California’s Housing Bubble in Case-Shiller Data

The irrational exuberance experienced by California housing market participants stands in sharp contrast to the relatively stable valuations seen in non-bubble markets. While the low tier of the Atlanta market has declined dramatically in the last two years, the Atlanta market did not experience the bubble-based valuation seen in San Diego, Los Angeles/Orange County, and San Francisco.

Case-Shiller Low Tier Indexes, California and Atlanta Markets

On a relative basis, the high end of the market did not rise as much — and has not fallen as much after the bubble collapsed. Nonetheless, the distinction between California markets and the non-bubble control (Atlanta) is clear.

Case-Shiller High Tier Indexes, California and Atlanta Markets

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Feb 2011 LAOC Case-Shiller Review

All data from Standard & Poors’ Case-Shiller Index

The above chart reviews the long-term history of housing prices in the Los Angeles & Orange County (LAOC) market. While the LAOC market had a modest bubble in the 1988-1991 era, the more recent price bubble from 2000-2006 dwarfs the overvaluation seen in the early 1990s. While all homes in the LAOC region increased in value — far beyond what fundamentals would support — such increases were largest in the lower tiers of home values. The subsequent correction of home prices retained this variability: the lower tier plunged the most.

A look at the data from Jan 2005 to Feb 2011 reveals the magnitude of the decline, by tier, in more detail. The lowest tier of homes in the LAOC area has lost over half its value. By contrast, the most expensive tier has declined “only” about 30%.

The more recent data also show the impact of the temporary $8,000 tax credit. This credit essentially provided an $8,000 subsidy to buyers, leading to over-valuation of properties by at least $8,000. The true beneficiaries of this credit were those who chose to sell a home during the time the credit was offered. Such sellers obtained at least $8,000 more than true (unsubsidized) market value for their properties — and benefited from a false sense of urgency related to the end date of the tax credit. Predictably, as soon as the credit was no longer available, prices fell by at least the amount of the credit — and credit-enabled buyers simply overpaid by $8,000. The rub for these buyers is that they are now overpaying property tax ($80/year in California) for as long as they own the home.

Mathematically, an $8,000 subsidy has a much larger percentage impact on lower-tier homes (vs. upper-tier homes), and the data reflects that fact: the “bounce” from the temporary intervention in the market distorted the true market equilibrium price upward much more for the Case-Shiller LAOC low tier data series.

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