Where's the Bottom?

One question that keeps popping up as the meltdown unfolds is: "When is it all going to end?" In truth, that question is almost impossible to answer, because it depends to a great extent on the actions of some key players, including the Federal Reserve and the Washington political establishment.

Even so, given that many of the current woes stem from the plethora of distortions that developed in the residential property market, it seems a good bet that a true turning point will only really be seen when home prices fall back to levels that have some link to economic reality.

In "Mind the Gap: Home-Price Downside," the Wall Street Journal's Scott Patterson highlights a statistic that suggests we still have quite a ways to go before we reach that point.

The economic balance hangs in large part on how much further home prices will fall. A look at one important measure -- the relationship between home prices and household income -- suggests we might not even be halfway there.

Over the long run, home prices and income should march along the same path. As households earn more, they can afford to pay for more expensive homes.

But the two can get out of whack. During much of the 1990s, incomes grew faster than home prices. The landscape shifted around 2000. From the start of the decade through the mid-2006 peak, home prices nearly doubled, thanks in part to falling interest rates. Over the same period, income per household rose just 26%, according to Moody's Economy.com. ...

Comments

[tradeking13:]

When everyone stops asking "where's the bottom?", that's when we'll see the bottom.

2008 Mar 14 11:16 AM

[Wisdom-Seeker:]

Alas, with a recession now underway, household income is going to be falling right along with those home prices.

For instance, the Michigan and Ohio markets aren't getting clobbered because the homes are too expensive ($70,000 is a recent median home price in Youngstown Ohio!); they're getting clobbered because they're on the leading wave of the recession and people don't have jobs.

2008 Mar 14 11:56 AM

[300mph:]

True, real estate also follows a income/supply/demand relationship like everything else. But digging a little deeper, isn't there also a relationship between the cost of existing homes and the cost to build new homes. At what point does the fall in existing home prices become limited by the cost of new construction?

2008 Mar 14 12:00 PM

[Matt Blackman:]

And with a recession looking more likely, real incomes will fall harder and faster - not a good prognosis for home prices given their strong link to income growth.... One point missed in all the bottom picking analysis - such assumptions are based on home prices bottoming soon and this is a fatally flawed assumption based on the data and recession dynamics. If home prices have fallen the most since the Great Depression in the absence of a recession, it is probable that we will hit new levels of price deceleration once the impact of a recession takes hold....

On 300mph's point about building costs putting a floor under prices...prices for every aspect of building a home have gone thru the roof (no pun intended) and therefore have a long way to fall. Since I built my last home in the early 1990s, the costs to build a home have trebled leaving a long way for costs to fall in a recession or heaven forbid, full blown depression. Also, with huge inventories of existing homes, new home prices can remain below cost for extended periods as prices fall to clear those inventories. However, once those inventories have cleared, the cost of a new home becomes a more important metric and does provide a base for new home prices.

But one more point to remember, existing homes represent 85% of housing stock and so the price of a new home impacting existing home prices would be like the tail wagging the dog.

2008 Mar 14 01:55 PM

[jurp:]

One no longer has to explain why one is renting. It is cheaper, and wiser.

House's peak production was 1926-7, and they bottomed about 1940.
they went down 75%.

So, for sake of argument, say all is over in 3.5 years, and only goes 1/4 as far. That gives you a 18% decline, in 1/4 the time.

Then, using the rent to price rational of Fortune Magazine, now 250 times rent, houses will be 188 times rent. Not great, but manageable.

2008 Mar 15 08:08 PM

[User 163394:]

As Erick says:

"When everyone stops asking "where's the bottom?", that's when we'll see the bottom."

The business cycle has amazed me since I first studied it during my freshman year in college. History continues to repeat itself. When will we ever learn. What goes up does not have to come down. Business cycles are "learned and practiced" and have been since the Great Depression.

Seems to me that it always starts when someone mentions the word, "recession."

Things go well and then a few select, seemingly "expert" people decide that it's got to end and they begin to spread that dreaded word. Soon it's like someone yelling "fire"when their is none.

2008 Mar 16 02:52 AM

[bearybeary:]

I have continued to be amazed at the level of denial in this market. The deflation of the asset bubble in housing is simply following classical economic theory, i.e. regression to its mean. Guess what-- the 8.25% decrease in housing values thus far is only about one-fourth of the regression we can expect, if the pendulum effect in fact doesn't take values even further down. What will this mean? Approximately $6 trillion of mostly middle class wealth will vanish; two in five houses will have a mortgage in excess of the homes value; the retrenchment in consumer spending will of necessity be draconian; the Dow will see 8,000 (if we are lucky) before it sees 14,000 again. The Fed and the market are fighting the last war(s). Every recession since the Great Depression has had a common floor-- a stable or increasing value of the country's housing stock. Not this time. Why the market does not give this precipitous decline in housing it's true weight I cannot comprehend. Remember Hannibal Lecter's admonition to Agent Starling-- first principles, simplicity. Read Marcus Aurelius, "Of each particular thing ask what is it in itself, what is its nature." Simply, the nature of this market decline is the continuing fall in housing prices and it will not stop in three months or the second half of the year or 2009. Get ready, we are in for a long and scary ride.

2008 Mar 16 09:09 AM

[DanH:]

Reading User 163394 and bearybeary back to back is striking; the first post shows the magical thinking pervasive in bubble psychology, and the second concisely explains the downslope of a bubble. Kind of like going up, then down.

I agree that regression to the mean is inevitable. Home values doubled in six years (and tripled in some markets), absent real growth in income. Credit has been yanked, and buyers are absent. Prices will regress to an inflation-adjusted mean, presently in the range of Nov 2002 prices. The time to that regression is our wild ride.

2008 Mar 16 05:50 PM