Housing Market in “Freefall”, But How Low Can it Go?

In yesterday’s blog post, I warned you that, contrary to popular Wall Street opinion, the housing induced, sub-prime market shock is far from over.

The reason is simple: the U.S. housing market appears to still be in “freefall” – indicating that home prices have much further to decline. This continued deterioration in household wealth, occurring at the same time that hundreds of billions in adjustable rate loans reset to higher monthly payments, has the potential to send home prices spiraling even lower, but just how low is the key question.

Wall Street’s cheerleaders would have you believe that the worst is over, and it’s back to business as usual. The big banks and brokers are booking billions in loan losses as they report dismal third-quarter results, but don’t worry they say, markets are getting back to “normal” – whatever that is.

The Fed’s half-point cut in interest rates is widely viewed by the consensus as a panacea that will cure all ills in credit markets, and the housing sector alike. Shares of struggling home builders are jumping higher again; and bankrupt mortgage lenders are actually getting buyout bids from private equity firms – so all’s well that ends well, right? Wrong!

Housing Bubble Deflation Still Has a Long Way to Go

The ugly fact is that we’re nowhere near the end of the line in this housing debacle. In fact, both Wall Street and Main Street are going to be dealing with the after-shocks for years to come. Let’s look at some of the numbers I’m seeing.

The U.S. housing market has been deflating for more than 18 months now, but according to comments from BCA Research, “prices are still very high relative to rents and wages.” In other words, in spite of sliding home values in 75% of major U.S.-metro housing markets, housing affordability remains very close to 20-year lows.

This graph (from BCA Research) shows the fall in existing home prices from a peak growth rate of 15% year over year in 2005, to a low single-digit decline currently.

Now take a closer look at the bottom panel of this graph and you’ll see that the National Association of Realtors Housing Affordability Index has barely budged from the record lows reached last year.

In fact, home prices in the U.S. are still very close to the most unaffordable levels since the mid-1980s. And it’s bound to get worse before it gets better.

Expect Fresh Shocks to the Economy from Falling Home Prices

A few weeks ago, Congress convened special hearings in Washington D.C. to do a post-mortem on the housing crisis, as politicians love to do after the fact and when the damage is already done.

Robert Shiller, a Yale economist who correctly warned about “irrational exuberance” before the tech-bubble burst in 2000, has recently been sounding the alarm about a similar steep correction in housing. In fact Shiller, in conjunction with Standard & Poor’s created his own home price indexes (see graph) – to better track the unfolding carnage in the housing sector.

So far, the Case-Shiller house price index shows roughly a 4% year over year decline in average home prices across the U.S. -- that's it. Shiller warned Congress that “the decline in house prices stands to create future dislocations like the credit crisis we have just seen.”

Former Fed Chief Alan Greenspan has said that it would not be surprising to see double-digit declines in home prices from their peak – which means that at the moment we aren’t even half-way through with this housing bear market.

Where’s the Bottom is the $3 Trillion Question

Congress heard from other experts on housing who predicted a 15% fall in home prices would wipe out $3 trillion of household wealth. If true, that means we are less than one-third of the way through the current housing recession. The trigger for such a steeper slide in home prices is sitting right on the horizon.

According to various research estimates I’ve seen, there are about $650 billion worth of sub-prime adjustable rate loans that are scheduled to reset to much higher rates (meaning sharply higher monthly payments) over the next 15 months. In fact, we won’t even reach the peak in resets until sometime in the spring of 2008 and the amount of mortgages resetting to higher rates may not subside significantly until 2009!

Bottom line: the housing market may have much further to go on the downside, taking a very large chunk of America’s net-worth down with it.

Comments

[Scott]

There is a solution to these ups and downs in all markets -

Commodity standard money supply
Gold Standard
Fixed Monetary Supply

All the same thing and the same result - stable markets.

[Scott]

There is a solution to these ups and downs in all markets -

Commodity standard money supply
Gold Standard
Fixed Monetary Supply

All the same thing and the same result - stable markets.