Record Drops in House Prices

From the January 2007 Trumpet Print Edition

If you purchased a new home after September 2004, odds are it is now worth less than you originally paid for it.

According to the U.S. Commerce Department, the median price for newly constructed homes fell 9.7 percent from September 2005 to September 2006—a drop of magnitude not seen since 1970, and the fourth-largest year-over-year drop on record. Median home prices as of September were down 15.5 percent from their record high posted last April (cnnMoney.com, Oct. 26, 2006). At the same time, the volume of new home sales has also plunged 14 percent from levels a year ago, according to the U.S. Census Bureau.

The big danger, according to Jim Jubak, senior markets editor for msn Money, is that this housing slowdown might continue to build on its own momentum.

“It was surprising just how quickly the market seemed to turn,” says Mark Zandi, Economy.com’s chief economist. “It was like, boom, boom, bust. It was like, ‘What happened?’ The psychology in the market place unraveled very rapidly” (USA Today, Oct. 26, 2006).

When home prices are soaring, nobody wants to wait to buy a home in fear that they will have to pay more for it later. And sellers don’t mind waiting for higher bids because they think they can get more money later.

Conversely, however, when market temperaments change and people begin to anticipate lower future prices, the incentive to make a quick purchase disappears. “Bids are drying up. Many potential buyers are simply waiting for lower prices. The word is that ‘it pays to wait,’” says economic analyst Richard Russell (Daily Reckoning, Sept. 19, 2006).

Michael Shedlock of Mish’s Global Economic Trend Analysis agrees, calling this “a procrastinator’s market” and saying, “Prices have only one way to go and that is down.” Why buy a house today when you can buy it for less next month or maybe much less next year?

Even with the housing downturn in what could be its infancy, some analysts are already forecasting that prices have hit bottom. “The worst is behind us as far as a market correction—this is likely the trough for sales,” said David Lereah, the National Association of Realtors’ chief economist. “When consumers recognize that home sales are stabilizing, we’ll see the buyers who’ve been on the sidelines get back into the market” (Associated Press, Oct. 25, 2006).

Where exactly this sideline for buyers is that Lereah refers to is unclear. Homeownership is already at record levels. Additionally, according to some estimates, 40 percent of houses purchased in 2005 were second homes or investments.

Moreover, over the past few years it has become much more commonplace to buy a house without a down payment. If prices continue to remain weak, the market could be flooded with people trying to get out of their mortgages with what little is left before prices weaken more. According to Shedlock, the market is already “flooded with inventory from those who now want to cash out” (op. cit.).

Perhaps the clearest indicator of the end of the housing bubble, from a contrarian point of view, is that people can now, along with pork bellies, soybeans and stocks, invest in a home-futures market. This past May, the Chicago Mercantile Exchange created a home-price-futures market that gives people and investors the ability to speculate on home prices across 10 major U.S. cities, including Boston, Miami, San Diego and Chicago, without actually purchasing any property.

This kind of speculator excitement—typified by a plethora of new and improved investment ideas like home-futures contracts, interest-only mortgages, negative amortization home loans, 50-year mortgages, widespread adjustable-rate mortgages and other products—is characteristic of the froth that usually surrounds bubble peaks—like that of the dot.com mania in 2000.

The noise of a deflating housing bubble is getting louder. For the U.S. economy, which has become so dependent on the many jobs surrounding the home-construction, real-estate and property financing sectors, this is certainly not a good economic development. If you haven’t started preparing for post-bubble economic trouble, now might be a good time.