why couldnt it happen here

Time to Get Real About the Future of Home Prices
Published Feb 21, 2008 | RSS Feed | Text Size
American homeowners are desperate to believe that the gains they have seen over the last ten years will not disappear completely, but the truth is that there is only one direction for home prices to go.
BY BAILEY HARRIS

Home prices have been falling for more than a year straight in some areas of the country. Nationally, prices have dropped six percent in a year-over-year comparison. In some areas of Florida, California, Arizona, Nevada and Michigan, the declines have been in the double-digits.

Why is this happening and when will it stop?


Americans Can't Afford to Buy

Home prices began climbing at an unprecedented rate in 2001. Lax lending standards, borrower and lender mortgage fraud, low interest rates and unreasonable speculative fever all helped contribute to the accelerated pace.

The one thing that didn't contribute was incomes:




Median home prices increased by more than 45 percent in ten years time. During the same period, the median household income increased by only 10 percent.

The gap led to the inability of most Americans earning the average income to purchase a median priced home in their area. Instead of admitting that they could not afford to buy, many people bought out of their price range.

The result is that millions of homeowners are now underwater in their mortgage (they owe more than their home is worth.) Thirty-nine percent of the people who purchased a home in the last ten years owe more they could ever recoup by selling. By the end of 2008, 15 million homeowners are expected to be underwater.

There is no doubt that these figure will get worse. As it stands, home prices are still unaffordable for the average American. That will not change until prices have fallen far enough to be in line with incomes once again.


The Disconnect Cannot Continue

Home prices are disconnected from incomes, but they are also disconnected from another fundamental factor: rent prices.

Home prices and rents almost always rise at the same pace. Rents were between 5 percent and 5.5 percent of home prices between 1960 and 1995, according to a new study from Morris Davis. The rent-price ratio fell to a historically low level (3.5 percent) by 2006.

This 30 percent difference indicates how disconnected home prices are from rents and how necessary it is for home prices to decline. The housing market will not be flooded with eager buyers ever again unless home prices fall to pre-boom levels and the disconnect is corrected.


Why Delay the Inevitable?

There has been a lot of talk from consumer advocates and government officials about the need to stop the fall of home prices through foreclosure rescue schemes. While this could work in the very short term, the reality is that there is no way to stop home price declines at this point.

The home prices we see now are not sustainable. Prices are not relative to income, rents and other indicators of affordability. The rapid run-ups we saw during the boom weren't real, and neither is the equity that people thought they gained.

When the housing bubble finally bursts--what we have now is a slow leak--it will have a direct impact on housing valuations. It will also cause real distress in mortgage markets, among investors and in the broader economy.

Keeping someone in a home they cannot afford (or paid too much for) in the hope that prices will remain artificial for a little bit longer is illogical, dangerous and more than a little unfair.

Delaying the inevitable may be helpful to the banking industry that originally forged the bubble with fraud and irresponsibility, but it does nothing for the American taxpayers who will be flipping the bill.


Bottom Line

It's time to get real about the future of home prices. They are going to fall. People will face foreclosure and banks will fail as a result. The collapse of the bubble is going to cost us. We can either accept it now or accept it later after we have paid out trillions of dollars to delay the fallout.