House Prices Falling - And Worries Rising

On Tuesday we received updates on U.S. house prices from two different sources. The OFHEO national house price index recorded a 1.3% decline in the price of a typical U.S. home during the fourth quarter of 2007, while the S&P/Case-Shiller home price index registered a 5.7% decline during the last three months of 2007. Here in San Diego, the respective numbers showed a 2.6% decline according to OFHEO and 9.1% decline from Case-Shiller during the quarter. For the year as a whole, Case-Shiller calculates that home prices fell 9.8% nationally and 15% locally.

Home price index for San Diego as reported by OFHEO and S&P/Case-Shiller, each normalized so that August 2005 = $545,000.

This tendency for the Case-Shiller index to record a stronger drop in home prices than OFHEO was also observed during the 1991 housing downturn. The two indexes apply the same basic methodology to different data sets. OFHEO is based on mortgages handled by Fannie Mae and Freddie Mac, while Case-Shiller uses publicly recorded data on all home sales in selected communities. It appears to be the case that the nonconforming mortgages that don't get to the GSEs were characterized by a bigger run-up in the boom, and should experience a bigger decline now, since nonconforming mortgages will be more affected by the breakdown of the private mortgage securitization process.

The 9.1% fourth-quarter drop for San Diego recorded by Case-Shiller is similar to the 7.4% decline in the median asking price of homes for sale reported by Housing Tracker. Although the latter is a much less satisfactory measure conceptually, it has the benefit of being more up-to-date than Case-Shiller. The San Diego median asking price has fallen an additional 5.9% since December, the most recent value for the Case-Shiller index.

Home prices for San Diego as reported by OFHEO and S&P/Case-Shiller, and median asking price of homes for sale in San Diego (from Housing Tracker).

The reason to be concerned about this is that the farther house prices fall, the greater the number of homeowners who move into the category of negative net equity, that is, owe more on their mortgage than the home is worth. And the farther into the red a household becomes, the greater the incentive and propensity for the homeowner to default on the loan. More defaults mean more losses and greater risk of insolvency for large financial institutions.

And if you think the economy can continue to hum along without those institutions continuing to extend credit, well, we may get some interesting additional data relevant for your hypothesis in a rather short while.

Comments

[WAKEUP]

Professor Hamilton: I have been saying for months that the readily available data points to a gutting and permanent reduction in the price of single family dwellings. I say now that, short of a Full Socialist-type government propping-up of said prices, there will never be a return to anything like the inflated prices we have been seeing until recently. Further, it strongly appears to me that the era of the HOUSE as an overridingly expensive item will be ended, as soon as the last plank of the false price-structure of real estate has fallen through. Please publish your thoughts on this, as it appears to this reader that we are at an historic junction in the evolution of the residential real estate market.

[Awake]

So basically all your indexes and charts lead you to the conclusion that if home prices continue to fall, more people will find themselves motivated (or forced) to default, which will in turn create more downward price pressure - resulting an economic death spiral? Problem with that theory is (and I am sure there is an index or chart for this somewhere), eventually real estate will reach the price point in which it becomes affordable as a home and/or cost effective as an investment vehicle. At this point - it will of course stimulate demand, which will in turn reduce supply. Ultimately...drum roll please... resulting in higher prices. As a finite commodity, land has no choice but to trend higher OVER TIME. If you doubt me - just take a look at oil now that "peak oil" claims have been tossed about.

I am curious if your charts take into account that it is ultimately just the human dynamic that disturbs the orderly upward progression? Can they quantify greed?

The bottom is known for those who care to take a look at the historical value of real estate in relation to the earnings potential of its consumers and the premium placed upon its potential scarcity.