Housing Prices Continue To Tumble

The S&P Case Schiller index, the best measure of housing prices, showed prices were still declining in February. The 10-city composite was down by 2.1% for the month, 18.8% year over year and is 31.6% off its peak (May 2006). The 20-city composite has a shorter history but tells much the same story — it was down 2.2% for the month, 18.6% for the year and is off 30.7% from its peak (also May 2006).

As the chart below shows, the most positive thing that can be said is that the year-over-year rate of decline has started to slow a bit, particularly for the 10-city composite. This was the first time in over two years (20-city composite, 16 months for the 10-city composite) that the year-over-year decline did not set a record. For the month, housing price indexes were down for every one of the 20 metropolitan areas followed. For eight of the 20 cities, the monthly declines were at least 3.0%.

The worst-hit cities for the month included many of the usual suspects, which means that the hardest hit places continue to get hammered. For the month, Cleveland registered a 5.0% decline, followed by Phoenix with a 4.5% drop and Detroit with a 3.8% decline. The other hard-hit cities include (in order of monthly declines) Las Vegas, Chicago, San Francisco, Minneapolis and Miami. The only city to have less than a 1.0% decline for the month was San Diego.

However only two cities have housing prices below January 2000 levels (when the indexes were all at 100) — Detroit and Cleveland. The three cities with the highest current index levels are New York (178), Washington D.C. (168) and Los Angeles (163). Only time will tell if they are simply behind the curve, or are more resilient than other areas. I suspect the former.

The level of house price decline is one of the key metrics for the so-called “stress tests.” As the second graph shows, the “more adverse” scenario under the stress tests is the one that most closely matches the economic reality.

The baseline scenario is not even worth considering, for it involves no stress at all. Any bank that cannot pass the baseline scenario should be avoided by investors at all costs (depositors are fine up to $250,000, for at least as long until the FDIC runs out of money, but even then the Treasury or the Fed will bail it out). Such a bank is insolent, not just illiquid, insolvent. They will need to raise very large amounts of capital that will severely dilute the existing shareholders.

Passing the “more adverse” scenario means that the bank should be able to make it, provided there are no major exogamous shocks to the system — like, say, a worldwide flu pandemic.

The decline in housing values is really at the core of the current economic troubles. To be more precise, it was the unwarranted rise in those housing values (which are now returning to earth) that was the core problem — it is just that the pain is felt on the downside of the bubble.

The continuing decline in housing prices will lead to more people being underwater on their homes. That will lead to more foreclosures (and rising unemployment will speed that process along). Those foreclosures will cause more pressure on bank balance sheets.

Since the administration seems intent on being extremely nice to the bankers, it means that there will be more taxpayer money flowing to the coffers of the banks to shore them up. It certainly does not come as a surprise that Citigroup (C) and Bank of America (BAC) are likely to need to raise more capital. However, if recent history is any guide (under both the Obama and Bush administrations), they will probably get it from the government on extremely preferential terms, with the government going out of its way to asset any ownership rights that might protect the taxpayers.

The decline in housing values also means that those still with positive equity in their houses will have less of it, further diminishing retirement nest eggs for millions. This will keep the pressure on for people to try to save out of current income. That is a good thing over the long run, but the savings will come at the expense of consumption, and the lower consumption will further depress the economy.

On the bright side, young people (and renters) may actually be able to afford a house in the near future. They will need a low monthly mortgage payment given the amount of taxes they will have to pay in the future given the debt the country is taking on to make sure that bankers can live in the style that they have become accustomed to.

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