" (nee Santa Clara County) in California, there are dozens of of defined (by the local realtor ass'ns) "Areas". Some, such as the Los Gatos/Saratoga Area have seen next to no decline in prices, and have seen something of pick-up since May of this year in houses under contract. Other "Areas" of the county (Alum Rock, South Almaden, Morgan Hill?) have seen prices plummet >30-40%, and the "average" house price decline for the Silicon Valley is of no help (nor interest). And all this variance is within one county of one state.

    In any case, just by discounting with updated (and potentially upcoming) increased interest rates – without any change in supply/demand factors – "drops" the value in "national" home prices, so I would submit that the stated overvaluation measure is neither particularly accurate (probably far too conservative), nor particularly meaningful – except of course to the extent the US taxpayer is picking up the tab for FNM and FRE's (necessary) recapitalization.

    (However, isn't there a conundrum within the valuation problem once "risk free" (US Treasury) capital is being used to underwrite the assets? Should the value of the REO owned by the US govt be calculated using a discount equal to the risk-free rate, or at the rate corresponding to the originator who has offloaded the asset, or at a rate corresponding to the potential buyer? (But if the Buyer uses a GSE sponsored/gtee'd loan, what discount rate applies?)

    (NB the quotes around "risk free"… NAB has already weighed in with its assessment, and the continuing decline in the value of the dollar supports a modification to that longstanding assumption…)

    R in NY

  2. David Merkel

    Yves, here’s the link.

    The caveats that I would point out are inflation arresting the slide in nominal terms but not real terms, that we are dealing with averages, that land scarcity does lead to some upward change in land prices in real terms, and that we could get an undershoot. Economic systems rarely return to equilibrium.

    Aside from that, he is in the right ballpark.

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