Ben Bernanke’s Fed publishes the quarterly US Flow of Funds Release. Each 125 page “Z1 Release” appears at least two months after each calendar quarter, and:

• Shows the issuers, investors, and market intermediaries that buy and sell securities in the U.S. capital markets;
• Reveals where market players get their funds and how they apply their resources; and
• Provides macro level balances sheets for households and corporations.

So, you can appreciate my shock when I discovered that the Fed’s own report:

• Missed most of the housing bust until December 11, 2008; and
• Underestimated the size of the housing decline by roughly $2 trillion.

FLOW OF FUNDS RELEASES, 18 Sep 2008 vs 11 Dec 2008

As of 11 Feb 2009, the last two Flow of Funds releases occurred on the following dates, with accompanying links:

• 2008Q2, on 18 Sep 2008 | http://www.federalreserve.gov/releases/Z1/20080918/
• 2008Q3, on 11 Dec 2008 | http://www.federalreserve.gov/releases/z1/Current/

CHANGE IN HOME PRICE INDEX

The “Data Revision” section for the 11 Dec 2008 release contains the following note:

• The market value of residential real estate … has been revised from 2000:Q1 forward to reflect improved data sources. The value of owner-occupied housing … is now benchmarked to data from the American Housing Survey, and changes in the value of single-family homes … are now estimated using a repeat-sales house-price index from LoanPerformance. Previously we used a price index from the FHFA (formerly OFHEO). [emphasis added]

This index switch, from FHFA/OFHEO to LoanPerformance IS important, because:

1. FHFA/OFHEO only tracks changes in prices of homes financed with conforming loans that were purchased or securitized by Fannie or Freddie; while
2. LoanPerformance tracks changes in price of homes financed by Fannie, Freddie, or Ginnie Mae, as well as those that were financed in the non-conforming (jumbo or subprime) securitization markets that shut down in 2007-2008 and precipitated the housing crisis.

REAL ESTATE VALUE COMPARISON

To get an idea of how different “FHFA/OFHEO Indexed” real estate values are from “LoanPerformance Indexed” real estate values, consider Figure 1, below. The Fed’s change in methodology can be seen in the post 2000 divergence between the:

• Real estate valuations released by the Fed on 18 Sep 2008 (the blue line); and
• Real estate valuations released by the Fed on 11 Dec 2008 (the red line).

I’ve also prepared a chart of the simple difference between the two Federal Reserve releases, which were published within 84 days of each other (i.e., 18 Sep 2008 & 11 Dec 2008). It appears in Figure 2, below.

As the chart suggests, at the 2005Q3 peak, there was a $2.7 trillion dollar difference between the two Federal Reserve estimates in the value of households’ real estate.

Finally, to see how different the housing bust looks, depending upon which Fed release you use, consider Figure 3, below.

As of the Sep 2008 release, the Fed’s own report only recognized a $0.731 trillion residential real estate decline, through June 2008.

Eighty-four days later, in Dec 2008, the Fed raised its estimate of the real estate decline by about $1.5 trillion, so that – through June 2008 – residential real estate had declined by $2.233 trillion.

Finally, using the same Fed Dec 2008 release, and looking at the housing bust through Sep 2008, the Fed came up with a $2.790 trillion residential real estate decline.

UNANSWERED QUESTIONS – Why Did the Fed Wait To Get Smart?

1. Might this previously unrecognized disappearance of more than $2 trillion in residential real estate explain 2008’s bailout muddle, or this week’s latest $2 trillion bailout wishlist?
2. Was the switch from FHFA/OFHEO to LoanPerformance timed to paint an unjustifiably rosy picture of the housing market until after the November 2008 election?
3. Did the Fed, Treasury, or Congress really believe the Fed’s Sep 2008 release?

I can’t say.

Maybe we should give Chairman Bernanke a call. Let’s see if I can get him on his shoe phone.
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I used to work with numbers for a living. Even though I’ve been eighty-sixed, I continue my search for a new job or at least my next idea. Till next time.

REFERENCES

 
Federal Reserve, Flow of Funds, Table B 100, Page 102 & Data Downloads- 2008Q2 on 18 Sep 2008, and 2008Q3, on 11 December 2008.