US Housing Prices Continue To Plunge

It was no surprise that the Case-Schiller index came out showing big year-over-year declines in housing prices, and that the declines were extremely widespread. The 18.5% decline in the 20-city average was just slightly worse than consensus projections of an 18.2% year-over-year decline. The 10-city composite, which is a subset of the 20 but which has a longer history, was down 19.2% on a year-over-year basis. From the peak, the 10-city composite is down 28.3% and the 20-city is down 27.0%.

So does this mean that we are close to the bottom? Well, we are closer than we were a few months ago, but things still have a way to go on the downside. Check out the graph below (larger version available at http://www.calculatedriskblog.com/). Over the long sweep of history, housing prices generally go up at about the same rate as the pace of inflation, or just a touch higher as incomes rise.

The rise from, say, 1997 to 2000 could have been explained as the index just catching up from a few below-par years. Everything after that was just a pure and simple bubble. There were no demographic changes that would explain it — nothing but easy credit and momentum trading.

The value of houses over the long term has to be related to 2 things — rents and incomes. As unemployment rises and hours are cut back, incomes are falling (not rising), and in real terms the median income has not risen so far this millennium.

Over the last decade, rents have increased generally in-line with overall inflation. There has been no large diversion between either the rent component, or the owners-equivalent rent component of the CPI and the overall CPI. Together, they are by far the largest portion of the overall CPI, so that is not a huge shock.

However, if the price of an asset continues to rise, and the cash flows that asset produces do not rise, there is going to be trouble brewing. It is the same thing as seeing a stock with flat earnings or slowly growing earnings year after year soar to the sky on just multiple expansion. It is unsustainable.

The higher prices induced a flood of new supply, as cornfields across the country were turned into subdivisions. Now all those empty homes are looking for people to fill them, either as owners or as renters.

In the cities, new condo developments reached for the skies, and now they sit empty, or are becoming “luxury rentals.” Yes, there has been a pick up in existing home sales — we will see if that has continued tomorrow morning when the existing home sales report comes out.

But a huge percentage of existing home sales (45% last month) are “distressed sales,” or homes that had been foreclosed on or are about to be. The majority of those sales are probably going to cash-flow investors who hope to rent them out. This is, in turn, putting downward pressure on rents. Sort of like buying into a stock when the company’s earnings are falling (gee, sound familiar about now?).

This makes the fair value of the houses even lower than it otherwise would be. Before this is all over with, I suspect that the Case Schiller index will most likely fall to about the 120 level on the 20-city composite, from its current level of about 150 and its peak north of 200.

As it does, more and more houses will go into foreclosure, more mortgages will go sour, and more banks will end up on life-support, or as wards of the government. Homebuilders like D.R. Horton (DHI) are hopeless — the last thing the country needs right now is more new homes built.

The mortgage insurers like PMI Group (PMI) are toast, even though they were relatively responsible during the bubble.  The big banks, like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are destined for at least a short time in the arms of Shelia Blair’s FDIC, or an entity like it set up to deal with mega banks.

Efforts to prop up a huge market like housing are futile, although efforts to allow people to refinance are worthwhile. The Obama housing plan will help a little bit in that regard, but anyone who thinks that housing prices are about to stop falling is deluding themselves. Anyone who thinks that there will be a big bounce back after the declines stop is just plain being silly.

On the bright side though, renters and young people will eventually be able to have affordable housing.

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