Economic Predictions for the New Year: 2009

Economic Predictions for the New Year: 2009

Austin J. Jaffe, Ph.D.Chair, Dept. of Insurance and Real Estate, andPhilip H. Sieg Professor of Business AdministrationPenn State University

PAR Business MeetingsHarrisburg, PA

January 26, 2009

Overview of Presentation

Introductory Remarks Some Amazing Data 2008 Overview

“Ten Events That Shook the Real Estate World” The Pennsylvania REALTOR (December 2008)

Updates for 2009 Nationally Pennsylvania

Jaffe’s Five “Big-Time” Predictions Concluding Comments Q & A

Introductory Remarks

Thanks for the invitation. Pleased to be back in “Central PA” PAR Blogs, a new feature: “Just Listed”

“A Fine State of Affairs” (L&H) It was suggested that I talk about the “state

of the economy and how it affects housing in general and PA in particular.”

There is a great deal of uncertainty in this business currently and the next few months may be challenging.

My plastic shields have been raised, so feel free to throw whatever tomatoes you wish!

Some Amazing Data

I have only 2 graphs today. There are many more available

but we will look at only these today.

Some pictures can be important: (1 Picture = 1000 words)

Then we’ll look at several issues.

Conclusions from Case-Shiller and Shiller Data

We have yet to hit bottom of the national house price decline.

Whether one uses the 10-City or 20-City (or “100-City”) Indices, housing markets are very highly correlated, especially now.

Most experts predict further declines in house prices and housing transactions during the year ahead.

Most experts predict further increases in time on the market, defaults, and foreclosures during the year ahead.

Conclusions from Case-Shiller and Shiller Data (cont’d)

Examining the long-term house price data series, the boom in house prices from about 1996-2006 was unprecedented.

There are several reasons for the boom/bubble in house prices.

The fact that the traditional equilibrium ratios are still considerably above historic levels suggests continuing falling prices.

The economic environment is making life even more difficult.

Are We Having Fun … So Far?

These developments are the ultimate reality check for many people in our industry. How many of us argued that there was a housing

bubble growing and one day it would burst? (Very few of us.)

Who knew how toxic the MBSs were despite AAA ratings? (None of us.)

Who expected continually falling house prices which turned all financial calculations upside down? (Absolutely no one?)

How many times did you refer to housing as a financial asset rather than as a consumption decision for the household? (Over the past 15-20 years, almost always!)

Well, There is Some Good News!

Pennsylvania is not like the formerly “hot” markets (e.g., Nevada, California, Florida, Arizona).

Pennsylvania is not even like its western neighboring states (e.g., Michigan, Ohio).

While Pennsylvania’s population tends to be unevenly distributed across the Commonwealth, few urban areas are in as serious trouble as in those above.

2008 Overview and 2009 Updates

The PAR staff asked me to write a summary piece for The Pennsylvania REALTOR about the turbulent year which has just passed.

It was entitled “Ten Events That Shook the Real Estate World” (December 2008).

Today, the plan is: a) to review these seismic events from 2008, b) to update them for 2009, and c) to focus on Pennsylvania (where possible).

2008 Overview and 2009 Updates: #10

“The term ‘subprime mortgages’ became part of our vocabulary.” The rise of Subprime and Alt-A mortgages

was widely heralded when property values were rising and credit was readily available.

Qualifying for mortgage finance was often trivial and aggressive, new mortgages were used.

By late 2006, the party was over and housing prices began to fall (and they have not stopped declining for at least 25 consecutive months).


“The term ‘subprime mortgages’ became part of our vocabulary.”

2009 Update: Subprime mortgages are dead; new subprime

borrowers are non-existent; old subprime borrowers are often in trouble and where they have refinanced, they are often back in default.

In Pennsylvania: Considerably lower incidence of subprime

mortgage borrowing/lending existed than in most states; part of “The Pennsylvania Story” is the relatively low amount of housing speculation.


“Foreclosure filings rose significantly during 2007.” Defaults and foreclosures became major issues

since 2007. Recent data indicates more than 3 million

foreclosures occurred nationwide. More recently, foreclosures resulted from

traditional economic problems (unemployment, weak economy); in 2006, problems stemmed from ARM resets and falling house prices.

More attention paid to foreclosures now than any time since the 1930s.


“Foreclosure filings rose significantly during 2007.”

2009 Update: Most recent RealtyTrac data shows foreclosure

numbers are up 81% at beginning of 2009 from a year ago.

However, virtually half of all foreclosures in AZ, CA, NV, and FL.

In Pennsylvania: Foreclosures are up more than 127% from 2007-08

in the most recent study. Yet, PA ranks 32nd amongst 50 states and DC at

about 1/3 of the national average. I would expect foreclosures to be problematic in

only a few counties in PA.


“Financial problems led to bankruptcies.” Many large residential lenders failed in 2007

(e.g., Ownit Mortgage, ResMae Mortgage and New Century Financial) and others followed (e.g., Countrywide Financial and Washington Mutual Bank) during 2008.

Many of the loans made at these institutions were highly risky.

With falling house prices, they did not have a chance to survive.


“Financial problems led to bankruptcies.” 2009 Update:

Despite billions in TARP funds for lenders, it is not clear that the financial crisis is over for institutions with “toxic” mortgages on their books.

Giants have fallen during 2008 and will more tumble in 2009?

In Pennsylvania: I am not an expert on the status of PA banks but if

the financial system does not settle down, mortgage lending in PA will definitely be affected.

Smaller, state-chartered banks claim they have plenty of funding since they have not been mortgage market players.


“Mergers and acquisitions grew in the mortgage market.” Countrywide and Merrill Lynch became part of

Bank of America, Bear Stearns and Washington Mutual were taken by JP Morgan, Lehman Brothers is being sold in pieces, Wachovia is gone too (now part of Wells Fargo).

Equity values collapsed overnight as fear rose about the declining values of large MBSs (e.g., CDOs).

Mortgage products became unwanted goods.


“Mergers and acquisitions grew in the mortgage market.”

2009 Update: It appears that the major changes occurred

during the second half of 2008. However, there is still plenty of trouble (e.g.,

can Citigroup survive? Which smaller, regional banks are heading for failure? AIG might need more?).

In Pennsylvania: Does anyone have any new data? My guess is

that PA will produce fewer bank failures than other states.


“Mortgage and mortgage-backed security (MBS) write-downs hit Wall Street.” From 2007 onward, every major investment

bank had major write-downs including UBS, Morgan Stanley, Merrill Lynch, Citigroup, AIG, Bank of America, HSBC, others (except Goldman Sachs).

Many banks had several write-downs in various periods (earnings quarters).

These are billion dollar losses (e.g., $5-15 billion is common, and some have multiple write-downs).

2008 Overview and 2009 Updates: #6 “Mortgage and mortgage-backed security (MBS)

write-downs hit Wall Street.” 2009 Update:

It was said that after TARP financing, the problems would stop.

Now there are new fears that there are more toxic loan portfolios on several balance sheets.

Continual falling prices will make conditions worse. The Fed may pursue an aggressive policy of buying

up billions of these mortgage pools to stabilize mortgage markets.

In Pennsylvania: There will continue to be fallout in PA from this Wall

Street turmoil. Weak financial markets are now taking their toll on

financial industries in PA.


“Fannie Mae and Freddie Mac became illiquid and nationalized on September 7th.” Also, AIG was bailed out (now at $150 billion);

GSEs cost taxpayers $200 billion. The was a genuine fear of the collapse of the

entire financial system. Note: shareholders did not get bailed out. The future is uncertain for Fannie and Freddie.


“Fannie Mae and Freddie Mac became illiquid and nationalized on September 7th.”

2009 Update: Fannie and Freddie were instrumental in running the

secondary mortgage market and held ½ of the mortgages made and sold nationally.

One way or another, the GSEs will be reinvented since they are a fundamental part of the US financial system.

They may be reconstituted as federal agencies. They will definitely not reappear as they were before.

In Pennsylvania: PA mortgage lenders are limited (as elsewhere) with the

freezing of credit and mortgage markets. The experience of liquidity “sloshing about” including

mortgage credit, is definitely over for some time. No more easy credit and loose lending standards for

years to come.


“ ‘Underwater’ took on a new meaning.” It used to be called “negative equity” and it

was relatively rare. Now, one is “drowning” when the amount of

the mortgage exceeds the value of the house.

This is not due to non-amortizing loans; it is due to falling prices throughout the country.

Estimates are that as many as 20% of homeowners are “underwater” during 2008.


“ ‘Underwater’ took on a new meaning.” 2009 Update:

Expect the problems to continue: perhaps as high as 15 million households!

In Pennsylvania: Since property values have not dropped very

much in most PA cities, negative equity is a relatively rare experience in the Commonwealth.

Nonetheless, where negative equity conditions occur, watch for defaults and foreclosures, just like anywhere else.

The PA numbers will be smaller, but the pain will be just as tough for those involved.


“The federal government took an active and historic role in the mortgage markets.” First, Hope for Homeowners (FHA decides to

refinance programs to avoid foreclosure but only to a small percentage in need).

Next, TARP funding (but not used directly to bail out mortgage borrowers).

Then, the Fannie and Freddie rescue attempts (the results are still not clear).


“The federal government took an active and historic role in the mortgage markets.”

2009 Update: Expect a continuing, active role for Treasury and

the Fed. New administration may be even more activist. Look for more attention to be focused on

avoiding foreclosures than on stabilizing the financial system.

Also, $1 trillion “fiscal stimulus” plans abound … In Pennsylvania:

Weakening economy will exasperate problems in mortgage markets: just announced 6.7% PA unemployment figures.

Mortgage lending in Pennsylvania will return but probably at a slower pace.


“The nation continued to witness declining house prices.” Falling house prices has to be the

biggest surprise (and most significant problem) of the crisis.

The price/income and price/rent ratios remain historically very high (see data below).

Any new building and foreclosure sales make things worse.

2008 Overview and 2009 Updates: #2 “The nation continued to witness declining house

prices.” 2009 Update:

Price/income and price/rent ratios are still too high. Prices will not stabilize until inventories are

reduced (now at 11-12 month levels). There is no evidence in the empirical data that the

bottom is near: sorry! In Pennsylvania:

Since PA housing markets tend to lag national figures, expect greater losses than in previous periods. More to come …

However, PA price changes will never be as significant as in many other states.


“Finally, we can welcome 2009 as the ‘year of the thaw’.” This was CNN’s recent prediction. However, the economic news has not

been good since the end of 2008. Many experts continue to expect (hope)

for the beginning of a recovery during the second half of 2009.


“Finally, we can welcome 2009 as the ‘year of the thaw’.”

2009 Update: There is no question that a thaw has begun in credit

and some mortgage markets. However, there is a long way to travel down this road! Even if credit spreads return to normal, housing

markets will take even longer to resemble normality. In Pennsylvania:

I expect the second half of 2009 to be much better for PA housing markets.

We are fortunate that while a thawing in PA is welcome, it is not as desperately needed as in many other states.

However, if the general economy continues to decline, “all bets are off.”

Jaffe’s Five “Big-Time” Predictions

This is the grande finale … I am fairly confident about each

of the following claims and predictions.

However, only time will tell if they are correct …

“Big-Time” Prediction #1

House prices will continue to fall (despite our hopes and prayers to the contrary).Evidence: the standard price/rent

and price/income ratios remain out of line. (See next slide.)

Also: futures markets suggest continuing lower prices.

Other Studies Predict Lower House Prices in the Future

From 2001-06, house prices rose 74%, yet household incomes rose only 15%. (MSNBC, 2007)

From 1960-95, average rent/house price ratio was 5.0%-5.25%. By 1996, the ratio was 3.48%. (WSJ, Jan 3, 2008)

From 2000-05, the ratio of house price to family income rose 42% above the mean ratio for the previous 25 years. As of Aug 2007, ratio was still 32% above the mean. (Goldman Sachs, 2007)

Fortune Magazine (Nov 7, 2007) compared current price/rent ratios with 15 year historic averages:

Orlando: Current 23.8 / Traditional 14.9 Miami: 27.2/16.0 Philadelphia: 18.6/12.5 Etc.

Thus, they reported that real estate markets were poised to fall 20-35% over next five years.


One turning point in the housing crisis will be when the rate of foreclosures slows down. Evidence: foreclosures have dramatically

weakened prices since they increase the supply of housing units available on the market.

Foreclosures began due to sub-prime defaults, but now are being complemented by households who are unemployed and are being rejected by credit markets.

Sheila Bair (of FDIC) has persistently argued for new governmental programs to stop foreclosures. Watch for some developments!


Another turning point will signal the end of the housing crisis. Evidence: when house prices stop falling,

market confidence will quickly return. After all, at that point, down payments and

equity build-up will no longer be at risk. Also, this event will tell borrowers and

investors: “it is safe to go back in the water.”


Low or falling interest rates will lead more to additional refinancing of existing mortgages rather than to new purchases. Evidence: the financing gains to current

borrowers have begun to stimulate a new round of “refi” financing.

This is very good for current homeowners but does not affect the real estate brokerage industry directly.

Mortgage interest rates are important for a housing recovery but less so than other factors this time.


Housing in Pennsylvania has its own, unique characteristics. Low appreciation rates since the 1990s. Low depreciation rates since 2006. Significant lags in price changes compared

with other states. Less risky borrowing practices. A stronger state economy (despite some

weakness) than the national averages.

Finally, one of the best groups of REALTORs and the best REALTOR association in the country!

Concluding Comments

I hope these remarks have stimulated some interest, new thinking and forthcoming conversation (later today in small groups).

I hope it has not been too depressing! 2008 is likely to be the most difficult year in

real estate since the early 1930s. 2009 appears to be when recovery begins. However, much depends on national politics,

the overall economy, and the inventory of housing on the market.

Reminder: Local markets are never identical to regional or national markets, but they are very often positively correlated.

Q & A …

Thank you for your interest and attention!

There are no silly questions!

We have time to discuss any of the issues raised here or any other real estate matters!

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Economic Predictions for the New Year: 2009

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