Tuesday, January 18, 2011

House Price declines mean the Biggest Deflation since 1950

- by New Deal democrat

Last week Zillow made headlines with a report stating that Home Value Declines Surpass those of the Great Depression, specifically that:
November brought continued declines in home values. In fact, the Zillow Home Value Index has now fallen 26% since its peak in June 2006. That’s more than the 25.9% decline in the Depression-era years between 1928 and 1933.

Since there was no consumer price sub-index for housing in existence until 1935, Zillow either had to be comparing house prices to the overall inflation rate, or else using a different source. Since then, Zillow has confirmed that its source was Robert Shiller's book, Irrational Exhuberance, in which Shiller says in a footnote that house prices declined 25.9% from 1929 to 1933.

The problem is, like our own era, housing did not peak in 1929. In fact house prices peaked in 1925 according to tables derived by Shiller. Thus Zillow is comparing prices from our peak, but not the peak in the 1920's. For an apples to apples comparison, we need to calculate from peak values. Originally I thought that would negate Zillow's conclusion. The truth turned out to be just the opposite.

Using the data from Shiller's price table linked to above, we see the price index declined from a peak of 6.34 in 1925 to 4.41 in 1933, or 30.4% (note: Shiller's table only calculates on an annual basis for that era). In our era, the quarterly index peaked at 190.44 in Q1 2006 and has declined to a trough - so far, at least - of 131.39 in Q1 2009, for a decline of 33.0%. (Since then, it has rebounded slightly to 133.22).

But what about in "real" terms? Officially, we have inflation now, vs. about 25% deflation between 1929 and 1933. But of course back then CPI wasn't calculated using "owner's equivalent rent." Which means that doing a Case-Shiller price index adjusted CPI (or CS - CPI) comparison of cumulative price changes is the best method of comparison.

According to the BLS, the weight given to owner's equivalent rent is 23.830. For our purposes we can round to 25%.

The BLS calculation is that between April 2006 and March 2009, overall inflation was +6.5%. Owner's equivalent rent's 1/4 share of that, believe it or not, increased 7.8%. Thus replacing +7.8% with -33.0%, and giving that a 1/4 weighting of the inflation index gives us CS-CPI decrease of -3.4%.

In other words, not only have house prices declined slightly more than they did during the Great Depression, but the best apples to apples comparison of inflation from April 2006 through March 2009 means that we experienced a deflationary episode that is the worst since the -4.1% of 1948-50 (the 1938 Recession's was -5.5%). And while they haven't yet hit their 2009 bottom yet, since the expiration of the $8000 housing credit last May, house prices have started to decline again.