Goldman's Former Head Of Housing Research Predicts Housing Crash, Recession Within Three Years

It's one thing for contrarian financial websites to accurately predict the transitory phase and housing price dead cat bounces which are only sustained by the unholy trinity of foreclosure bottlenecks (which are simply supply-side subsidies), offshore money laundering into US real estate (thanks to the NAR's AML requirement exemption) and Wall Street-as-a-Landlord (through REO-to-Rent and other Fed-funded programs): after all the point of such correct analyses is to be ignored and blasted as conspiracy theories until they are proven, inevitably, correct.

But when a former Goldman executive and the previous head of its housing research team comes out with a shocking analysis so contrary to what the same individual would do in his "former life" when he would be extolling the inevitably rise of home prices from here to eternity and beyond, and also throw in an open letter to none other than president Obama, predicting at least a 15% crash in home prices in the next three years, a move which would without debt catalyze the next US recession, it is time for everyone to pay attention.

Meet Joshua Pollard, who in February 2009 took over coverage of US Housing at Goldman Sachs at the tender age of 24. We can only assume he was given the responsible position because everyone else in his team who had, bullishly, covered housing right into the Lehman crash, was fired.  But regardless of Pollard's career and how he got to where he is now, what is more important is that in a report released today, the former Goldmanite has cautioned Obama on the economic impact of an imminent 15 % decline in home prices over the next three years.

In short. the former Goldmanite says that "House prices are 12% overvalued today. They have already started to decline. Today’s misvaluation matches the excess of 2006-07, just before the Great Recession... 5 of the last 7 US recessions were led by a weakening housing market... I am lamentably confident that home prices will fall by 15% within three years." Or, as some may call it, crash.

While we provide his entire extended analysis of just how this crash will take place, here is the punchline, which incidentally is spot on: when all is said and done, it will be "never-before-seen public policy reactions that determine when and where prices eventually trough."

In other words, if the timing of Pollard's forecast is correct, the last thing on anyone's mind in mid-2015 will be a rate hike. Instead, what people will be talking about, if and when the housing market crash begins, is how to finally engage in Bernanke's favorite para-dropping activity...

Here is how Pollard classifies the three stages of home price decline:
3 Stages of the home price decline

Unless the calculus of history is a poor guide, there is a 60% chance that home values decline materially, in fact, the correction is already underway. This probability rises when new negative shocks emerges. The home price decline will be defined by 3 Stages:

Stage I: Hot to Cool: Active since Summer 2013*, Price growth is slides across the country as flippers lose money outright in the red-hot investor markets (NYC, San Francisco and Las Vegas); New home absorption rates - sales per community - are declining; investors slow their home purchases; total home sales decline year over year; developers lose pricing power, press outlets shift from positive to mixed about the health of the housing market.

Stage II: Demand to Supply: Small shocks convert demand pools into supply ripples. A first wave of investors begin trimming prices to get ahead of future declines; discounts increase to incentivize purchasers as purchasers increase their delays for better deals; developers reduce land budgets as cancellations tick up; major financial press outlets take a more negative tone toward housing lowering confidence overall.

Stage III: Deflation & Response: Falling home prices create a negative deflationary feedback loop that foreshadows a once-in-a-lifetime policy response. Deflationary economics take full hold; leveraged bets on real estate unwind in quarterly ripples due to the public reporting cycle & asset manager redemption schedules; willingness to lend shrinks; the broader consumer finally understands it is a bad time to buy a home, a shrinking housing market negatively impacts jobs causing recession; the estimated effects of never-before-seen public policy reactions determine when and where prices eventually trough.
Some details on timing and where we are now:
Rates & Shocks

We are 16 months into Stage I. A sooner-than-expected rise in mortgage rates - or other adverse shocks - will domino the decline into Stage II unintentionally. Because financial markets rely heavily on Federal Open Market Committee (FOMC) communication and the fed funds rate is near zero, “forward guidance” shifts have as much impact as yesteryear’s rate increases. To that end, two recent policy communications raise immense concern that Stage II of the home price decline could be incited soon: the first public speech of Loretta Mester and a recent letter from the ranks of the Federal Reserve Bank of San Francisco.

September 5, 2014: Loretta Mester, President and CEO of the Federal Reserve Bank of Cleveland, in her first public address since becoming a FOMC voting member welcomed and expects increased volatility following future Fed guidance and rate changes. Mrs. Mester, the FOMC’s newest communication sub-committee appointee, described volatility as a “necessary part of price discovery.” Her personal view is that forward guidance should be tied to actual progress, anticipated progress and the speed at which progress is being achieved (volatility); progress toward full employment and 2% inflation has occurred faster than she and the Fed expected. While stock market volatility has hovered near all-time lows during the Fed’s most recent communication expansion, home price volatility is at extremely elevated levels.

September 8, 2014: A letter from Jens Christensen, a senior economist at the Federal Reserve Bank of San Francisco, highlighted a concerning expectation gap between investors and the Federal Reserve regarding future interest rates. In the letter titled Assessing Expectations of Monetary Policy, the author showed that public investors are expecting a more rate-accommodative policy than the Federal Reserve and these investors are more confident than the Fed in this stance.

As public policy makers debate seminal decisions on “forward guidance” and unconventional monetary stimulus we note that each 1% increase in mortgage rates drops home values by 4%. At a 2% fed funds rate, where Fed officials and investors expect to be by the end of 2016, today’s over-valuation of 12% grows to 20%. Respectfully, the United States can not afford another housing driven recession.

With home price volatility at an all time high, the escalation from Stage II to Stage III is difficult to predict today. At Stage III, the virtuous cycle of housing, a unique mix of causal financial and social relationships, breaks. At these points in history unique governmental intervention provided the only spark that reignites demand. Price discovery is volatile around each new catalyst of information, and the trough will emerge as consumer and investor confidence rebuilds at lower prices. I believe confidence rebuilds at 15% lower valuations without premptive positive shocks.
Unless, of course, the momentum ignition mentality, made so prevalent in capital markets thanks to HFTs in recent years, takes over and the 15% threshold to "rebuild confidence" and BTFD is really 30%, or 40% or more...

Taking a step back, here is the analysis that Pollard uses to base his opinion that housing is due for a 15% crash within three years:
House prices are 12% overvalued today. They have already started to decline. Today’s misvaluation matches the excess of 2006-07, just before the Great Recession. Since World War II home prices have been tightly correlated to income and mortgage rates (R2 = 96%). Investors/cash purchasers, which make up 50% of home sales, have driven real estate volatility to unrivaled levels in trackable history. As public policy makers debate seminal decisions on “forward guidance” and  unconventional monetary stimulus we note that each 1% increase in rates drops home valuations by another 4%; at a 2% fed funds rate, where fed o cials and investors expect to be by the end of 2016, the overvaluation equals 20%. Respectfully, the United States can not a ord another housing driven recession. The facts and correlations - the tenets of probabilities - suggest it is more likely than not that home prices fall 15% in the next three years.
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