By AUSTIN NELSON

Have you ever wondered what the heck it means when you read that economic data is “seasonally adjusted?” How can non-seasonally adjusted data show one trend while seasonally adjusted data shows something completely different? Which dataset is the most reliable?

The in-depth answer to these questions requires a PhD in statistical analysis. For those of us who don’t know a kernel regression from a Henderson 13-term moving average filter, the short answer is that seasonal adjustment is a process by which consistent seasonal effects are removed from a time series of data. And yes, you can trust them. Well … sort of.

The effect of seasonal adjustment can be most easily explained through an example. Suppose you are looking at a series of data measuring gasoline consumption in the United States to identify trends related to the price of a gallon of gas. A logical hypothesis is that when gas gets more expensive, people drive less.

In examining this dataset, however, we would expect to see increased consumption in the summer months when everyone hits the road for their vacations. Gas prices often rise during the summer when that additional demand constricts supply, so if you were looking at data from a single year without considering seasonal effects, you might wrongly conclude that people actually consume more gasoline when prices rise.

In fact, much of the increase in fuel consumption during summer months has nothing to do with fuel prices, so the seasonal effects need to be removed from the series before any meaningful analysis of consumption versus price can be undertaken.

Looking at non-seasonally adjusted figures by themselves is a bit like saying pumpkin sales spike in October, without mentioning Halloween.

So how does one “remove” seasonal effects from a dataset? By examining several years of data, patterns in the movement of the data can be identified that happen over and over again in the same way each year. From these patterns, statisticians create (through a variety of near-magical statistical techniques) a “filter” that allows them to subtract the seasonal effects from the dataset of interest, theoretically leaving only non-seasonal effects, like that of price on gas consumption.

And VOILA! you have seasonally adjusted your data. The same techniques are applied all the time to financial and economic datasets, so much so that most people accept this “seasonal adjustment” without thinking twice about it.

Our advice is to think twice about it - especially with housing data.

One of the most common patterns in home buying is that sales tend to slow during the winter months. This makes sense, since moving in the winter sucks, and its easier to move kids from school district to school district over the summer. Now, housing economists — particularly our friends at the National Association of Realtors — are adept at spinning even the worst reports in a positive light.

Data released today showed abymsal existing home sales in November, which should come as no surprise to anyone who’s opened a newspaper in the past couple months. Nevertheless, the Realtors managed to find a silver lining.  Chief economist Lawrence Yun “[hopes] the home sales impact from the stock market crash turns out to be short-lived, as was the case in 1987 and 2001,”. If data don’t improve this winter, look for Yun and his crew to start blaming bad weather, snow and a whole host of things that make conditions look better than they are.

The lesson: Never accept data or data analysis at face value.

As my grandfather always said, there are lies, damn lies, and statistics. Unless you can understand how a particular piece of data is derived and can trust the collection and analysis methods that went into its creation, it is as informative as a two-year-old’s fingerpainting.

Seasonal adjustment is no different. Even though almost none of us can understand the mathematical techniques and statistical assumptions that go into the production of official economic figures, you can still look critically at datasets to determine whether they make sense.

In many cases, non-seasonally adjusted data is available along with seasonally adjusted data. Compare the two. Do the changes make sense?

For instance, if all of a sudden non-seasonally adjusted home sales are on par with activity over the summer, one could logically conclude the efforts to unfreeze the mortgage and credit markets may be working. If data bumps along about the same as last year, well, they better get a bigger bailout.

Also think about the source of the data. Does the source have a reason to overly stress or even inappropriately apply a seasonal adjustment to suit their needs? If so, you probably shouldn’t be trusting any data that comes from that source, seasonally adjusted or no. The data source should also have citations for the methods used to complete the adjustment. Even if you don’t know what the citation means, there are those that do and the information should be available to those experts to review.

All this being said, in most cases seasonal adjustment is a completely legitimate analytic technique. Government data has standardized techniques for seasonal adjustment that are well accepted and continually scrutinized. And while many take issue with the government’s collection techniques and even the way they count, say, unemployment, rarely are seasonal adjustments accused of being used to fudge official numbers. Most institutions that put out data reports on a regular basis are also very open about their techniques: These are the ones that can be trusted.

To conclude, with all the sources of data that are available in today’s information age it is becoming increasingly important to develop a healthy skepticism for any particular piece of information. Data is only as reliable as its source and its application.

By ANDREW JEFFERY

This post first appeared on Minyanville.

It’s wishful thinking that artificially low interest rates alone are enough to rehabilitate the housing market.

The mortgage industry has undergone a swift and ruthless downsizing over the past 18 months. While a necessary part of the corrective process, the market is ill-equipped to handle the onslaught of new loans that regulators are hoping to incite.

Last week, the Wall Street Journal reported the Treasury Department is considering pushing down mortgage rates to levels not seen since the heyday of the housing bubble. Through the recently nationalized mortgage giants, Fannie Mae (FNM) and Freddie Mac (FRE), loans would be offered to qualified homebuyers with rates as low as 4.5%.

The story sparked a wave of refinancing as rates on all types of mortgages tumbled. Coupled with the Federal Reserve’s plans to buy agency debt and freshly originated mortgage-backed securities, the stage is set for renewed buying activity.

Although Treasury Secretary Hank Paulson has since denied that he’s planning such a move, he did say that he’s “always looking at new ideas” and that “the key thing to get us through this period is getting housing prices down.”

Whether there’s an official program of 4.5% mortgages is immaterial, as Washington is doing everything in its power to push rates as low as possible.

It’s hard to argue cheaper mortgages won’t encourage buyers to leave the sidelines and jump into the market. However, as Bloomberg noted this morning, layoffs at mortgage companies and banks like Citigroup (C), JPMorgan (JPM) and Bank of America (BAC) have greatly diminshed origination capacity. Lenders, having already tightened underwriting standards, have limited resources to process new applications.

Many are hoping low rates will encourage refinancing and help clear out the toxic subprime and Alt-A securities still plaguing the financial system. Unfortunately, the loans originated for securities in 2005, 2006 and 2007 – the ones causing all the trouble — were done with minimal down-payment requirements. Falling home prices mean most of these borrowers are underwater - and thus unable to refinance.

Furthermore, any renewed buying is likely to be met with a flood of new supply. There’s a concept in real estate known as “phantom inventory,” which refers to homeowners who want to sell, but keep their homes off the market while they hope for conditions to improve. Some experts believe actual inventory levels, when these would-be sellers are taken into account, is as much as 25% higher than official data show.

Anecdotally, this makes sense. For each buyer waiting for lower prices to step in, there’s a seller waiting for a better market. So any pop in buying activity will offer sellers an opportunity to list their homes in a seemingly stronger market. As foreclosures continue to spread into previously unaffected areas, inventory levels are likely to remain high throughout much of the country.

And while attractively-priced, well-maintained homes in desirable neighborhoods will continue to sell, more of the same will be available in each successive month. Patience remains the best ally for the prospective buyer.

By AUSTIN NELSON

Housing starts in the U.S. fell to their lowest levels since the government started keeping statistics on the subject in 1959. The drop is staggering — almost 20% since October — and is another stark indication of the current state of the U.S. housing industry, not to mention the economy as whole.

As noted ad nauseum on this site, supply far outstrips demand in most of the country’s real estate markets. Homebuilders are being kept busy simply trying to sell the homes they’ve already built, tens of thousands of which sit empty where they stand, surrounded by bank owned properties and uncompleted projects. There is simply not enough demand to support continued building.

Housing starts will likely continue their decline as large nationwide homebuilders contract their operations and some even close their doors. The homebuilding industry will struggle to improve until unemployment eases, lending standards loosen up and the flood of foreclosed properties recedes. It will be years until we see these events unfold.

In the meantime, savvy investors and prospective buyers will stay far away from the remote suburban housing developments that litter the outskirts of our major metropolitan areas. While these houses are often huge and full of top quality amenities, they’re simply too far away for any but the retired and semi-retired to reasonably consider making their home.

Services are already spotty in these areas, and as the nation as a whole becomes more eco-conscious and fuel costs emerge from their current swoon, demand for McMansions in the exurbs will remain low, perhaps indefinitely.

By RYAN TAYLOR

What exactly does an appraisal mean?

Perception doesn’t always equal reality. The perception is that an appraisal represents the most accurate value of a property. The reality is that it’s a value provided by a licensed professional, given the purpose and functional use of a property on a given day. The key in that statement is “on a given day.”

While appraisals are indeed very thorough evaluations of a property, they’re not always the most accurate valuation, since they often don’t take into account all the inputs required to derive the current and future value of a home.

An appraiser uses three separate approaches to derive a property’s value:

(1) Sales Approach
(2) Cost Approach
(3) Income Approach

The Sales Approach is similar to comparative market analysis, or CMA, performed by a real estate broker. The appraiser examines comparable (ie, similar) sales and listings from the last 6 months in order to come to a value conclusion. Typically, sales are weighted more than listings, since sales are actual transactions and represent a home’s true resale price, while a listing is simply what a seller hopes to get.

Comparables must conform not only with respect to the subject property itself, but also in neighborhood characteristics. 3 bedroom, 2 bath, 2500 square foot homes on opposite sides of town often sell for very different amounts. Comparables should be within 1-mile of the subject property, but this rule is far from set in stone, as certain neighborhoods dictate a narrower — or wider — radius of comparison.

In the Cost Approach, the appraiser examines the dimensions of the property and structure to determine how much it would cost to duplicate the same home on an identical lot. This is often referred to as “replacement cost.” While this is a useful method for certain types of properties, it’s rarely the most accurate for residential real estate — especially in a volatile market such as we’re currently experiencing.

In the Income Approach, the appraiser determines how much income can be generated from the property and a value is derived from this number. The appraiser usually projects into the future and assumes some ongoing stream of income, discounting the value of that cash flow for the time value of money.

The concept of the time value of money assumes (basically), that most investors would rather receive a lump sum payment now than many smaller payments over time, since inflation causes money to be worth less in the future. Of course, all bets are off during deflation, but that’s another topic for another day.

More often than not, the value of a single family residence is reached through the use of the sales comparison approach.

In reality, the sales comparison approach is effective in providing a well researched value, but it fails to utilize all necessary inputs. While comparable sales are very important to the value of a home, the comparable listings can be — and sometimes are — more important.

We like to view comparable listings as an upper bound for a property’s value, especially in a declining market. For example, if all comparable sales sold 3 months ago for $500,000 and there is a comparable listing is now on the market for $450,000, the listing is far more important than the sales. To ignore the listing and rely on the sales would be inaccurate.

Equally important is the concept of affordability, which is rarely used by appraisers. If there have been very few comparable sales in the past three months, affordability will be increasingly important when trying to understand how much buyers can afford. Weak demand indicates few willing and able buyers in the market, so evaluating prevailing income levels in a particular area help determine whether values are set for small declines, steep declines, or may be approaching stabilization.

Finally, mortgage and credit market conditions — especially now — are very important to the value of a home. In today’s lending world, you need a down payment, good credit and a strong employment history to get a loan. There are plenty of areas where the qualified buyer pool is very shallow. Appraisers don’t put a lot of weight into this fact. 3 sales in the last 6 months means a very different thing if last year there were 30 during the same time period, or just a handful.

While the sales approach does have value, it could be more comprehensive.

A crucial point to understanding appraisals is that the value is today’s value, saying nothing for tomorrow. The reality is that this is an appraisers job; they are not forecasters.

In the current market place, the appraisal can, and some would argue should, be considered irrelevant 30 days after the completion date. When markets can drop upwards of 5-10% in a single month, an appraisal that’s a month old isn’t worth the paper it’s printed on.

However, since the appraisal is still considered by the housing industry to be the most accurate representation of a home’s value, always look at the completion date to determine what lenders and investors believe a home to be worth on a given day. Whether you like it or not, this is the value on that day.

Is the process of reaching an appraised value the most defined valuation process in today’s marketplace?
Definitely.

Is an appraisal the most accurate process to determine the true value of a single family residence? Maybe.

Is an appraisal a projection of what the value of the property will be in the future? Absolutely not.

By RYAN TAYLOR

It’s still a lousy time to be selling new homes.

The National Association of Home Builders, or NAHB, shared its sentiment index for December, which remained at a record low of 9. The index is based on 426 residential developers nationwide; a reading below 50 reflects negative sentiment. In addition to the general index number, confidence levels for current sales dropped to 8 from a reading of 9 last month. The six-month sales forecast dropped from 18 to 16. To say confidence remains extremely low is a bit of an understatement.

The NAHB sentiment index number is an important gauge of the health of the overall market. In many of the hardest hit areas of the country, there remains a glut of housing supply - particularly new construction. Homebuilders are aggressively cutting prices, which is adding to existing downward pressure on prices caused by foreclosures. Since new homes are often more desirable than existing homes, watch any strength in homebuilder sentiment as a prelude to possible strength in the broader market.

While many prognosticators are starting to believe we’re moving into a bottoming phase in the housing market, the chief economist of the NAHB, David Crowe, remains unconvinced:

“We have seen no improvement over the past month in terms of sales conditions for new homes. In fact, certain factors have gotten progressively worse, not the least of which is the job market, where massive layoffs are having a devastating effect on consumer confidence.”

The sobering reality of the housing market is that its recovery has been postponed due to the global recession and the resulting job losses. Despite aggressive moves by the Treasury Department and Federal Reserve to lower interest rates and spur demand, people without jobs simply do not buy houses.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Speculators have been flocking to California for centuries. Gold, computers, absurd dot.com start-ups, real estate - if it’s an asset, it’s probably boomed and busted in the Golden State.

The bursting of the latest bubble — real estate — is still in progress, as foreclosures push up inventory and drag down prices. Nevertheless, for every speculator that got burned on the way down, reinforcements are flooding the state with new money, hoping they’ll be lucky enough to pick the bottom.

In a trend that’s just beginning to emerge from the smoldering ashes of California’s housing market, the next wave of buyers could be armed with armloads of cash that’s red, rather than green. The Chinese are coming.

The Los Angeles Times paints a colorful picture of “Caravans of cash-rich Chinese in Hummers and Lincoln Navigators weaving through American neighborhoods in recent months, looking for foreclosures and other bargain properties to buy.”

What used to consist of small-scale, individual trips by wealthy Chinese buyers to scout for properties have turned into massive, safari-like operations. According to the Financial Times, SouFun.com, the biggest real estate website in China, received over 300 inquiries within days of announcing a home-prospecting trip to California.

For now, the groups are focusing on areas with existing Chinese populations, making San Francisco and Los Angeles prime targets. Almost 20% of San Franciscans hail from China; parts of LA, specifically the UC Riverside area and the San Gabriel Valley, boast large Chinese American communities.

And while not every potential Chinese investor is itching for a foreclosed tract house, a penchant for paying cash makes them desirable buyers in troubled markets. Big lenders like JPMorgan (JPM), Bank of America (BAC) (thanks, in part, to Countrywide) and Citigroup (C) have massive portfolios of foreclosed homes they’re trying to unload. Countrywide has over 6200 in California alone, up from 3900 just a year ago.

With mortgages increasingly tough to come by, banks are typically willing to knock 10% or so off the asking price for a cash bid. Countless sales have been falling through because the buyer can’t line up a loan, and cash is now king in the world of distressed home sales. This is no secret, and investors trying to snap up foreclosed properties at the courthouse steps tell stories of buyers showing up with millions of dollars in cashier’s checks at the ready.

Experts in China, however, are urging caution. Home prices in California are down 40% by some measures, but few expect the declines to taper off any time soon.

One tour operator told the LA Times he aims to give visitors a better sense of what life is like in America before they take the plunge: “What we sell is the culture, American culture.”

And what better souvenir to take home from a trip to the US than a shiny new…house.

By AUSTIN NELSON

Nationwide pending home sales were down 0.7% in October, according to the National Association Of Realtors (NAR). Pending home sales are those under contract but not yet closed, and the index is viewed as a predictive measure of actual sales that will occur the following month.

Month-over-month, seasonally adjusted data show the ongoing divergence in the real estate markets around the country:

• US: -0.7%
• Northeast: 0.6%
• Midwest: -4.3%
• South: 7.8%
• West: -8.7%

Year-over-year (seasonally adjusted):

• US: -1.0%
• Northeast: -14.1%
• Midwest: -6.8%
• South: -2.9%
• West: 17.4%

On the whole, a 0.7% drop in sales activity is a marginal change, not indicative of any huge changes in the market. Of the regional data, the most interesting is the West, where the index was down almost 9% month over month. The West had seen a sharp spike in home sales activity, a change that NAR had pointed to as a possible sign of a market bottom. This new data once again shows that the bottom calling was premature, as even the 27% year-over-year decline in median home sale price reported for October was not enough to spur a sustained rally.

While these declines were less severe than had been expected given how bad October was for the economy, they do not indicate a market stabilization: Prices continue to tumble. This trend will likely continue given the current employment situation nationwide. Furthermore, until credit becomes more freely available to the American homebuyer, few with steady jobs will be able to purchase homes. Expect further declines for the foreseeable future, especially as October and post-October economic events factor themselves into the housing market.

December data, which won’t be released until early 2009 will be interesting to watch, considering the federal efforts currently being undertaken to renew demand for housing. Refinancing activity has spiked in recent weeks as mortgage rates have been pushed down and the Treasury Department is considering a plan to give cheap mortgages to anyone brave enough to buy a house in this environment.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Unprecedented. Unpredictable. Unparalleled. Extraordinary.

These are the adjectives offered by mortgage industry executives defending their relative innocence in the collapse of the housing industry. Conditions, they argue, deteriorated so rapidly and in such unpredictable ways they couldn’t possibly batten down the hatches fast enough.

As it turns out, that’s not exactly true.

The Washington Post reports that chief executive offers at both Fannie Mae (FNM) and Freddie Mac (FRE) ignored warnings about their firms’ exposure to risky loans. The findings of the House Committee on Oversight and Government Reform are being discussed today on Capitol Hill.

At Freddie, an internal report explicitly warned that certain types of loans might default at a higher rate than expected if borrowers’ true financial positions were to be made known. Furthermore — and troubling insofar as these firms and their Washington backers actively pushed these risky loans on low income immigrant communities — senior executives were told many such mortgages could be particularly harmful for non-English-speaking homeowners, since many didn’t fully understand the confusing loan terms.

At Fannie, no smoking gun was produced, but the oversight committee discovered what it called an “underground” effort to actively buy subprime loans.

For their part, former Fannie CEO Daniel Mudd and deposed Freddie chief Richard Syron are directing the blame elsewhere - not surprising, given their well-documented penchant for obfuscation and finger-pointing. To Mudd and Syron, responsibility for the crash lies squarely at the feet of regulators and Congress: One was asleep at the wheel while bad loans ran rampant through industry as a whole; the other all but forced lenders to give out loans to under-qualified borrowers under the auspice of the Community Reinvestment Act, or CRA.

The CRA, introduced in the late 1970s but used by the Clinton administration to support the now-maligned American dream of home ownership, aims to give low-income borrowers equal access to cheap mortgages and other banking services. Think of it as reverse “red-lining,” which is the outlawed practice of refusing to lend in certain neighborhoods that may be perceived as riskier than others.

Homeownership rates — not to mention political backslapping — surged as the housing market boomed, even as borrowers became increasingly exposed to predatory lending and risky loans. Wall Street and banks like Bank of America (BAC), Citigroup (C) and JPMorgan (JPM) saw loan portfolios balloon as low interest rates, securitization and an influx of foreign money fueled the red-hot market.

A lucky few managed to sell at the top; the rest are now left holding the bag, with everything tenuously held together by an ad-hoc glue of taxpayer money and a ballooning national debt.

And while we now know how the story ends, the future, as they say, has yet to be written.

Mortgage regulations, as much as they’ve been tweaked since the crisis began, will undergo an even further-reaching overhaul by the time we emerge on the other side of this mess. Along with the rest the financial industry, laws regarding borrowing and lending are slated for massive changes in the coming years.

Regulators could choose to punish the industry and homeowners alike with oppressive rules and regulations, which will will push up interest rates and prolong the housing market’s eventual recovery. It will, however, do little to punish those actually responsible, since most have either lost their jobs or are living high off their spoils. Sadly, we appear well along this path.

The other option, however politically inexpedient it may be, is to once and for all remove the government crutch from the mortgage industry and let the free market determine interest rates, borrowing terms, and home prices.

To be clear, this is not to advocate lawless cowboy lending, but simple, prudent rules that protect borrower and lender alike without home loan subsidies in the form of artificially low interest rates.

At the center of any responsible regulatory regime is a realignment of incentives. The current system still rewards housing-market actors like real-estate agents and mortgage brokers for encouraging borrowers to make bad decisions. The higher a buyer’s price, the more an agent is paid; the more the terms of the loan favor the bank, the more a mortgage broker stands to profit. This needs to change.

And until it does, as George Santayana said, “Those who cannot remember the past are condemned to repeat it.”

By ANDREW JEFFERY

This post first appeared on Minyanville.

Treasury Secretary Hank Paulson is hoping he’s found the magic bullet to solve the US housing market’s seemingly never-endless woes.

He hasn’t.

By throwing around the weight of recently nationalized mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), the Treasury Department is considering a plan to push interest rates on purchase money mortgages down to 4.5% - well below the current market rate of around 5.75%.

Artificially lowering rates so buyers can afford more house led us into this mess; it’s doubtful the same tactics will lead us out.

According to the Wall Street Journal, the plan is in the early stages of development, but officials expect the initiative to spur buying activity. The aim is to prop up home prices by enabling borrowers to afford more expensive houses. Columbia University economists believe such a program could help between 1.5 million and 2.5 million Americans buy new homes.

In order to qualify for the low rate, borrowers have to meet Fannie and Freddie’s now-stricter loan underwriting requirements. But even with more affordable monthly payments – the lower rate amounts to savings of $150 per month on a $200,000 loan — precious few prospective buyers are willing and able to pony up the tens of thousands dollars still required for a down payment.

Combined with the Federal Reserve’s recent $200 billion lending program for securities backed by newly originated mortgages, bureaucrats are pulling out all the stops to buoy falling property values.

This is the latest in a series of botched attempts to re-inflate the housing bubble. And like the others before it, the plan fails to address the root causes of ongoing home price declines: Negative equity, over-supply and mounting job losses.

The flood of recent loan modification programs championed by FDIC Chairman Sheila Bair and rolled out by JPMorgan (JPM), Citigroup (C) and Bank of America (BAC) also miss the point. Like any distressed market, the housing market badly needs price discovery. And like any other asset class, the true price of a house is only discovered when someone buys it on the open market.

By creating unnaturally low interest rates and allowing buyers to purchase bigger homes than they could normally afford, Paulson and Bernanke are preventing home prices from falling back to where responsible, fiscally minded Americans can buy without the crutch of government subsidies.

These continued distortions of the free market end up running in contrast to their intended goals: As long as the charade continues, as long as the real estate market is prevented from finding a natural bottom, home prices will continue to fall.

The silver lining — for those brave enough to uncover their eyes and look – is that just as it overshot on the way up, the housing market will likewise overshoot on the way down.

A protracted period of stabilization will ensue, during which time the opportunity to purchase high-quality residential real estate below its long-term intrinsic value will be extraordinary.
Savvy investors with the ability to identify attractively priced properties will, eventually, have the buying opportunity of a lifetime.