Local economist Chris Thornberg was one of the few voices five years ago warning of a housing bubble. At the time, Thornberg, now 41, was an economist for the UCLA Anderson Forecast, which he left in 2006 to launch his economic consulting firm, Beacon Economics. Even when most economists in 2006 were predicting a “soft landing” for the housing market, Thornberg stuck with his prediction of a 25 percent drop in home prices. Of course, even he underestimated the actual price collapse: a stunning 40 percent drop over the last 18 months. With no end in sight for the housing troubles, the Business Journal asked the prescient Thornberg for his take on when the L.A. area will hit bottom and start to recover.
Question: When do you think home prices will hit bottom?
Answer: Not to be flippant, but we’ll hit bottom when prices stop falling. The home price-to-income level has now returned to historical norms, but often these corrections overshoot the mark. And this time, we’ve got two factors that could mean we have further to fall: More foreclosures are coming and the unemployment rate is likely to rise significantly higher.
Q: You mean we haven’t seen the worst of the foreclosures?
A: Not by a long shot. First, there are still all those Alt-A mortgages that have yet to see their interest rates reset. But there’s something else going on: Banks are not filing notices of default immediately. Instead, they are letting people continue to miss payments and remain in their homes. Banks don’t really want to watch vacant homes be totally destroyed. And they don’t want all those additional foreclosures on their books. But the people living in those homes are never going to be able to resume their payments, so eventually the banks will have to foreclose.
Q: So when do you think we’ll reach the bottom?
A: I’d say somewhere around the end of this year. But hitting the bottom and actually coming off the bottom are two completely separate events. It could be years before home prices start rising again.
Q: How many years?
A: To answer that, let’s go back to the last major downturn. Home prices in the Southern California region hit a peak in 1989. They didn’t start climbing again until 1995-96 and they didn’t reach 1989 levels again until 1998. So we had six years when home prices were either dropping or rolling along the bottom. Even though the underlying causes are different this time we don’t have a major industry imploding now like aerospace did in the early 1990s I would expect a similar scenario this time around. So, if you plan on buying a home here soon, plan on holding that home for at least five years, because for the foreseeable future, homes will not be a liquid investment.
Q: What about the government response to the foreclosure crisis?
A: The government response has been useless so far. Everything has been focused on interest rates and the length of mortgages. The chant has been, “We have to stop the foreclosures.” Well that’s all wrong. What you have is a fundamental mismatch between incomes and home prices. People need to be foreclosed upon. The market needs to function, which means prices must continue to fall until they reach a point where buyers come in. The lower the prices go, the faster the foreclosed homes will get bought.
Q: You were one of the few economists who correctly surmised that we were in a housing bubble years ago. How did you know that?
A: I actually began suspecting we were in a bubble in early 2003. We already had three or four years of rising home prices here in Southern California, thanks in large part to declining interest rates. But then interest rates started to rise; given that, one would have expected home prices to flatten out. Instead, price increases continued accelerating. As we went through 2003 and 2004, I thought we were in a traditional bubble. But by 2005, I realized this was no longer a typical bubble. Prices had so far outstripped incomes that there was no way to support these prices.
Q: What specific factors were you looking at?
A: I mainly look at the ratio of housing prices to income. Historically, over the last five or six decades, the ratio of housing prices to median homeowner income was between 3.5 and 4.5. By 2005, that had shot up to about 7.5, nearly twice the historical norm. It was way out whack. That’s why I believed a crash looked more and more certain. So I started forecasting that home prices in the region would fall as much as 25 percent and people said I was crazy that prices would fall at all, let alone 25 percent. Of course, it turns out I was way off prices have fallen more than 40 percent.
Q: Why was this not a typical bubble?
A: What I knew was that the home price appreciation was absolutely ludicrous. What I didn’t see back in 2005 was the back end, what was driving the show. It turned out to be the crazy mortgage market. I started to get my first hints about this when I left the UCLA Anderson Forecast in early 2006. I got a pair of phone calls from mortgage brokers with such outrageous anecdotes about how they were pressured to make loans. I thought those were outliers picking the craziest events. A year or two later, I realized that these guys were actually understating the insanity that was going on.