Things Aren’t Always As They Appear

We’ve all read recent reports on the U.S. real estate market, which appears to show great strength.  In fact, yesterday it was reported that The S&P CoreLogic CaseShiller Home Price Index for January increased by 5.7% year over year for the 20-city composite index.   On the surface that sounds quite positive.  However, I have a friend who is one of the country’s leading real estate analysts, who has been complaining about the current state of the U.S. real estate market.

However, I have a friend, Keith Jurow, who is one of the country’s leading real estate analysts, who has been relaying his concerns to me about the current state of the U.S. real estate market.  What in the numbers scare him?  As it turns out, it isn’t what is being reported, but what isn’t.  Keith feels that the index doesn’t appropriately capture the true economics of our market.

Given this concern, I asked him to write an article for the KCS Blog, which follows.  I hope that you find his insights useful – I certainly have.

Why the Case-Shiller Index Distorts Home Price Gains by Keith Jurow

For many years, the Case-Shiller Index has mesmerized pundits and Wall Street alike. It is the undisputed gold standard for assessing housing market price changes and its credibility has remained unchallenged. Who doesn’t believe that this Index truly depicts what is happening in major housing markets around the country?

Its former publisher — Standard & Poors – actually put out a 41-page explanation of the methodology behind the Index upon which this analysis is based.

The index uses what is known as a “repeat sales” model because it takes recent home sales and matches them with a previous sale of that same property. It is essential for you to understand that at the foundation of the index are certain key assumptions. The most important is that different weighting is assigned to matched pairs of home sales depending on certain criteria.

Paired sales are assigned a weight anywhere from zero to one depending on how far the pair differs from the “average price change for the entire market.” The purpose of this is to “smooth out” distortions which the Index creators believe are caused by extreme price changes that differ markedly from most of the other price changes in a given metro.

Here is an even more important weighting factor. A home which has a longer time interval between its two paired sales is given considerably less weight than one where the interval is much shorter. For example, a home in which the interval between sales is 10 years may be assigned a weight equal to only 80% of a paired sale with a six-month interval. An even longer time between paired sales could be given a weighting as low as 55%.

The S & P explanation describes the assumption behind the weighting given to different time intervals this way: “Over longer time intervals, the price changes for individual homes are more likely caused by non-market factors” (i.e., physical changes in the property such as a room addition).

As a result of this assumption, the paired sale of a house in any metro which composes the Index can be given a weighting significantly different from other paired sales in that metro.

Why is this assumption built into the Index? A sale is a sale, isn’t it? Shouldn’t all home sales be given the same weighting in compiling the Index? Apparently not, according to the economists who created this Index.

Why does this matter? The very different weighting of paired sales necessarily causes the index to grossly distort the raw sales data. To put it differently, the Case-Shiller Index is in no way an accurate measurement of what price changes are occurring in any major housing market of which the Index is composed.

Let me be crystal clear. The only way to get an accurate picture of any housing market is to take houses recently sold where there is data on the previous sale of that house. Then you can measure the actual gain or loss on that property over the specific time period between sales.

No index does this. The closest attempt actually made was a US Home Sales Report put out by RealtyTrac in April 2016. I wrote a detailed article on this a year ago. Let me explain briefly.

The report took 125 major metros which had at least 300 home sales each in March 2016 where they also had data on the previous sale of that home. The compilers of the report took an average of the net gain (or loss) for all the home sales in that metro. These were not annual price increases but gross gains over the entire period of ownership. For all the metros, homes were held for an average of 7 ½ years. The median gross profit (excluding sales commissions) for all these metros was 16%. After deducting the commission, the average net profit was barely 10%. Thirty metros had gross profits of between 1% and 10%.

For an average holding period of 7 ½ years, this average gross profit is really terrible. The property owners would have been better off with a portfolio of high-quality corporate bonds during that period.

In 15% of these markets, there was actually a loss for those who sold in March 2016. This included major metros such as Chicago, Cleveland, Milwaukee, and Birmingham. Take a look at this table showing the major metros with the highest and lowest price gains.

There is a reason why the top three markets are all in California. More than 40% of all outstanding bubble era non-prime loans have been modified. This percentage has steadily risen from only 17% in early 2011 and continues to increase.

Why is this important to know? Because so many delinquent bubble-era mortgages in California were brought current by these modifications, foreclosures have completely collapsed – from a peak of 30,000 in August 2008 to slightly more than 1,000 in December 2016. Had these seriously delinquent mortgages been foreclosed instead of modified, that would have dumped hundreds of thousands of properties onto the market at distressed prices. Because this did not occur, median sale prices, as well as the Case-Shiller Index for metros such as Los Angeles, have been artificially inflated.


When you re-read the latest Case-Shiller report, keep what I have explained in mind. Its distortions tell you very little about what is occurring in these major metros. To understand the reality of housing markets and where they are headed, following my upcoming articles might be a good place to start.

Keith Jurow is one of the nation’s leading real estate analysts. Many of his in-depth articles can be found at his website,

Back To The Future

I’ve just found a great article by Robert M. Ball, titled “Old-Age Retirement: Social and Economic Implications”.  For regular readers of the KCS blog, you know that we spend a lot of time trying to highlight and understand both the social and economic ramifications of our failure to provide a stable retirement benefit.  Many of the points discussed in Mr. Ball’s article echo topics that we’ve raised, including:

  • Over the next 15-20 years will we make the fundamental adjustments that are necessary if older persons are to make the economic contribution that they are capable of making?
  • For most workers today, retirement means inadequate food, clothing, housing and a sense of insecurity.
  • For those workers forced into retirement (lay-offs) the worker loses more than an income, as they are faced with emotional and spiritual problems equally as serious.
  • Work means recognition in our society, and it is largely through work that one gets a sense of being a useful participating member of society.
  • Our failure to give the aged a responsible role in the community is making them into a class apart.
  • The very technological improvements that increase labor productivity and make it possible to support the aged in retirement constitute a serious threat to the employability of the older worker.
  • The older workers who lose jobs are at a greater disadvantage in securing a new one.
  • The future will find us with a considerable number of job vacancies at the same time that we have a hard core of unemployed workers (review the current U6 and LPR data).
  • Individual savings for old age is extremely difficult for most wage earners.
  • What savings the worker generates is often used up during illness or unemployment, or is spent bringing up children.

The article concludes with the following, ” We cannot afford the separation of the aged from the community or the organization of the aged against the community. The aged need the secure place in our national community that can come only from the continued participation in the life of that community, and the national community needs the wisdom and the skill of older persons.”

I suspect that most of you agree with the points being made above.  Given that, you’ll probably be shocked to read that this article that I just “discovered” was written in 1950.  Mr. Ball was the Assistant Director, Bureau of Old-Age and Survivors Insurance.

I was particularly impressed by his statement regarding the tug of war between those that are unemployed and the significant number of vacancies that employers might have as a result of a skills mismatch.  He was quite prescient. Furthermore, he hits on a major issue regarding the transition from defined benefit plans to defined contribution plans, by highlighting how difficult it is for workers to generate enough savings, especially the low-wage earners.

The article is lengthy but well worth the read for anyone who wants to better understand what we are facing today nearly 70 years after Mr. Ball wrote his piece.

And Then There Are Student Loans…

As recently reported by the NY Post, a study of government data by the Consumer Federation of America found that the number of Americans in default on their student loans jumped by nearly a fifth last year.  According to the analysis, student loans in default, meaning that they haven’t made a payment in more than 270 days, jumped from 3.6 million to 4.2 million by the end of 2016.

The 4.2 million loans in default are roughly 10% of the number of student loans in the market.  Furthermore, Americans currently owe about $1.3 trillion in federal student loans.  Including private loans, the amount of debt grows to $1.4 trillion.  Shockingly, student loan debt has grown from just about $0.5 trillion in 2006 to $1.4 trillion in 2016.

As the article points out, “Defaulting on a federal student loan can be a financial disaster for the borrower. Unlike other types of debts, most federal student loans cannot be discharged in bankruptcy. Those who go into default face serious repercussions including wage garnishment, damaged credit scores and potentially added costs in fees, interest,  and legal fees.”

The significant increase in the cost of education and the greater use of student loans to meet this expense is placing an unfair burden on our younger generation.  This burden makes it nearly impossible for one to begin to fund a defined contribution retirement plan, but that is basically what we are left with at this stage.  The more it delays funding the less likely it is that one will generate a retirement account meaningful enough to accomplish one’s goal of retiring.

At KCS, we focus on issues related to one’s ability to retire, but the burden of greater educational costs impacts so much more from establishing family units, housing, and the general demand for goods and services.  It isn’t shocking to us that the US economy hasn’t generated a >3% GDP growth since 2005 when one looks at the significant growth in student loan debt since 2006.

Why Are Death Rates Rising?

Researchers Ann Case and Angus Deaton have discovered that death rates have been rising dramatically since 1999 among middle-aged white Americans, and the economists believe that they have a better understanding of what’s causing these “deaths of despair” by suicide, drugs and alcohol.

They attribute the premature demise of 45-55-year-old, non-college educated white people to shrinking opportunities in the U.S. labor force, which leads to despair, broken marriages, and ultimately, substance abuse.  With the rapid advancements in technology likely replacing many more jobs, this tragic situation will likely become worse.

Couple this development with the loss of traditional DB plans that provided financial security, and you can imagine the profoundly negative social and economic ramifications that will follow. For those of us, and today it is most of us, in a defined contribution plan, the build up of assets in our accounts tends to occur later in life when many of those expenses related to having children or paying for our educations are no longer impacting our incomes.

Job losses for those in their late 40s and 50s can be devastating, as individuals often have to tap into their “retirement” account to help bridge the employment gap. If you are fortunate to find employment, this strategy may be temporary and not devastating, but for a significant percentage of those that find themselves out of work, this can be a financial death knell.

As a nation, we must once again find a way to offer pensions that provide a monthly annuity and survivor benefits, while taking out of the equation the investment management responsibility by those least capable of performing this task. In addition, we need to provide job retraining for those workers who have been displaced.

My son, Ryan, has suggested that there should be a late-in-life Americorps-type program where displaced workers take classes for a year.  He suggested that these workers should be retrained in those sectors likely to benefit from technology’s advances. Importantly, if you have the good fortune to spend two years working for a public entity, your program costs are forgiven.  I like the idea.

We cannot afford to write these people off.  As a country generating weak growth already (GDP at 1.6% for 2016), forcing millions of potential workers to the sidelines won’t do anything to jumpstart demand for goods and services. Getting people re-trained, working, producing goods and services, and earning wages for their effort is far more ideal than having our social safety net stretched beyond our wildest imaginations.


A Wake-up Call?

Jacksonville (Fla.) Police and Fire Pension Fund might close to new hires later this year following approval from the city’s police and fire unions of a proposal from Mayor Lenny Curry’s office.

This development should be a wake-up call to all the public DB pension systems that think that their plans are perpetual. Poor funded status and escalating contribution expense will get the attention of the taxpayer.  DB plans must be preserved, but they need a new focus and direction (see the KCS website and blog for our many thoughts on this subject). Clearly, the all-out pursuit of the return on asset assumption (ROA) has failed, as many pension plans continue to struggle despite 8+ years of a bull market in equities and nearly 35 years in bonds!

The move by Jacksonville to push new employees into a defined contribution plan might ultimately reduce the City’s liability, but it isn’t in the best interest of their future hires.  Although the proposed employer contribution of 25% is quite generous, DC plans still must be managed by the individual employee, who in most cases doesn’t have the financial literacy to execute a successful program.

Furthermore, with a vesting schedule that allows full vesting after just 3 years, Jacksonville should expect far greater turnover in its ranks.  We appreciate that there is a financial burden to fund these systems, but closing them isn’t the answer.  We believe that there are strategies that can be deployed that will help stabilize both the funded status and the contribution expense while beginning to de-risk the plan so that it remains a viable option.

A retirement system solely dependent on a defined contribution plan is no retirement system!  DC plans are glorified savings accounts.

Real Estate Update

Regular readers of the KCS blog will know that we have occasionally shared real estate updates provided to us by our friend, Keith Jurow.  Here is a brief note that he recently shared with us.

“Yesterday, Fannie Mae announced the winning bidders in its ninth non-performing residential loan sale. The fourth group was composed of 2,427 loans with an average loan size of $211k. It also had an average unpaid principal balance of $511k.

Wait a minute. How is that possible? Let me explain. It confirms what I said in my latest article:

These are bubble-era loans which were modified and then re-defaulted. The interest arrears were tacked on to the unpaid principal (called capitalization) and apparently averaged about $300,000. These loans are so far underwater that I wonder how the new loan owners will ever see a nickel when they are liquidated.”

We suggest that you pay heed to Keith’s concerns.




60% Are At Least Somewhat Confident. Really?

The WSJ is reporting on an annual study conducted by the Employee Benefit Research Institute (EBRI) that claims that 60% of workers are very confident or somewhat confident in their ability to retire.  This figure is down 4% from last year, and 10% since 2007, but up slightly from 2012.

The report also goes on to say that current retirees are more confident (79%) than workers in their ability to retire.  That leaves 21% of current retirees who must be struggling in their retirement.  It makes sense to us that current retirees are more confident than future retirees, especially when one considers that roughly 50% of the private sector once participated in a DB plan, while private sector participation is only about 14% today.

Furthermore, the study of 1,671 participants indicated that 47% of households reported having less than $25,000 in savings and investment, when not including one’s home.  How is it that 60% feel confident in their ability to retire when 47% have less than $25,000, and nearly 50% of those had less than $1,000 saved?

We’ve frequently expressed our concerns about the impending retirement crisis in the U.S.  The social and economic ramifications will be grave, and there is nothing in this recent study that diminishes our concerns!