Book Review – The Housing Boom and Bust (Thomas Sowell)

One of my roles away from here is that of  moderator for a book club at my local library.  (Non-fiction, primarily foreign affairs and current events)  That role has reintroduced me to a love of reading that proved elusive with a life (in the early 2000’s) of early business meetings, client presentations, and getting the kids off to bed.  As it takes reading three books to find the one I can recommend to the group, and since “the crises” has been so much on every one’s radar, I’ve had the chance to read them all.  (Collapse of Lehman, Collapse of Bear,  Collapse of AIG, Collapse of …..).

The book that stands out from that crowd, that I would like to tout here, both for being well-written and due to its relevance to this site’s themes is  –The Housing Boom and Bust(revised edition) by Thomas Sowell.

Mr. Sowell’s approach is to explain (in the newly updated, slim paperback version)  how forces (incentives, mostly) built up over a period of years, were the reasons behind the inevitable real-estate crash.  He tars politicians (both local and national, Democratic and Republican) with their use of policies that were designed to appease either in the short-run, or to limited constituencies.

A conservative by nature, he suggests that “Affordable Housing” programs represent an intrusion by the government into market practices.  He argues that many of the affordability products that were created during the boom years, that were designed to increase home ownership, by having banks lend (and then securitize) to those borrowers, were only made to appease mis-guided government policies.

While the common wisdom is that we all learn from our mistakes, he offers a dire, but critical forecast that  “…those who say that politicians never seem to learn overlook the fact that there is no reason for them to learn, when they pay no price for being wrong when they can simply blame others and continue on with policies that have been politically beneficial to themselves, however detrimental those policies may be for the country.”  (No surprise to WSJ readers, Mr. Sowell cites Congressman Frank and Senator Dodd several times as their roles and views on housing policies have “evolved”). 

This is the best book that I’ve read on the roots of the real-estate financial crises (although there are some other great ones on how money was made or lost).   They say  ” If you want to know where you are, figure out how you got here”.  This book does a great job showing how small, well-meaning actions, took us down the path to where we are today.

Similarly, if you want to figure out the political angles on key issues related to home prices down the road (e.g. fiancial regulation, the role of the GSEs), and to home price futures contracts, then I strongly encourage you to read this book.

Basics – CUS Calculation

It might be useful to walk through the calculation of the CUS (The 10-city Nationwide) index once, as the index presents an opportunity for possible trading strategies.  To start, the table (below) lists the weights of the index and shows the weighted average price of the 10-cities for the May CS release.  (Weights are from S&P report on Case-Shiller index archived here under reports tab.)  Thankfully, the weighted average for this exercise equals the published index result.

 With these weights in mind, one can attempt to trade forward values of the index or the key underlying cities in an attempt to take advantage of discrepancies, trends or relative liquidity.  For example note that two cities (NY and LAX) make up more than 50% of the index (weighted by price index).  Changes in those two cities alone may dominate the value of the CUS -particularly if others (say Denver) remain relatively quiet. 

Recently NY and LA have been moving in opposite directions (NY one of two cities that fell in value last month) while LA, and the West Coast cities of SF and SD that in total make up 40% of the index by weighted average, have been the stars.   Those offsetting effects have somewhat dampened price moves in the CUS.  As such there may be trading opportunities if the bullishness of certain markets spills 1:1 into the CUS index while NY lags.  However should California and NY ever begin to move strongly together (up or down) look for the CUS to become more volatile.