Lok Sang Ho

Futures Show Home Prices Continuing To Plummet

Before the housing market stabilizes, the financials will continue to hurt, and the declines in financials will spill over to the real economy through tighter credit and a dampened psychology. Many analysts are predicting that housing prices have another 10% to 15% to fall. Can the US economy afford this? Can the world economy afford this? The required rescue package when another 15% per housing values disappear would be unthinkably huge.
On the other hand, it is possible to put a floor to existing home prices if the Federal Government, with Fed backing, offers a buy-back at the market price frozen at some point in time(a snapshot, so to speak, say in November 2008). The cost appears to be unmanageable because of the sheer size of the market. But if the offer is limited to homes below the national median price or the median price for each regional market, the cost would be manageable. Because the government can rent out any acquired properties, there will be a sizeable cash flow too. The important thing to note is that this will immediately change the market psychology. Buyers will emerge, while some owners will withdraw their homes from the market. This will effectively stop the the further bleeding of financials.
Some may object that this would imply the Fed creating a large quantity of money and would be inflationary. I argue that inflation is predicated on excessive aggregate demand. The money created is not for anyone to chase after scarce goods, but only to withdraw some excess housing stock from the market. It will put a floor to the lower half of the housing market while allowing more expensive homes to find their equilibrium price levels given this limited intervention. The government is not actively buying, only acquiring homes from existing owners who need to sell.

Why Housing Dragged Down Stocks

The graph is misread. Actually housing investment leads non-housing investment. The decline in residential investment will lead to a decline in non-residential investment.

When housing prices decline, consumption falls because of the negative wealth effect(this is controversial; some argue that cheaper homes allow more consumption on other goods; but empirical tests appear to confirm the wealth effect dominates). When housing prices decline, investment also declines, partly because businesses expect lower demand for their products(auto industry is a case in point), and partly because falling housing prices lead to a credit crunch as the collateral values of homes fall.