Housing Predictions: Guesses and the Data

What could cause inventories to increase?

About science, Richard Feynman once said (1 Minute video here):

First, we guess … Then we compute the consequences of the guess … to see what it would imply and then we compare the computation results to nature or we say compare to experiment or experience, compare it directly with observations to see if it works.

If it disagrees with experiment, it’s wrong. In that simple statement is the key to science. It doesn’t make any difference how beautiful your guess is, it doesn’t matter how smart you are who made the guess, or what his name is … If it disagrees with experiment, it’s wrong. That’s all there is to it.

I take the same approach to making housing predictions. First, I make some guesses as to what will happen (I tell myself some stories), and then I see if it fits the data. If the data doesn’t fit the story, my guess is wrong.

During the housing bubble, I thought that 1) house prices were too high, 2) there was significant speculation, and 3) lending standards were too loose (“fog a mirror, get a loan”). I was predicting a significant decline in house prices, although I was uncertain when the bubble would end. When inventory started to increase sharply at the end of 2005, it was clear the bubble was about to burst (see Inventory will Tell the Tale). And the data matched my story.

Last year, some people thought the sharp increase in forbearances would lead to a huge wave of foreclosures and cause house prices to fall. That never made sense to me, unless people were unable to find new jobs, since the lenders were offering easy loan modifications. See: Forbearance Will Not Lead to a Huge Wave of Foreclosures

However, there is no shame about making an incorrect guess (prediction). Just change your mind when it doesn’t fit the data!

Currently my view is house prices seem too high, but lending has been reasonably solid, and there are some fundamental reasons for the high house prices (See: The Housing Conundrum)

If inventory stays low, then house prices will continue to rise fairly quickly (although it appears house price growth is slowing). Double digit house price increases aren’t sustainable, so the question I’m asking now is: What will cause inventories to increase?

I’m considering three possibilities: 1) mortgage rates rise fairly quickly, slowing demand, 2) economic problems in China spillover into the US, and 3) unregulated areas of finance cause economic problems. The third possibility is something I’ve mused about on twitter:

This is something I mentioned on my blog in 2013:

Each new generation of Wall Street wizards figures out a new way to turn lead into gold, and to become wealthy while damaging the financial system.   Some of these wizards are probably perfecting their financial alchemy right now.

This week, Rick Palacios, Director of Research at John Burns Real Estate Consulting wrote about some research is related to this possibility:

The most likely cause of higher home inventories will be higher mortgage rates, but unregulated areas of finance are always a concern and something I’ll be watching.