Another Projection: 20% Additional Decline for Housing

Includes: IYR, KBE, KRE, XHB, XLF
by: John Lounsbury

Barry Ritholtz provides the following chart, originally from the New York Times, but updated for The Big Picture by Steve Barry.

For larger image, click here.

This decline is certainly within the possible limits I have discussed earlier in the year (see here and here) but the projection curve drawn by Steve Barry shows a much more gradual drop to the bottom than I have envisioned. I estimate that he is showing another 3.5 to 4 years to get 90% of the way there and 5-6 years to fully bottom out. My thinking is that the drop to the final bottom will be much quicker, driven by the weight of foreclosures over the next one to two years.

There are scenarios where I could see the Barry projection occurring. One of them is a couple of years of weak to moderate economic recovery followed by another significant recession. However, in that case I would not expect the decline to the final bottom to be smooth, but to occur after a period of time where house prices remained relatively flat before a second steep step down to a bottom.

What has not been considered by either Barry or me is the recurrence of another depression for housing, such as occurred from WW I to WW II. What sort of economic disaster would cause home prices to decline 55% to 60% from here? That is what would happen if the decline reproduced the 1920 bottom.

Or, asking a different question: What sort of economic disaster would result if home prices declined 55% to 60% from here? In such severe deflation, most mortgagors would default and every mortgage lender would be insolvent. There would be no future TARP or other shenanigan that could accommodate that eventuality.

Disclosure: No positions.