The Consequences of Another 10% Housing Price Decline

It is sometimes pointed out that the percentage decline in housing prices is much less than the percentage decline in stock prices, and this is not withstanding an estimated 4.28 trillion dollars spent on various forms of bailout programs. According to CNBC, this is more than what was spent in World War II.

It is important to interpret this observation correctly. It must not be concluded that this means the housing market decline is less of a problem. Rather, it is evidence that the housing market decline is all the more threatening. Analysts generally agree that the problem of the financial market turmoil really started in the housing market, in particular the segment of that market that is financed by sub-prime mortgage loans. It is increasingly clear that the emergence of the sub-prime market to promote homeownership was ill-motivated, and that the widespread and abusive use of CDS has contributed to serious moral hazard that greatly aggravated the crisis.

We need to seriously consider if we can allow home prices to decline by another 10 to 20%. Those who hope that this would make homes more affordable need to think carefully. If home prices do decline by this much, it is likely that they still won't be able to afford them as there is a good chance that they lose their jobs, and even more likely that they won't easily find banks able to and willing to lend them money.

Economists often use the concept of elasticity in their analysis. Elasticity refers to the percentage change of one variable(such as stock price) in response to a percentage change in another variable(such as housing price). Suppose 1% housing price decline leads to 2% stock market decline, elasticity of the stock price index to the housing price index would be 2. There is clear evidence that the effect of the housing price declines in the US has been horrendous. The damage to financial market and the US and the world economy has been horrendous. Many innocent people lose their life savings, their jobs, their businesses, their homes, some even their lives. Some people complained about the government spending money to bail out poorly managed companies.

Consider Lehman Brothers (LEHMQ.PK). It was excessively leveraged; its leverage ratio before its downfall was reported to be above 30. Its management should be responsible and should not be bailed out. Yet its downfall in September was the cause of the terrifying financial tsunami that ensued. Innocent people in Hong Kong, including many elderly and low income people, who had been persuaded to buy Lehman 'mini-bonds' of various stripes, lost their life savings and suffered greatly. Retail sales fell greatly. Housing price declines accelerated. Car sales plummeted. The ranks of the unemployed soared.

The Federal government is aware that not bailing out Citibank is unthinkable. The damage would just be too great. The FDIC just reported that the number of problem U.S. banks and thrifts jumped in the third quarter to 171, from 117 at the end of the prior quarter, marking the highest level since the end of 1995, according to regulators. And this has not even taken into account of the effects of the terrifying October crash.

If the markets were normal, we do not want bailouts. But saving the economy from a possible depression is the most important thing at hand right now. During the Great Depression, over 8000 banks failed, and unemployment soared to over 20%. It must not be repeated. Another 10% decline in housing prices will aggravate the credit crunch, cause more bank failures, lead to widespread business failures, and potentially threatening the ability of many state governments to pay their staff.

As an outsider(I live in Hong Kong and I do not own any property in the US), I argue for putting a floor on home prices for less-than-median existing housing, and have demonstrated that it will cost much less than many other bail-out programs and that it deals with the problem at the source. I have argued that it costs less to the US taxpayer than other bailout programs and will even return a profit to the government. It does not represent a handout to big businesses, does not interfere with higher-than-median-price homes, and is non-intrusive because the government does not go out and selectively buy from any one. It is also fair because the proposed buy-back program requires that the buy back be done at fair market price as of the 'snapshot' date.

Comments

[JPDD:]

<i>Those who hope that this would make homes more affordable need to think carefully. If home prices do decline by this much, it is likely that they still won't be able to afford them as there is a good chance that they lose their jobs,</i>

It simply does not matter what we "hope" for. Anything that can't go on forever, won't go on forever: And house price-to-income ratios were (and still are) unsustainable.

So prepare. To quote our oh-so-esteemed US president, "This sucker is going down."

2008 Nov 26 06:55 AM

[vaughn:]

Excessive debt must be driven into open and defaulted. Only when excessive debt is cleared via default, then the true price of assets can be sustained.

All those bailouts by FEd via all kinds of funding facility can only delay the inevitable and is used to shift who shall eat defaults (such as from other agency debt buyers to federal reserve, etc.), the default will still happen for a very simple and basic reason: the home mortgage becomes unafforable for those who either shall not borrow in the first place or who lost jobs in this turmoil time.

The only possilbe way to put a floor on the housing price is if huge demand can be created from thin hair: such as US passing a special immigration status allowing 5 million immigrants green card status simply for investing a sum of $500,000 into usa and use that fund to buy a house in the USA. This might temporarily create a demand and encourage tire kickers currently on the sideline to buy a house now instead of waiting for another decline of 10-15%.

2008 Nov 26 07:05 PM

[Kunst:]

The house of cards that is the US dollar is going to collapse. When the value of the dollar drops by half or more, the housing problem will be "solved" by inflation. House prices will go up, albeit in cheaper dollars. Incomes will go up, even if not as much as prices. House payments will be a smaller percent of income. Higher house prices mean positive equity instead of negative. This is what's really going to happen. The current situation is a death spiral that will not be permitted by those who control the economy, specifically the currency. Don't sit on dollars, don't be a lender, do own things that have concrete value apart from currency values.

2008 Nov 26 09:07 PM

[Charto:]

Is this capitalism shrugged?

punchdickfuld.com

2008 Nov 29 09:36 PM

[TheMajor:]

On Nov 26 07:05 PM vaughn wrote:

> Excessive debt must be driven into open and defaulted. Only when
> excessive debt is cleared via default, then the true price of assets
> can be sustained.
>
> All those bailouts by FEd via all kinds of funding facility can only
> delay the inevitable and is used to shift who shall eat defaults
> (such as from other agency debt buyers to federal reserve, etc.),
> the default will still happen for a very simple and basic reason:
> the home mortgage becomes unafforable for those who either shall
> not borrow in the first place or who lost jobs in this turmoil time.
>
>
> The only possilbe way to put a floor on the housing price is if huge
> demand can be created from thin hair: such as US passing a special
> immigration status allowing 5 million immigrants green card status
> simply for investing a sum of $500,000 into usa and use that fund
> to buy a house in the USA. This might temporarily create a demand
> and encourage tire kickers currently on the sideline to buy a house
> now instead of waiting for another decline of 10-15%.

THAT WOULD BE TREASON! NO MORE FOREIGNERS IN OUR COUNTRY - GOING DOWN WOULD BE BETTER THAN THAT.

2008 Dec 28 01:22 AM