Tuesday, September 28, 2010

The housing market has adjusted to new realities

The top chart shows inflation-adjusted prices for homes in 10 major metropolitan areas since 1987, while the bottom chart shows prices in 20 major metropolitan areas since 2000 (and is also seasonally-adjusted). Both show that real home prices have fallen by one-third since the peak in 2006, and both show that prices stopped falling over one year ago.

Because of the lags in the way this index is constructed, the latest datapoint (July) tells us only about the average of prices in the second quarter of this year, and that's admittedly old news. But it's impressive that prices have remained firm for over one year after a significant decline. This is the way you would expect an overbuilt market to work: prices have to decline to a new clearing level that allows excess inventory to be worked off. That has happened.

The issue going forward is whether we need another significant decline to allow what is presumed to be a "new wave" of foreclosures to be sold. Put me in the skeptical column, because a) the housing market has had almost 5 years to adjust to new realities, b) prices have adjusted very significantly, c) prices have been stable for over a year, d) mortgage rates have declined by one-third since their peak in 2006, which further reduces the effective cost of buying a home by a substantial amount, e) new home construction has plunged by two-thirds, which contributes mightily to work off the excess inventory of homes, and f) the economy has recovered and we are now seeing job and income gains. That adds up to a giant amount of price and inventory adjustment, and enough time for all sorts of things to be dealt with. Why would we need more?

The housing market is clearing and has apparently stabilized. It's time to worry about other things, such as what will happen to taxes beginning next year.


Bill said...


Don't you think that the expiration of the first time buyer tax credit will cause prices to drop further? I sure see a lot of "reduced" for sale signs in the Atlanta metro area and real estate agents tell me that folks are forced to drop their prices to move homes. I sure hope you are right

Bill said...

It seems that all the charts show inflation adjusted prices. Any idea what the non-inflation adjusted prices look like? I would love to see a chart.

The reason why I ask is that mortgages are a fixed (and hopefully declining) debt while inflation adds to the nominal values of the homes. The greater the values it seems the better off the banks will be as there is more collateral to seize and people can sell to satisfy mortgages which they can no longer afford rather than simply defaulting.

Scott Grannis said...

Bill: the nominal versions of these charts show that prices have increased by more (i.e., by the rate of inflation). Inflation, as you point out, has a great way of bailing out debtors over time.