Roubini Now Says House Prices to Fall 30%

Nouriel Roubini, a professor of economics, foresaw the current mess in U.S. housing and financial markets (see this article, for example). He recently gave an interview and had this to say:

“Two years ago, I predicted home prices would fall cumulatively 20%, but now I believe it will be at least 30%.

With a 20% fall in home prices, about 16 million households are under water. They have negative equity, which means the value of their homes is below the value of their mortgages. With a 30% drop in prices, you have 21 million households that are in negative equity. And since the mortgages are no-recourse loans, essentially they can walk away.

Even if only half of the 16 million households were to walk away, that alone could lead to losses for the financial system of $1 trillion. Even a 20% drop in home values may imply losses of $1 trillion that are not priced into the market today. So that's the floor. Again, it could be higher — as much as $2 trillion — if prices fall 30% and more people walk.”

Comments

[mavericks]

Any idea of how many of these loans were no money down? I don't understand how in this latest downturn in RE, why it is assumed that such a large % are going to walk away. Granted, if you're in a dire financial state, bought more home than you could afford and put no money down...walking away may your best option. However, people got to live somewhere...its not like you had to own tech stocks during the crash. Each situation is different but I got to figure most people are going to try to hold onto their home in the anticipation that what goes down could also come back up.

[Pmorgan_m3]

A large number will walk away because the negative equity means they will have to continue to make years of payments as they wait for the home value to increase to just equal what they owe....and more time after that to build equity from amortization or future price increase. If they walk away they can rent a place to live much cheaper and save the difference.

[Pmorgan_m3]

They will walk away because they can rent similar quality housing for much less than their mortgage + real estate taxes + home owner's insurance + repairs. They can save the difference, instead of continuing to make years of loan payments until the market goes up enough to give them positive equity.

[Malkiel]

In past real estate downturns the differential between salary and mortgage leverage was nowhere near as high as it is in certain cases here; someone really needs to parse this in detail and determine how far under water a buyer has to be before they'll consider walking away. In past downturns having your home decline 15% wasn't usually a disaster, the loss usually put you under by less than a year's salary, and you stay put or took an acceptable loss to sell. If we have generation of owners who's loss of equity amounts to multiple years of salary, that may--or may not--change the thought process. I wouldn't believe anyone, even experienced real estate or lending professionals, can really make an educated guess here on how the most bubbled borrowers will behave, or how many there even are...

[WAKEUP]

Regarding how many homeowners will walk away: Many years ago I worked for a finance company, one of those where the interest rate is high, but lending standards are low. If a potential borrower had collateral, that company would loan money to them. I can tell you, from that experience, that almost anyone will walk away from almost any kind of collateral, including a house, once it is obvious that they will be paying and paying for a disproportionate amount of time, in order to clear the debt. I have had home owners, car owners, boat owners, even small business owners BOLDLY tell me they were NOT going to continue paying on the loan, because they would rather lose the collateral than continue paying what amounted to an upside-down debt. And they would BACK UP their words, by WALKING. People are not different, now. Despite the fact that the so-called "American Dream" is to own a house, people WILL walk away from any "Dream," once it starts costing more than it is WORTH. We can expect a VERY HIGH PERCENTAGE of upsidedowners to simply WALK. Now, ask yourself this very delicate question: What would YOU do?

[cfish]

Walking is assuming that people actually understand that they are upside down. If most ARM borrowers have no idea that they are holding an ARM, how do you think they'd recon that they are upside down?

I do think people will walk once it becomes the norm. I would, if I had a house.

[User 174721]

Hmmm... Say you bought Nortel at the equivalent of 1250/share in 2000. Today it's worth about 8 bucks. Good luck on ever seeing the top again. Housing will be the same. If you hold your house for 100+ years you might get your money back, if you live that long.

[Jim in Hav]

WHO is Nouriel Roubini, and ON WHAT BASIS does he say home prices will drop 30%??? Let's ask some questions everybody.

[Stillrenting]

My brother owns three downtown condos with zero equity. Every time he refinanced (often) he invested the difference and bought nice property in two foreign countries which will remain nameless.

When the market tanks, he walks away and ex-patriates.

He is in the mortgage business. This was his plan for this thing several years ago.

[Stillrenting]

Jim, I believe this thing is much like a swinging pendulum. It swings too far in both directions. Home prices will drop FARTHER than economics would dictate and then find a relative equilibrium.

When everybody (and I mean pretty much EVERYBODY) "knows" real estate is a bad, terrible, horrible investment, it is time to buy.

[David in D]

We have arguably been in decline for about 18 months (housing-wise); I'm interested to hear how long people think it will take for the housing market to hit its bottom? Another 18 months? Longer? (Incidentally, I live in Denver, CO).

[Expat]

Ignore discussions on real estate prices which talk about length of the decline or the percentage, unless those figures are explained. Professor Roubini justifies his 30% by using rental/price and price/income ratios.

The long-term price/income ratio for the median house price in the US is 2.8 times income. I believe this ratio also takes into account a long-term average downpayment of 10% (correct me if I am wrong). Arguments over bigger houses, better insulation, more marble are irrelevant and part of the reason for the bubble. People can keep homes they can afford. The median income in the US is about $48k. The median house price is about $200k; it needs to drop to about $135 just to revert to the mean. But....

But, in order to re-establish the mean ratio, it must "over-adjust"... to the downside to balance out, otherwise the long-term ratio increases. There is no economic justification for it increasing. Given the state of US banks (Citi, BOA, Wells Fargo all unable to lend right now) and the US recession, I expect the price/income ratio to head to 2.5. That means the median house price will fall to $120k, a drop of 40% from here.

So, to answer the question as to how long it will take, it depends on how much sellers will cut prices, how quickly banks will foreclose, and what insane measures the government uses to try to prop up prices. Japan, for example, has not recovered from its real estate bubble twenty years on. The US housing market will probably slide for another five years.

[laynez]

Fascinating stuff. We are in unchartered waters with this mess, there is just no precedent to mirror it. The historical examples of bubbles blowing from real estate investment/speculation excess is too thin to draw on for any kind of reliable forecasting, and even in those cases (Japan, 1920's Florida, 1980's California etc), the attendent economics were much different. In the case of Japan, their base economy, export machine and manufacturing infrastructure were still mighty engines of wealth creation. The US has debased its currency, outsourced its manufacturing to China and much of its IT industry to India. By far the biggest negative however is that Americans for the most part no longer constitute an energized talent-pool of dynamic, creative idealists with strong character and work ethic, in fact maybe just the opposite. As James H. Kunstler points out, "we're a nation of overstuffed couch potatoes and TV zombies", suffering from adolescent 'gimme, gimme' child psychosis, spending our time fantasizing on carnally debased websites and movies. The only thing we really have left is an unmatched in history military. We can still blow the hell out of everybody!

[PopGoesBend]

Yawn. I live in Bend, Oregon where we are already seeing some drops of more than 30%. Some houses are being listed at 40% off their last sale price. We WISH it would only be a 30% drop. With the inventory we have now (1400+ homes on city lots, about 15-18 months inventory) we are going to see bigger losses. In the desirable/nice parts of town we will be down 40%, and in the outskirts we will see 50% off or more. I'm amazed when I see people freak out about 20%-30% down and realize we are already there, heading further.

[Ace T]

Learning the math here, trying to figure out if someone I know is upsidedown or headed there.
Luxury Condo - bought early 2007 $615,000 (mortgage et al $5200/m)
Income - $170,000 (mortgage is 3.6 times income)
Mortgage was a 80-15-5

So what is that equity situation?

Btw - units on the same street as this condo have over 6 mos on market w/ price drops of 20-30K, hovering at the preconstruction purchase price and nothing is moving.

[Mark in SF]

I'll buy a house when it makes sense to: when it's no longer much cheaper to rent. Homeownership has it advantages, but I'm sorry... at 50%+ premium like we *still* have in San Francisco is just not worth it, no matter what euphoria the NAR is trying to push on us. Half my friends want to 'buy on the dip' with new jumbo limits as a 'once in lifetime opportunity'. Amazing how many people are still smoking the crack.

[blangererer]

I don't understand what the big deal is. Assets got massively overinflated, now they seem to be back on their way to normal. A bunch of paper wealth gets wiped out. Big deal. It mostly hurts the suckers that bought into "real estate only goes up." Anyway, if banks need to fail and people need to lose everything they own to teach people how this whole housing boom was a load of crap, that's fine with me. I wasn't part of the problem. I did my part telling everyone only an idiot would take out a loan on a house that had increased 60%+ in 5 years and expect values not to fall. Idiots.

[Zeppelin]

Everything is fine, this is America. Wall St. will figure a way to blow smoke up all the Global Investors (Gamblers) butts. :( Cash is King...
Greed Kills!!!

[cdrich]

If house prices drop 30% how is over bidding accounted for. For example, when I re-financed my house, the appraiser only based the appraisal on what the comparabel houses sold for near me. He did not account for any improvements I had made on the house. So, if my house is now "worth" $200,000 more because someone over bid on a comparable house, would a price drop of 30% be enough to "correct" the market? Or is some of the pricing too local to determine how much correction needs to happen. By the way, I sold that house in 2001 and sold my last house in 2006. I am a very happy renter!

[Refuse tobuyoverpriced]

Hey Mavericks,

Between July 2005 and June 2006, 50% of all home sales were no money down. Average down payment durng the same time period was 2%!

Unlike other banks, ING has only had 15 foreclosures since 2000, because they insist on substantial down payments.

No down payment is the #1 reason for this mess. No one should be allowed to purchase a home without at least 5% down, and pay their own closing costs.

[MattBlackman]

Think your math is a little off there Larry. At the peak U.S. residential real estate had a total value of $21.5 trillion of which $10.5 trillion was mortgaged. A drop of 20%0 of $21.5 trillion in value is more than $4 trillion my son, not $1 trillion... whether people walk away or not that is still money (equity) lost to the financial system in terms of household wealth... and we still are waiting for the NBER to confirm that we are in recession. I think a 30% total drop in prices is a conservative estimate...