Tuesday, January 31, 2006

Demography is Destiny

In the long run the demand for housing is driven by demograhic factors including household formation and incomes.

On an inflation-adjusted basis household incomes in the US have increased substanstially and fairly steadily for many decades. To get a closer look household income distribution is divided into five 20% bands. Using this data we find that incomes have increased at a faster rate for the upper bands than for the lower bands.

The data is presented on a nominal (current dollars) and inflation-adjusted (2004 dollars) basis on this Census bureau web page: http://www.census.gov/hhes/www/income/histinc/h03ar.html

Note that real income has increased substantially in every income band over the decades through 2000 or 2001, and then slipped a little in the last few years.

Housing prices are heavily driven by the upper income bands. Generally, the middle band is the source of first-time buyers, while the upper bands are the trade-up buyers and second home buyers. The bottom two bands are predominantly renters.

But what about the future real demand or real need for housing?

By looking at population distribution by age we can forecast the real housing demand for many years into the future. Here is a graphic display of population by cohort:

Note the steady increase in the forecast of adult population in the coming decades. This is not speculation – the people are already born for the 2020 forecast. If you slice this data carefully and evaluate the propensity to own by age cohort, the result is not only a rapid rise in household formations in the next 10 years but also a strong rise in expected homeownership through the next 20 years.

However, none of this precludes cyclical downturns.

For the benefit of housing demography buffs with insomnia, here is a Census report that gives some interesting perspective on population trends.


At February 01, 2006 1:21 PM, Anonymous DoctorWho said...

Interesting demographic charts at NationMaster. Looks like a rodent passing through a snake.

Good links, good analysis.

The housing market? Minor downward trend in the range of 3% to 6% per year in the hot spots only, for ~ 3 years, then trending up. No national decline. I imagine I'll be buying again in 2010 here in coastal CA.

At February 01, 2006 4:44 PM, Blogger fewlesh said...


Thanks for that gem, NationMaster.
Now on to analysis.

In an earlier article, you state that during the S&L crisis many banks defaulted before even hitting the peak. You argue that since we don't haven't the number of bankrupties as last time, there is no panic, and to exagerate, say move along, nothing to see.

Unfortuntaly, this time around, we have Freddie Mac and Fannie Mae, or FF for short. Much of the housing risk has been transfered to these government institutions. They have been made "too big to fail". Whenever someone creates something "too big to fail", in the past, it has done just that. Much of the credit risk has been transferred to FF. In an email argument from my friend he states this:

"You have it backwards about the source of the strength of the link. derivatives and MBS spread the risk around, instead of forcing it to remain concentrated in those sad government institutions. The spreading of risk reduces the probability of implosion and discontinuous or jump movements in the market. It increases the number of players who basically hold all of this debt paper, so in the event of default each market participant suffers reduced losses. In the event that rising interest rates induce a drop in housing prices, the ARM payers will experience a higher rate of default. However, derivatives will significantly reduce the chances of cascading defaults by those who have written all of these bad loans. Losses don't necessitate default."

Do you believe any systematic shocks caused by the falling prices in houses can be contained by FF?


At February 01, 2006 9:53 PM, Anonymous doctorwho said...

Interest rates and unemployment will tell the tale. If those spike, watch forclosures. If rates and employment stay steady, watch the paint dry.

At February 01, 2006 11:59 PM, Blogger zephyr said...


Large stress when concentrated has a more disruptive effect than the same stress when spread widely. I agree with your friend’s assessment that the risk of system collapse is much lower now than in the past, if faced with the same magnitude of stress.

However, my point about the bank failures etc. in the late 1980s is that the stress and damage then was greater than what we have seen in this cycle. So far we have not reached the same level of stress on the system, as evidenced by the lack of such failures to date. It could happen. I am not saying there is nothing to worry about – only that it was worse last time.

You say that “Unfortunately, this time around, we have Freddie Mac and Fannie Mae...” You imply that their presence is a new negative factor. However, they are not new at all. They were part of the last cycle peak, and have been around for decades. Their system withstood the stress of the 1990s bust.

The fear of Fannie Mae and Freddie Mac as a market destabilizing factor is misplaced. It would be more accurate to observe that the mortgage market is at less risk today because the system that they provide is less vulnerable than the other alternatives. Their increased market share has been favorable to stability.

At February 02, 2006 7:36 PM, Blogger fewlesh said...


(one of my favorite series, btw. especially ironic that you pick the title of a person who can travel back in time and attempts to fix problems caused by time travel)

employment is such a lagging indicator that it is poor to make investment decisions based on this number.

interest rates are an extremely broad measure of so many factors, it is difficult to gleam too much from them. There are many people who parse the minutes of our fanciful FED, and have them predicted out much better than I. I look to long 10 term bond rates. I think they provide a good "pulse" of things to come, as bond investors must make long term bets, and use a lot of analysis to guage their decisions.

Notice the inverted yield curve. Long term bonds are priced very low. Bond investors are predicting recession. I'm sure you are aware of this. I enjoy how the inverted bond yields are crunching the sub-prime mortage lenders (CFC looks extremely juicy). I was thinking of shorting them, but I don't like making short term or short investments.

What do you think of the 30 year treasuries coming back? Sounds like our government is trying to lock up dollars for a long time.

At February 02, 2006 11:02 PM, Anonymous doctorwho said...

Interest rates and unemployment are leading, not a lagging indicators for housing in my opinion. I believe Zephyr and I may disagree on the effect interest rates have on the housing market, but in my experience there are very few things that can stop sales NOW like a steep rate increase. Stated another way, the housing industry (NAR, BIA et al) are fearful of rising rates like little else, save employment.

The mortgage rate graph at the bottom of this page shows where rates were during the last corrections in '80 and '90. I'm not saying a causal relationship exists, but I do say rates play a leading role, among others.


As to unemployment, obviously if many folks lose their jobs (as they did in L.A. in the early 90's), homes in forclosure will follow, making it a leading indicator.

Re: bond yeilds, the flat or inverted curve, etc.: That is not an area that I know enough about to speculate on.


I don't much care or follow what bonds etc. are doing or trending. Bores me rigid. Personaly, my money is made from business ownership and invested either in expansion, new ventures, real estate, or a "balanced" portfolio of stocks and bonds etc.

The portfolio has always been by far the lowest performing element of my investments. By far. Yet it is also supposedly the least risky. But I digress.

At February 03, 2006 9:15 PM, Blogger fewlesh said...


just to inform you of my limited knowledge of yield curve inversions, and to use data that you gave me.

Please look at the figure
"Historical Graphs For Mortgage Rates: Long-Term Trends" for 1992 - 2005

See how the interests all bunch up Jan 00-01. Well what happened around then? Nasdaq colapse.

Now I know that I'm extrapolating from one event, but let me put yield curve inversions into context.

Yield curves invert when the FED raises interest rates quickly. It is like a bull whip. The interest rates ripple through to longer and longer terms. When the short term rates rise over the long term rates, that is the crack of the whip.

That cracking of the whip makes it hard for banks to make money: borrow long at low interest, to lend short at higher interest. It creates all sorts of strange problems. It is why right now a 15 year mortgage is cheaper than a ARM loan, etc.

nice weekend all.

At March 15, 2006 12:01 AM, Anonymous Anonymous said...

You really should either up-date this blog or put it out of it's misery, old chap.

At March 20, 2006 10:22 PM, Blogger zephyr said...

Anon: This site is not meant to be an active discussion board - nor is it a daily brain dump like so many others. I am not looking to be a news source or an aggregator. I post only occasionally and only regarding what I feel are key issues.


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