Lots More Downside For US House Prices?

Anyone who has been around the financial world for a while knows that when prices swing too far away from where they should be based on fundamentals, they eventually revert back towards equilibrium.

However, they usually don’t stop there. More often than not, prices end up overshooting in the opposite direction. In other words, a market that soars to euphoric highs — like, for example, U.S. residential real estate did during the first half of this decade — will, at some point, fall to desperation lows.

Given that, I think we can safely assume that the numbers cited in the following Reuters report, “U.S. House Prices Overvalued by up to 20 Percent: IMF Paper,” should be seen as a minimum downside projection for home values from this point going forward.

The downward spiral of U.S. housing prices still has a way to go and homes were overvalued by between 8 percent to 20 percent in the first quarter of this year, according to research by an International Monetary Fund economist published on Friday.

In his report “What goes up must come down? House price dynamics in the United States,” IMF economist Vladimir Klyuev used several economic techniques to determine by how much U.S. home prices are overvalued.

Klyuev drew from a government study of single-family home prices to conclude that values were “around 14 percent above equilibrium in the first quarter of 2008, with a plausible range of 8 to 20 percent.”

His research showed that home prices became considerably overvalued from 2001 and while the housing market has started to correct itself, there is still a long way to go.

U.S. policy-makers are now trying to guide the housing market into a soft-landing after a five-year run-up in home values that ended in 2006.

The report also said that it is likely home prices will swing well below their equilibrium level before they start to recover.

Klyuev’s research included data gathered by the U.S. Office of Federal Housing Enterprise Oversight which regulates mortgage-finance companies Fannie Mae and Freddie Mac and collects purchase price data.

Klyuev analyzed the dynamics of home prices and found the inventory-to-sales ratio the most important driver of changes in property values in the short run.

“Starts in foreclosures, which obviously add to inventory, seem to also exert additional downward pressure on prices,” he added.

According to the research the bloated inventory-to-sales ratio, high foreclosure rates, and inertia in housing markets imply that recent price declines are likely to continue.

The research also considered whether the current fall in U.S. housing prices represented a nationwide bust.

“While the national price level is falling on every measure, there is an opinion that this decline might reflect oversized drops in a few isolated markets rather than a countrywide phenomenon,” it said.

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