A Bright Spot in Housing: Construction Costs

By Casey B. Mulligan
A construction worker at new building site in Arlington, Va.Michael Reynolds/European Pressphoto Agency A construction worker at new building site in Arlington, Va.

Update | 2:46 p.m. Updated to clarify what components the price index refers to.

Today's Economist

Casey B. Mulligan is an economics professor at the University of Chicago.

Yesterday the Bureau of Labor Statistics released its producer price index for residential construction. Its significant increase from July to August is a good sign for the housing market.

The producer price index for single-unit residential construction measures the average change over time in the selling prices received by domestic producers of materials for houses. The chart below displays the index for each month of 2008 and 2009.

source: Casey B. Mulligan, using data from the Bureau of Labor Statistics

The price index is of economic interest because it is an important determinant of the prices of existing homes. Few people want to pay more for an existing house than they would pay for having one built new. As a result, the housing P.P.I. is an important ingredient in economic forecasts of housing prices. For example, once it was clear that the housing “bubble” was over, it was (part of) the basis for my forecasts last fall of how far housing prices would ultimately fall (see also Edward Glaeser’s post).

Additionally, the housing construction P.P.I. is more amenable to real-time analysis than are the housing price indices. For example, the Bureau of Labor Statistics releases its P.P.I. within about two weeks of the end of a given month, whereas the Case-Shiller index is not released for another two months.

An end to the housing price decline is welcome because low housing prices are the main reason for the extraordinary prevalence of foreclosures.

When housing prices fall, many homeowners owe more on their mortgage than their house is worth (that is, “their home equity is negative”), and even a homeowner with plenty of income can gain financially by letting the bank take his house rather than continuing to pay his mortgage in full. That’s why Stan Liebowitz, a professor at University of Texas, Dallas, found that negative equity was a more important factor than unemployment in causing the foreclosures, and why the researchers John D. Geanakoplos and Susan P. Koniak argued that foreclosures are “stunningly sensitive” to the amount of home equity.

That’s one reason why it was good news yesterday to learn that the housing P.P.I. was greater in August than it was in July. Once housing prices stabilize, homeowners will start to accumulate equity again, and we can eventually close the book on the foreclosure crisis.

Comments are no longer being accepted.

simon September 16, 2009 · 8:24 am

The upward tick at the end of the curve is, I think, the result of buyers anticipating the end of the 8K tax deduction program, and does not necessarily indicate that home prices are now trending upward.

Gignere September 16, 2009 · 8:35 am

Good try professor but we are not at bottom yet. What happens when interest rates goes up?

How can any economist even begin to predict a bottom in housing prices when we are not even at a normal interest rate (0 is anything but normal)?

It just totally confuses this lay person.

AnnS September 16, 2009 · 10:10 am

(1) Rising costs are GOOD? For whom?

Rising costs are most certainly NOT good for the buyers whose wages have been flat or falling for years!

NYT is always worrying about affordable housing. How can it possibly claim that rising prices for an essential goods (shelter) are good in the face of declining incomes?

(2) The NYT keeps on prattling this false statement of “An end to the housing price decline is welcome because low housing prices are the main reason for the extraordinary prevalence of foreclosures. ”

NO NO NO NO! Falling prices did NOT cause foreclosures,

Foreclosures were caused by:

(a) People buying more than they could afford and using 2/28 and 3/27 ARMS with ridiculously low teaser rates. When the payment reset, they couldn’t pay the real interest and principal. (These were the subprime.)

(b) People buying more than they could really afford and using ‘liar’ or NINJA loans with no documentation of their income and assets to get a loan for more than they could really repay. They were a wreck waiting to happen.

(c) People buying more than they could afford and using interest-only or option ARMs or hybrid option ARMS. They couldn’t afford the house if they had to pay principal and all the interest so they used these suicide loans to get more house than they could afford. Now these loans are beginning to reset and the borrowers are toast.

Any bloody fool KNOWS that the price of anything can not keep going up and up and up when the income of buyers does not change.

If prices had not been artificially inflated and borrowers had not used too-scary-for-words loans to buy more than they could afford, and a buyer later ran into financial trouble (divorce, medical bills) or needed to move (job, retirement), the borrower could have sold the house or defaulted. The defaults would not have much of an impact on the market.

What has happened here is that too many buyers bought more than they could afford and then defaulted when the payments reset or are resetting. That floods the market. There are not enough buyers who could really afford housing at those inflated prices.

Falling prices did NOT make the borrowers with 2/28 ARMS or interest-only or NINJA loans default and go into foreclosure. They went into foreclosure because they couldn’t afford the house to start with!

(And the idea that they could buy more than they could afford and refinance when it “went up in value’ is ludicrous. If they couldnt afford to pay back the $200,000 or 400,000 loan to start with, it doesn’t matter whether the house was worth $200,000 or $2,000,000. They would still owe the same amount that they had borrowed in the first place and couldn’t repay.)

So many bought more house than they could really afford that they drove prices up so that prices had no reational relationship to the ability of the population to actually pay for housing. And since so many were so greedy and borrowed more than they could repay, there were too many houses priced too high flooding the market when they began to default when their loans reset.

And that is what drove down house prices – and prices are still too high relative to income by about 18%.

Quit putting the cart before the horse. FOreclosures caused prices to fall. Prices did not cause foreclosures!

R Matthew Songer September 16, 2009 · 10:42 am

Right —

Being totally over-leveraged with car loans, credit cards, medical debt, education loams and losing income in a recession while living in a home that was over-priced when you bought it will all be solved by pumping the housing price bubble back up.

Well, maybe —

But for how long?

As an aside, if it is a home that one lives in, the loss of that home actually means something. More so than if it is just a house. That emotional attachment is more powerful than an underwater mortgage.

R Matthew Songer September 16, 2009 · 10:44 am

I gotta stop commenting without my glasses on. I can spell and proof better than this.

JimK September 16, 2009 · 11:04 am

Professor Leibowitz’ chart does not support some of his conclusions. The title of of the chart, “No Skin in the Game” is somewhat misleading and does not support his theory that “negative equity” was the primary reason for the spike in foreclosures.
The chart the Professor relies upon has a breakdown of foreclosures for the second half of 2008; of the 800,000 plus foreclosures cited 130,000 had a down payment of less than 3%. This would presume that the “negative equity” homes had larger down payments and therefore did have “skin in the game.”
In addition, the professor’s “negative equity” argument loses credibility when you compare the historical foreclosure rate, which minus the “bust” cycles of the early 90’s and the present, is approximately between .80 and 1 percent. The percentage of homes that the Professor’s attributes to “negative equity” is in line with the historic foreclosure rate.
However, I do agree with the Professor’s assessment that higher underwriting standards should be required but this assessment is somewhat at odds with his position on subprime lenders.

MM September 16, 2009 · 11:36 am

“An end to the housing price decline is welcome because low housing prices are the main reason for the extraordinary prevalence of foreclosures.”

What? It was higher housing prices, Sir, that started all of this. High housing prices pumped up by stupidly easy credit funded by all that capital sloshing around the world looking for easy returns. Now that the bubble has burst, and it’s taking the economy with it, foreclosures are rampant for those new unemployed and others dealing with the reality that housing actually does go down in value, and they’re stuck underwater with an Option ARM HELOC. What are you proposing? That prices during the last five years were “normal”? That we are just at the bottom of a cycle, and soon we’ll be back to 10-20% increases a year to a level where families with a 100,000 gross are sitting down at a desk and signing their life away for a 600,000 mortgage? And all the underwater, debt addicted “homeowners” will be back fueling our ponzi scheme of a consumer economy with new HELOC cash in hand? You’re an economist, do the math. How is that possible? And, why shouldn’t home values drop to the sane level of income to mortgage that is the mean historical line? Especially since we haven’t seen an average wage increase in at least a decade.

The more I read the stuff that comes from economists laptops, the more I am amazed how little you people really know, locked into your safe little high paying worlds of tenured academia. Especially the Chicago crew.

AnnS September 16, 2009 · 12:39 pm

GUess I missed who the writer was – Mullligan from Univ of Chic.

That explains the wackiness of the analysis. This is the same one who claims that there is no such thing as ‘involuntary’ unemployment. He thinks that all those millions who have lost their jobs involuntarily have ‘chosen’ not to work and are voluntarily unemployed.

I hereby invite Mr Mulligan to come across the lake to the resort area where I live. I will take him to the local bar where the good ol’ boys hang out. He can tell them that they have ‘chosen’ to be unemployed and they are not unemployed because their construction work has vanished. I would advise Mr. Mulligan to make sure his health insurance premiums are paid. He will need healthcare after the good ‘ole boys knock his teeth out and flatten him.

My husband is a Univ of Chicago alum – ’78. The other day he said he wished he could find a way to give his doctorate back to the U of C because he finds being remotely associated with their fruit-loop-land of ‘free marketer’ nonsense and their ‘how many-angels-can-dance-on-the-head-of-a-pin’ analysis in their tiny insular world which is completed disconnected from reality to be so-o-o-o-o embarrasing.

R Matthew Songer September 16, 2009 · 12:46 pm

— MM

Zingo! Last paragraph is superb.

Thanks.

Wonks Anonymous September 16, 2009 · 12:46 pm

The nice thing about unemployment is it makes labor cheap.

Back in my URPE days we called this the reserve army of the unemployed. Is Casey B Mulligan really a closet Marxist? Or is he just naively reinventing the wheel?

MM September 17, 2009 · 9:27 am

From Paul Krugman’s piece in the NYT magazine a few weeks ago about the wacky world of economic theory:

“Chicago’s Casey Mulligan suggests that unemployment is so high because many workers are choosing not to take jobs: “Employees face financial incentives that encourage them not to work . . . decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).” Mulligan has suggested, in particular, that workers are choosing to remain unemployed because that improves their odds of receiving mortgage relief.”

Somebody fell through a rabbit hole and drank and ate something they shouldn’t have, I fear.

Kevin simpson September 18, 2009 · 12:55 pm

I believe that the beginning of the curve rising is a positive sign that things may change. Constructing new homes means that people is having money and the market will get heat again…

Regards,
Kevin
//www.foreclosurelistings.com/

Wayne Caswell September 18, 2009 · 4:34 pm

Homeowners of Texas offers this collection of articles with conflicting opinions of Housing’s recovery. The collection also includes an interesting video of celebrities who’s mortgage is NOT upside-down.

//www.homeownersoftexas.org/08-16-09-MORTGAGES-48-percent-of-Mortgages-to-be-upside-down-by-2011,-up-from-26-percent-in-March.html

Storage Containers October 2, 2009 · 1:29 am

Thanks for the article.It is informative.It was higher housing prices, Sir, that started all of this. High housing prices pumped up by stupidly easy credit funded by all that capital sloshing around the world looking for easy returns. Now that the bubble has burst, and it’s taking the economy with it, foreclosures are rampant for those new unemployed and others dealing with the reality that housing actually does go down in value, and they’re stuck underwater with an Option .

Thanks,
Storage Containers,
//www.boxtcontainers.com