Declining Home Prices: When Will It End?

Declining Housing Inventory May Mean Something

One of the keys to recovery will be a stabilization of housing prices evidenced by a reduction in the supply of homes for sale. There are many elements to this recession but housing is the largest element and the focus of the credit bubble that led to the economic collapse.

The National Association of Realtors reported that the supply of existing homes in December declined to a 9.3 month supply, down from November’s 11.2 month supply. This is a major turn of event and the first decline in a year.

This was accompanied by a 15.3% decline in home prices. This is the biggest drop on record. The median home price is $175,400, down from $207,000 a year ago. They reported that 45% of the sales were related to “distressed sales.” The Case-Shiller index fell 18.2% in November.

Does this mean that the economy is turning?

The fact that buyers are entering the market to buy homes through distressed sales is a good indicator but wait before you cheer. Because of the breadth of the largest credit boom in history, we are having the largest credit cycle bust in history. All this has lead to a major recession. It’s not easy to cure overnight. In addition to the housing bust, we also have an excess of debt related to commercial real estate loans, auto loans, credit cards, student loans, and municipal debt. They are all showing signs of “distress.”

A bottom has to start somewhere though. We need further data to see if the trend continues over the next few months. If it is a trend, then, while home values may still decline for a while, it appears that home buyers believe that prices are getting low enough to get back into the market.

Here’s the catch. Even if home prices stabilize, we will linger in recession until the other debt classes work their way through the economy. 

The Obama Administration is betting the entire pot on Keynesian fiscal stimulus. They believe that the massive spending bill working its way through Congress will rescue the economy. They believe that spending $850 billion on projects chosen by the government will push cash through the economy, get people to spend again, and cure what the Keynesians call the “liquidity trap.”

The fly in the ointment for them is deflation. Why would “consumers” consume when they see their assets going down in value? The answer is that they won’t. Declining prices in housing, autos, and commodities are no secret to most Americans. That and the news of layoffs and companies going bankrupt make people conserve assets, reduce debt, and save for a rainy day. They won’t spend.

The home equity refi credit card has run out. From 2000 through 2006 the purchasing power of homeowners tripled. Fueled by cheap credit spending skyrocketed during the housing boom. Things have changed with deflating home prices. For the first time since 1945 homeowner equity has fallen below 50% of home value. Even if the housing market bottoms out, prices will remain “low” for years.  So where is the money going to come from to stimulate spending?

Until consumer debt is paid down and savings increase, the only impact of such fiscal stimulus will be to retard economic recovery. Massive government debt will negatively impact capital markets and will ultimately lead to inflation and rising interest rates. Since the government will borrow the money to pay for this spending, the debt will have to be serviced from taxes which sucks more money out of the economy and crowds out capital for private enterprise. Just ask the Japanese.

How long will it last? Longer than before.

What to do? Watch, wait, hold cash, and be patient.

Econophile