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Combined New & Existing Home Sales Price Indexes
and The Coming Great American Home-Equity Bust
by Bob Bronson
Bronson Capital Markets Research
March 28, 2004

Here are comprehensive house price indexes (mean and median) where we've combined both new and existing home sales prices weighed by their relative sales volumes. Because of the coming consumer-led recession, and probably two more recessions later during this K-cycle winter, or what we quantify as a deflationary economic BAAC Supercycle Bear Market Period, it's likely the July 2003 all-time price high (see chart below) for the average-priced home will stand for many years. A report explaining these terms and concepts is available upon request.

This is consistent with our call for a Great American Home-Equity Bust when the all-time high in the highest-price homes (over $1 M) occurred in 2000. Before I explain what that call is, and its significance -- should it prove to be correct -- I'll explain what data we used to opine that the highest-priced properties in America were peaking in price, on average, during the summer of 2000. 

We arrived at that conclusion by correcting for the lag and low volatility bias of the "official" house price indexes prepared by OFHEO, or the Office of Federal Housing and Oversight Management. OFHEO uses a "transaction pair" pricing methodology on their 20+ million "same" house in their database, which unfortunately introduces about a six-quarter lag compared to reality and dramatically reduces the associated price volatility. Transaction pairs of consecutive resales or refinancings have an about three-year duration between them, so that any price extremes, or trend turning points, that occur during those intervals are not revealed.

These index pricing problems from transaction pairs can be visualized by imagining what the Dow Jones 30 Industrial index would act like if every quarter only three components were marked to the market, leaving the other 27 unchanged. It would take 10 quarters (= 30 / 3) to reprice the whole index, which is about the same duration as the next resale or refinancing for a same house. Meanwhile this kind of index repricing would yield a times series that is much less volatile than if it was repriced much more frequently as the DJIA 30 really is. It also would cause cyclical turning points to be lagged, or reported late, by one-half the 10-quarter (30-month) transaction pair duration. This systemic lag means OFHEO's indexes will not report the cyclical turn in the trend in the average price of American homes until some six quarters after the fact, which according to the indexes below, means probably not until sometime late this year or early next year.

We avoid this lag and under-reporting of volatility problem by using a square-foot adjusted, same-subdivision pricing methodology. This is how we were able to make the our Great American Home-Equity Bust call when the all-time high in the highest-price homes (over $1 M) actually occurred in the summer of 2000.

The importance of our forecast is that we fully expect more than 50% of American homeowners will become under water, or upside down, on their home mortgages because of the deadly deflationary economic consequence of having borrowed too much on their homes and then their home price declining, on a comparable neighborhood-sales basis.

Because home equity constitutes the lion's share of family net worth, this complete loss of home equity by more than 50% of American homeowners will have a tremendous negative "wealth effect" on their consumption spending -- which is the primary force driving the American economy. This is especially a problem since Americans have run their income-based savings rate down to the its lowest level in history.

Since every family has to live somewhere, of course there won't be a selling panic and mass exodus from homes, although we fully expect an over-housing problem will be so exposed. Since homes are illiquid assets, we fully expect the negative-home-equity wealth effect will cause homeowner investors to massively liquidate their stock market investments, which will have already declined again -- see our recent calls for a major stock market top and subsequent second-leg, devastating bear market -- from having been so overvalued as they are today relative to a second coming recession. However this time the recession will be led by over- extended consumers, although businesses will have to cut back in concert, of course. We also expect it to be a global recession, but I'll cover that in another article.

Thus, a wealth-devastating positive correlation will arise between the stock market and home prices, which otherwise are importantly not so correlated. This will become an essential part of of a then emerging Mass-Correlation, Hyper-Volatility, Illiquidity Event, or what we have dubbed a MCHVIE. And more about this derivative-driven selling panic phenomenon in a later report.

No adjustments have been made for the fact that new home sales typically lead existing home sales by 30 to 60 days because new home sales are reported when a construction contract is signed or a deposit is paid, while existing home sales are reported when the sales contract is closed, which is typically more than 30 days after the sales contract was negotiated in its final form and signed.

Although the average new home is usually larger than the average existing home and no adjustments have been made for the difference in living space square footage or age or other valuation factors as required in fair market value appraisals, these missing comparable sales adjustment details do not significantly affect cyclical turning points in the home price trends that we're interested in anticipating.

© 2004 Bob Bronson
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Bob Bronson
Bronson Capital Markets Research
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March 28, 2004