At the Berkeley-UCLA conference last week, audience members queried Bob Shiller and Chip Case about how they adjusted their price index for foreclosure sales. Chip's answer was that they had a regression that contained a foreclosure dummy, but that only paying customers S&P-Case-Shiller customers got to see it.
This is a problem. CS is a repeast sales index, with the idea being that by looking at houses that sell twice, and seeing how their value changes across time, one has a constant quality house price change. The problem with including foreclosures is that the constant quality feature is almost certainly eliminated--foreclosed houses are almost certainly undermaintained (there are newspaper reports about this--I would be curious to know if there is a rigourous study), meaning that they are no longer constant quality houses. This feature will bias estimate downward.
My colleague Chris Redfearn notes another problem with the current index. For the LA area, the index is being disproportionately influenced by Riverside and San Bernardino counties, where foreclosure sales have produced big upticks in sales volumes. In stable neighborhoods with financially stable households, people are simply not putting their house on the market, so the relative stability is not reflected in the index. If one looks at any real estate web site, one will find that the number of listings in Santa Monica, for instance, is quite small.
All of this suggests that the CS Index is currently biased downward. While there can be no doubt that house prices here in Southern California have fallen a lot, they have almost certainly not fallen as much as the CS index suggests.
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