The results imply two problems with thinking about house prices through the lens of the Case-Shiller Index.
In Southern California, somewhere in the neighborhood of 40 percent of sales are distressed sales. If lenders make decisions that are based on Case-Shiller, they will underestimate the value of transactions that are taking place in the absence of distress. Appraisers seem to be taking a Case-Shiller view of the world right now, and so deals are getting undone. There is reason to believe that when buyers are willing to place 20 percent down on a house, they actually believe the house is worth the offer price.
On the other hand, let’s say we move to a world where only, say, 20 percent of sales are distressed. This will produced an observed increase in the index Case-Shiller Index of 6 to 7 percent–even if nothing is really changing about underlying house prices. This could lead markets to become too optimistic too quickly.
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