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Spin #1: Housing prices are not falling, have never fallen and will not fall
Some folks are still deluding themselves that home prices have not fallen yet and that they will not fall in the future. Indeed, since the Great Depression of the 1930 we have not had a year-on-year fall in median home prices, as opposed to some quarters in which home prices were falling. But now median existing home prices are only 0.9% up relative to a year ago and new home prices are only up 0.3% relative to a year ago. Worse, actual median home prices are falling – on a y-o-y basis - in every US region with the exception of the South. They are even falling in the Mid-West where, allegedly, there was not housing bubble to begin with.
Worse, as the NYT was reporting today, home sellers are now providing a variety of financial benefits (seller paid closing costs, buyer-side realtor bonuses, and seller subsidized mortgages, even $30K swimming pools free) that effectively reduce the price of a sold home, even if the headline price is officially not reduced: “The typical incentive package from a home builder consists of upgrades to the house — granite countertops instead of humdrum tiles, stainless-steel refrigerators and stoves instead of plain white models and wood blinds instead of plastic. At the extremes, some have thrown in $30,000 swimming pools.” Estimates of this effective price cut – via side benefits to buyers – are in the 3% to 8% range. So, while officially median home prices are “only flat” relative to a year ago, the effective median price has already sharply fallen. And if you were to control for CPI price inflation – now running above 4% - home prices are even lower in real terms relative to their nominal value. More ominously, futures contracts for home prices predict a 5% fall in home prices in 2007, and even a larger percentage fall in a number of key cities. It is now clear that, for the first time since the Great Depression, even official - i.e. not fudged by side incentives and subsidies - median home prices will be falling on a year on year basis; the typical lag in the adjustment in home prices to a gap between supply and demand and an increase in inventories of unsold homes will be trigger for this home price bust. On a year on year basis, real home price may fall as much as 10% or even more.
Why would prices fall so much if we have never had – since the 1930s – a year on year fall in median home prices? The reason is clear: part of the increase in prices in the last few years was not due to fundamentals but, rather, to a pure speculative bubble. Thus, once this bubble bursts the reduction in speculative demand that had lead to a sharp increase in the supply of new homes well above any fundamental demand, must need to an actual sharp fall in the prices of the previously bubbly asset. If there had not been any new supply response above fundamental demand, the bursting of the bubble would have led to a smaller price response. But since the initial bubble led to a glut of new housing whose support was only the speculative demand, the final bust requires a sharp fall in price and this fall in price is greater than otherwise: once fundamental demand falls, the real price of homes must be lower than before the bubble started as the increase in supply during the bubble was much greater than the increase in fundamental demand. So, over time the cumulative fall in home prices over the next two years may actually be very large. And, indeed, in the most bubbly regions of the US, home prices are already starting to fall – in real terms – at double digit levels
