Tuesday, October 09, 2007

The Daily 2¢ - New Math, Old Reality

It’s been about a year and a half now since the husband and wife team of Gary and Margaret Hwang Smith, two professors of economics from Pomona College presented a paper at the Brookings Institute entitled “Bubble, Bubble Where’s the Housing Bubble?”.

Their paper initially took the fairly sound position of estimating a home’s “net present value” by calculating its potential cash flow, including rental income, but then proceeded at great lengths to justify the price appreciation seen during the boom years by making overly optimistic assumptions as well as including some truly fuzzy logic.

For example, the Smith’s assist the cash flow derived from rental income with additional value derived from “non-financial factors”, such as a “pride of ownership” and “desire for privacy”.

That’s about where the papers leaves reality and enters the realm of shameless contrivance.

I guess that might not be too surprising from a couple of professional real estate and financial “experts” who, having just recently purchased a nearly million dollar Craftsman style single family home in Claremont California, clearly had a lot at stake in justifying their “investment”.

The paper eventually concluded that many of the hyper inflated metro areas such as Boston, Los Angeles and Chicago were not only NOT bubbles they were actually UNDER PRICED.

"Buying a house at current market prices still appears to be an attractive long-term investment."

What’s worse though is that their paper (and story of their home purchase etc.) was picked up by the New York Times and published in an article titled “Some New Math on Homes” ironically on April Fool’s Day in 2006.

This article and the Smith’s paper undoubtedly did some serious damage as it painted that classic “things are different now” picture at the exact moment that the nation’s housing markets were beginning peak and then steadily decline.

I can only imagine the scores of people who read their story, bought into their proposition, and then felt more comfortable taking the plunge to home ownership right at the very peak of the market.

As if to add a final "insult to injury" the Smith’s now have a blog where they persist in making their “housing market still appears attractive” claim and further reveal that their analysis is to become the basis of a new book they have coming out titled “Houseonomics”.

Well, if it’s any consolation, it appears that the Smith’s home has not escaped the “actual” fundamentals of the downturn dropping nearly 2% on a year-over-year basis in August according to a SoCal Real Estate News and Data Source DataQuick.

Furthermore, southern California is now seeing homes sales fall steeply and steadily with the latest results showing sales dropping to their lowest level in 15 years.

With the S&P/Case-Shiller Futures for Los Angeles predicting continued declines to the price for single family homes and the inventory for Claremont climbing to new highs, the Smith’s may get what they deserve after all.