Will housing shed another 30%?

[Kurt_and_Hunter]

A person bought a house in 2006 for $500K. Today it is worth $350K.

A few years from now it might be worth $450K or it might be worth $250K.

In the first case it is possible that helping her stay in that house helps the overall market, and helps her.

In the second case helping her stay in her house simply cements her utter financial destruction.

Over most of the last 30-40 years home prices were sensitive to how much money people made. The median home price was three times the median household income. When people made more money houses went up accordingly. Over the last 10-12 years housing decoupled from income. Housing prices went up, up, up while household incomes stayed flat.

The US median income in 2007 (last year available) was $50,233. Given high unemployment and asset deflation I think it is safe to assume that current median household income is not higher than that.

The median home price in November 2009 was $209K. That is after "collapsing."

Even discounting the fact that deflationary events over-shoot the mark it is distinctly possible that housing has only begun its slide and has another 30% to go.

Another data point: Rental prices used to track sale prices quite closely. Rental prices did not, however, participate in the boom in any big way. The fact that a house might go way up in price offers value to the owner but not the renter. Home owners are paying an average 40% extra to own versus the cost of renting an equivalent property. That is, IMO, unsustainable. That ownership premium is based on the assumption that home prices will appreciate at a ferocious clip. There is certainly no reason for it in the current market. In fact, people should be paying a stiff premium not to own. When prices are going down ownership is dangerous and renting *should* carry a risk-premium. (The renter gets the benefit of the house without carrying any of the risk of its deflation as an asset.)

Another data point: In Japan housing was throttled down to pre-boom levels. Since burst bubbles typically drive the assets in question down to pre-bubble levels that is what one would expect. What are pre-boom housing prices in the US? A lot lower than they are now. Certainly not 2002 prices! 1992 is closer.

Always remember that all previous home prices had a premium for anticipated appreciation that was, given what we know now, unwarranted. All 1990s housing prices that did not have a future housing collapse built in were faulty. This is an important concept. Even before the bubble people had an expectation that housing is a safe buy and tends to appreciate. That was built into prices. Nobody today thinks about housing they way they did in 2002, 1992 or even 1962. Nobody still thinks real estate is always a safe investment and that will be built into all housing prices going forward. If people in 1995 could see where we are today housing would have been cheaper in 1995 than it was.

There are condos in Tokyo today that are still underwater from their 1988 valuation!

re: "People bought too much house." Some people did, of course, but some people always have. But most people at the heart of this problem did not buy too much house at all. Let's revisit our $500K home buyer whose house is now worth $350K. She lives in a $350K house, not a $500K house. Things are worth what they are worth. If she has the same job today she has an income that qualified for $500K but lives in a house worth $350K. She is certainly not living beyond her means. Quite the opposite! She is living in "less house" than her income warrants. Keep in mind that the house has the same number of bathrooms whether the market says it's $500K or $250K. (Take that, Rick Santelli.) The reality is that she bought too much debt, not too much house. In 2006 she bought a house she could afford at the market price at the time. That's not very sinister behavior.

So now she pays a $500K mortgage every month on a $350K house. She is not facing foreclosure but her household net worth is down $150K. That has to be made up. Since she can not count on ever getting $500K for her house she has to greatly increase her retirement savings as percentage of her income to make up the difference. She cannot spend money. And even if she were inclined to spend wildly she cannot since she can no longer borrow money against her underwater house. (Actually it is even worse than that. She has to save to build up enough money to buy her way out of her house! If she needs to move she will have to either default or write the bank a check for $50K or whatever it works out to. So forget retirement... she has to save just to have the option of ever escaping her house!)

We are talking about the best case home-owner... she can pay her mortgage every month and will not face foreclosure unless the is laid off.

Anyway, the upshot of what I'm saying is that housing may bounce off the $200K median level (it could happen...) or housing could do what one would sensibly expect: go to 3 times median household income--which was the norm even in GOOD times-- with monthly rent and mortgage payments on comparable properties returning to the same range.

I don't see any reason to assume that housing will not decline an additional 20%-40%. Maybe it won't, but the argument for return to 1993 valuations is a lot more compelling than the case for housing prices stabilizing at levels unsupported by 1) incomes, or 2) a built-in expectation of dramatic appreciation.

QUESTION: If housing is going to decline another 30% what are the policy implications?

[WeDidIt]

1. If housing sheds another 30%, it's over

Sorry, but that's jst a fact.

It's over.

Since housing is a basic infrastructure investment for the average family, shedding that much wealth over the next two years puts the globe into a Depression that would make the great Depression seem a blip by comparison.

[Armstead]

2. As someone trying to sell a home, I have mixed feelings about that

We're trying to sell a home, so the situation brings mixed feelings about my own situation, and what is best for society.

Ultimately, what is happening could be seen as a necessary correction that could restore some sanity to the housing market in the long run.

A major problem with housing is that it got caught up in the Casino Mentality that brought down the whole economy.

During the "good" economic times,housing prices went far beyond their actual value, because of the climate of speculative investment. A lot of people were shut out of the housing market, especially in areas that were being gentrified. Affordable-housing was a major problem for many people, and it was bad social policy, because it exacerbated the gaps between the haves and have-nots.

What we need is a restoration of some real value-to-price ratio, in which housing prices are in line with what they are actually worth as HOMES, not speculative investments. A house can appreciate in value, but it ought to be in line with the actual income levels and otehr costs of living in a market.

Ideally, we could be going through a correction that may be painful in the short-run,but in the long-term will restore some sanity, and a sense of moderation that could ultimately make housing reasonably priced for everyone. If accommodations can be made to assist those who are presently hurt by getting caught in the middle of this current mess,it could be healthy to see prices become more reasonable again.

Worst case scenerio is that it merely reeinforces the boom and bust cycles of exaggerated price rises followed by exagerated panic drops.

[Kurt_and_Hunter]

3. Well, on the plus side for your situation...

If you are selling a property today you are in good shape even if you lose money unless today happens to be the very bottom of the housing market.

Anyone who can sell a property today and rent for a while will probably gain, in relative terms, even if the home sale today is at a loss.

Unless housing turns around in the short term.

So the question boils down to how likely that is. And since, as you note, housing is still expensive (particularly in the context of a declining economy) the best personal play is to not be holding property until the game of musical chairs plays out.

Unfortunately that rational individual decision is bad for the overall economy... just like saving, paring debt, etc.

Most of us are doing the right things, but in aggregate that's a disaster.

But hey, I'm not going to take one for the team by buying a jet-ski I cannot afford this week. Nobody is.

[Lorien]

4. It probably depends largely on the area. It can't drop much more in

Michigan or Ohio, but it my area I still feel that the homes are overvalued. I bought my 3/2 1920s Craftsman bungalow in downtown Orlando in 1996 for 155k. Two years ago it was valued at 535-610k. Insane! This home was probably built as a vacation property by a wealthy family in 1925. It's a well built 1,700 sq. ft. home with a two car garage and some mature live oaks on the property, but it's still a solidly MIDDLE CLASS home.And not even a very large one at that. It has no modern updates outside of electrical and plumbing-even the 1940s stove is still in use. Today it's valued at around 350-400k. That's still nuts. A middle class person can't afford that! 200-250k seems more reasonable but even a tiny 2/1 post war cinder block with no garage is selling for 315k a few doors down from me, so obviously there are more "corrections" to be made in a neighborhood like this!

[Kurt_and_Hunter]

5. What got me thinking about this was a chart of San Diego

Yes, regional differences are big and affect individual situations. Unfortunately they all add up to the national picture so in assessing our national prospects we cannot discount Las Vegas or Fort Lauderdale.

On CNN they threw up a chart of the San Diego housing market. There was no collapse at all. Hell, it was barely a correction. Yes, housing has declined a lot in San Diego recently, but from ridiculous levels. (Like a store that triples their prices then has a 50% off sale. Not impressive.)

It's obvious that San Diego hasn't even begun to sell-off. The bulk of bubble valuation is still in place there.

Now, if everything else in the country was ideal then maybe San Diego would stabilize at a frothy but no SO frothy price, but in the context of a global financial melt-down the idea that San Diego can hold one penny of bubble-era housing value long term is ridiculous.

[customerserviceguy]

6. Good analysis

I spent over two decades in the title insurance business, and everything you had to say rings true with me.

Housing, up until lately, has always been perceived as the "it can't go down" kind of investment purchase, and that's provided a floor for pricing for many decades. Of course, that ignores market economics, and hence, we have the current collapse. Government policies were partially responsible for pumping hot air into that bubble, and we face the dilemma of having to use government policies to cushion the landing.

If the Dow can lose half of it's value in two years, why can't real estate? We're never going to have the kind of wage inflation we had at many prosperous times in the post-WWII era, why should housing not come back to earth, so as to be priced to be affordable by ordinary working people?

Another thing to think about: The rise of housing prices from the 1940's onwards was propelled by the baby boom. As we boomers get older, we no longer need as much house as we did when we were growing up in larger families, or when we were raising our own families. The shrinking needs and the dying off of the baby boom is just as much resposible for the real estate collapse as anything else.

[Kurt_and_Hunter]

8. Since inflation is driven primarily by wages I smell a rat in the...

Since inflation is driven primarily by wages I smell a rat in the post-1982 low inflation economy. It's probably due much more to flat wages than brilliant monetary policy.

And with wages flat it makes sense that people have had to take up gambling in stocks and houses to try to see any advancement.

[PM Martin]

14. True.

The demand for real estate will not disappear though.
Would the value of real estate fall back to it's pre-boom value?
Before 2001, maybe back to the mid 90's.

[Kurt_and_Hunter]

7. ERRATA: "The median home price in November 2009 was $209K" should read 2008, not 2009

Whoops. If I knew the median home price for Novemeber 2009 I wouldn't be wasting my time on the internet!

[ddeclue]

9. Excellent analysis and one reason why I'm 42 and still don't own my own home...

Even though my salary did go up dramatically in the 1990's by the time it was close to enough to start buying a home, the home prices quickly accelerated out of sight and I never did buy a home because I couldn't afford to do so even as a single guy with no kids on an engineer's salary.

Home prices here in FL accelerated even faster than the rest of the country and were going up 15 to 20% a year while my salary has gone done 25% off the dot.com bubble high and gotten stuck at the same level for the last 6 years. Meanwhile everything (housing, insurance, gas, food) has gotten more expensive.

You've really nailed the problem, greedy speculators combined with greedy bankers and greedy but foolish investors to make risky loans and drive up the prices for all others in the market while passing off the risk to third parties like so much processed meat product sausage disguising the real content of those investments.

The real solution is to return to community banking and to break down all these mega giga banks like BofA, Wachovia/Wells Fargo, etc. into local banks and require them to keep all loans they make and to keep that risk on their books instead of passing it off on unsuspecting investors through accounting games and less than full disclosure.

Housing NEEDS to come back down to affordable levels, people deserve to live in decent houses, not overpriced, over valued, under sized, under featured ones. People deserve a yard and some space from their neighbors, not being packed in like sardines into these pitiful "row house" like developments that have been built by greedy developers here in Florida that pack too many houses onto too little land and chop down all the trees. These houses all look alike and make any sense of "neighborhood" impossible.

Developers should be banned from developing any more than 10% of the homes on a piece of land over 10 acres. More importantly they should be banned from vertically integrating the housing industry - builders should not also be in the business of buying and selling the land or arranging the finances- houses should be built individually by property owners. When builders vertically integrate, that's when we get the bad loans, the overpriced homes and the crappy cookie cutter developments that destroy the environment and destroy our quality of life.

Doug D.
Orlando, FL

[Dawgs]

10. "Housing NEEDS to come back down to affordable levels"

That's wishing for the economy to completely collapse.

It's already come down enough; unless you think losing $30,000-$75,000 isn't enough for many families.

[ddeclue]

11. No it's wishing for the market to correct itself.

There's no way to "re-inflate the bubble" to save all those people who bought inflated homes while I was unable to buy one because they drove the price up. More people are hurt by artificially high home prices than will be hurt by them coming down to historically normal levels.

I'm sorry about those people and I think there should be a law to allow for 3 months of missed payments every 5 years without any penalties whatsoever in every loan in America (house, car, or credit card) to recognize the obvious fact that people can go through hard times, get sick, lose their job etc, but there's just no way to restore the inflated "bubble" value of these homes. It would be better for the government to pass a law reducing the principal owed on these loans to their current market value and forcing the banks to write it off as a loss than to try to artificially re-inflate the bubble.

[Dawgs]

12. "Those people" is more than just a handful of people.

It's actually most home owners.

I agree that something needs to be done to help them, but prices going down any more will throw us into something much greater than a depression.

The market has ALREADY CORRECTED itself. It can't afford to go any lower, and especially not because some people want to buy a house.

[Kurt_and_Hunter]

13. Unfortunately it may not be optional

Supporting a given home value is like supporting a given stock value.

For all the things the government can do--and it's a lot--nobody can uphold bubble valuations. The question is, are home prices still bubbly? They appear to be to me, in the same way stocks appeared to be still over-priced after the 2000-2001 sell-off. If the fundamentals force housing prices down more then they'll go down.

That's why I don't think much of direct intervention in the housing market. It may be a useful short-term nessesscity but in the long run the houses will find their level. The sturdiest way to raise housing prices is for average household income to go up. That's also the way to support car sales, restaurant diners and pretty much everything else.

Get more money to the people and they will use it to buy a house or a car or a fistful of lottery tickets or a bag of pot. If housing prices offer attractive value then they'll use that money to buy a house.

[Frank Booth]

20. "The market has ALREADY CORRECTED itself."

I bet you don't live in southern California. Home prices have gone down quite a bit here, but the market is still insane.

Instead of spending $900,000 on a crappy two-bedroom house with no backyard, you can now spend $700,000 on a crappy two-bedroom house with no backyard. At the beginning of the decade the same house would have sold for around $300,000. So, there's still a lot of correction left to happen, and the sooner it happens the better.

[PM Martin]

15. Seeing that most of these new homes built in the past decade

are the cause of the bubble.
There is a surplus of housing. The value has to fall at this point.
As you said: "More people are hurt by artificially high home prices than will be hurt by them coming down to historically normal levels."

[hay rick]

16. Policy implications.

The recent talk about "stress testing" the banks involves evaluating their health by projecting what their balance sheets would look like under "extreme" conditions- conditions the Obama administration does not expect to face. One of those conditions is a 20% decline in housing prices. I think the policy implications for a 30% decline are: soup kitchens, bread lines, and homeless shelters.

Obviously, home prices are supported by household incomes. Stagnant or declining wages should be reflected in the price of real estate. I agree that the ratio between rental costs and homeowning costs should be self-adjusting in this market and a rental premium would seem rational in the current market.

I am not convinced that home prices need to return to the historic 3:1 ratio with family incomes. A more productive economy could reasonably support higher ratios. If people have a greater percentage of their income left over after they have satisfied their other basic needs- they can spend a higher percentage of their income on housing. Of course, we appear to be heading toward a less productive economy...

[Kurt_and_Hunter]

19. I agree. Even if we assume a higher ratio could be supportable after...

I agree. Even if we assume a higher income/housing ratio could be supportable after everything shakes out that still wouldn't prevent a mass-psychology/momentum driven move down to even lower ratios in the near term.

Which is another way of saying that an ongoing global economic crisis is a piss-poor environment to expect any best-case scenario to materialize in almost any area.

On the sunny side, the fact that housing is incredibly illiquid (compared with, say, stocks) puts a bit of a speed limit on declines and may end up smoothing out some of the worst effects. (One can dream, right?)

:shrug:

[hay rick]

23. illiquidity.

Are we inventing a new word? Anyway, I think the relative illiquidity of the housing market is helping to brake the decline in prices. People are stubborn and loss-averse. As long as they can afford to, they will hold onto a house rather than sell it at a loss. Note the sharp recent declines in home sales. Of course, if you look at a house as a place to live rather than as an investment, market declines shouldn't matter much. You get less for your old house but you spend less on your new house- a wash.

One reason the popping of the real estate bubble turned into such a serious crisis is the fact that people started thinking of their houses in terms of their "net worth." It was an appreciating asset and was the financial equivalent of savings. Unfortunately, in many cases it turned into a substitute for savings.

[Kurt_and_Hunter]

27. A substitute for savings... and a substitute for earnings

Flat wages have been papered over by people gambling to make up the difference. 401Ks, houses.

Now everyone is figuring out that society offering gambling opportunities in place of wage increases was a raw deal.

Looked good for a while...

[hay rick]

28. Excellent point and well said. nt

[grantcart]

17. You have to be very careful about comparing anything about Japan land to anywhere else.

Land in Tokyo was sold by the 'decameter'.

A friend of mine sold the rest of his lease to a piece of land to McDonalds for a million dollars, and he only had 7 years left.

Friends showed me pictures of their shoe box homes in Tokyo suburbs that were all valued at a million.

BTW Finland also went through a similar downward spiral after communism fell in Russia. Finland's entire economy was based on supporting quality manufactured goods to Russia's elites at exhorbitant prices in an elaborate swap system.

[Kurt_and_Hunter]

18. Just a throw-away observation

Japan is different for a lot of reasons but does provide a rare recent example of a housing bubble in a gigantic economy.

I wouldn't rely on Japan as an example of American specifics but the bigger point is that bubbles tend to take out all bubble valuation and then some. That is obvious in stocks and tulip bulbs but less so in real estate because real estate seems to demand a certain worth from it's tangibility.

So an example of a total-asset bubble that we can ascertain did drive housing down as far, or further, than it drove down stocks is a useful anecdotal antidote (what a phrase!) to the first-blush assumption that national housing numbers cannot possibly face the same magnitude of declines we have seen in stocks.

My hunch is that people buying housing today, even at depressed prices, are "trying to catch a falling knife."

And the fact that the national median home price is a significantly greater multiple of median income today than it was before the bubble started doesn't inspire confidence. If the PE ratio of the S&P 500 were a good bit higher today than it was in 1995 that would suggest that stocks were nowhere near done selling off. The situation in housing seems roughly comparable to that hypothetical. There are a zillion unique features to housing, but I am skeptical.

[Frank Booth]

21. Have you ever read the Irvine Housing Blog?

It's a pretty interesting website. He's predicting a continued long decline in house prices, in part because many ARMs are set to "recast" over the next three years. http://www.irvinehousingblog.com/blog/comments/the-arm-problem/

[Kurt_and_Hunter]

22. Fortunately that is one thing the government can fix if it chooses

The government has great power to assume risk. I want to see more of that.

There is a tremendous amount of risk-premium built into all mortgage, consumer and corporate debt interest rates today.

That makes sense because the whole world might roll off the table and even the best credit risks might go belly up. And collateral? The only sturdy asset is cash. Whatever you secure a loan with may deflate away.

The interest risk premium in sensible, rational lender behavior. I'm not knocking it. But it is putting a terrible drag on the economy. It is a feedback loop of misery... the worse things get the higher the risk premium and the further behind people fall on their debt which makes things worse, and so on.

One thing the government can do very well is assume that risk. If someone's interest rate is too high the government can refinance the debt at whatever rate it chooses.

(That's why interest drag is the easy dragon to slay while addressing loan principle is more difficult and dangerous.)

[Frank Booth]

26. Well, I think the problem here is bit more sticky.

This isn't just about rates resetting from 2 to 5 percent. It's about option ARMs, where the "homeowners" haven't even started paying off the principal. The mortgages have to "recast" to a fully amortized repayment schedule eventually, and that's what is about to happen in the next few years.

If people can't pay off their mortgages because the interest rate is a point or two too high, then I agree that the government should try to help out. But if they can't afford it once they have to start paying back principal, then I think the best solution is for them to give up the house and a find an apartment to rent.

[Kurt_and_Hunter]

29. Yes, but almost anyone can pay off principal at the right interest rate

Even people paying interest only mortgages would have little trouble paying a traditional mortgage if the interest rate was low enough.

A 30 year fixed at 0% lets you buy a $360,000 house for only $833 per month. That's pretty awesome!

Granted, 0% is unreasonable, but I wanted something I could do in my head. Just making the point that with the right terms people can pay off a lot.

Since the banks are screwed anyway I am somewhat sympathetic to the "4% mortgages for everyone" idea. It would certainly free up a lot of monthly household cash to either spend or pay down usurious consumer debt.

[Zynx]

24. Persistent asset price declines of any kind are very pernicious.

They destroy confidence as well as of course assets themselves. When people believe they will lose money in their homes and portfolios, their savings rates pick up, consumption drops, and therefore all future growth multipliers will decline too. Another 30% would be impossible to dig out of.

[Kurt_and_Hunter]

25. Very well put.

I didn't express it well in the OP, but the fact that houses are a tainted asset class for the first time since the depression has to affect future housing prices.

Who would say, "safe as houses" today except as gallows humor?

So even if everything magically returned to a 1995 economy housing would be lower than it was in 1995 because everyone now has the experience of seeing that the safety & appreciation premium built into home prices was unwarranted.

They say the spacing of bubbles is partly generational. Enough people who remember the folly and horror of the last bubble first-hand have to die off first.

[Zynx]

36. The funny thing about this generation is how we have had three major bubbles in ten years.

Stocks, housing, and commodities. Each one of them was extreme. Each one has ended badly. Normally a generation only produces 1 bubble. We're special.

[lumberjack_jeff]

30. I don't agree.

A person who bought a house bought a place to live. That primary function is not related to its worth as an investment.

If property values drop another 30% then either they'll either keep making payments or they won't; if they perceive shelter to be worth the payment, they'll stay. If not, they'll bail. If they can refinance the balance on attractive terms, they're less likely to default.

Too many people bought houses for their assumed value as an investment. It was bad logic then, and it's doubly worse now. We need to drop that paradigm.

Home values may very well continue dropping... a series of bubbles was a shitty model for economic growth anyway.

[eridani]

31. Bingo. Back to prioritizing use value over exchange value

Wealth that can be "destroyed" was never really wealth in the first place. For all the financial crap going on, we still have enormous reserves of real physical and human capita.

[olegramps]

32. Help me out with this:

Why can't we have 45 or 50 year mortgages. It would seem to me that instead of repossessing the home an attempting to resell it a a reduced price that extending the years on the mortgage to make them affordable would be a solution. I don't know dick about the subject so help me out.

[Doctor_J]

33. We just refinanced and were shocked at the appraisal price

We can afford the mortgage and aren't planning to move though, so we will survive.

[Rockholm]

34. Where are you talking about. Generalizations are dangerous.

Every real estate market is different. Different from town to town, state to state and region to region. What may (and is) happening in FL, AZ, NV and CA is not happening in CT, MA and other stable states.
And whatever you do, do try to value a home's value from Zillow.

[Kurt_and_Hunter]

35. All stocks are different also

The prospects of GE and Exxon are as different as housing in Las Vegas versus Boston but we still talk about the direction of stock market.

"Home prices" is an average, not a generalization.

[Zynx]

37. Very well put. People used the argument you responded to in trying to say the

housing market would not crack in the first place. We see how that turned out, of course.