Learning to love falling house prices

June 18, 2009

Christopher Swann– Christopher Swann is a Reuters columnist. The views expressed are his own –

Optimism has been all but extinguished from the U.S. housing market.

The number of Americans lining up for new home loans is shrinking again, according to Wednesday’s release from the Mortgage Bankers Association, and the best that can be said of homebuilding is that it has stabilized at almost 80 percent below its peak.

With no end in sight to falling prices, perhaps we should look on the bright side. Indeed, there are three good reasons why sliding prices are not such a bad thing.

Falling house prices are usually seen as wealth destruction. But they can also be seen as wealth transfer. The next generation of homebuyers will benefit from our loss. Those young homebuyers who have been able to cling onto their jobs are already reaping the advantage. The American dream of home ownership can now be achieved at bargain basement prices.

Take San Francisco. If you earned the median wage in San Francisco at the peak of the housing market in 2006, you would have needed to devote 75 percent of your income to meet mortgage payments on the average home. Now people will pay just 35 percent of their income, according to Ian Morris, chief U.S. economist at HSBC.

It would no longer be any surprise if prices remained stagnant for a decade – spreading the benefit of cheap housing for at least 13 million new households.

Americans may also reflect that much of their temporary housing wealth was illusory anyway. Since house prices in a given area tend to rise in tandem, the only way to cash out was to borrow against equity, or move to a cheaper area or smaller space, or die.

A second consolation is political. Tumbling prices have exposed the flaws in the American government’s efforts to subsidize housing.

It is now clear that these efforts did more harm than good. More thoughtful U.S. politicians must now question the mortgage interest tax deduction. The benefit of this tax was heavily skewed towards high earners since they paid a stiffer tax rate. Instead of fostering broad home ownership, the deduction encouraged rich Americans to borrow more and build bigger homes.

This is bad financial and even worse environmental policy. At the very least, Congress should now cap this deduction at $500,000.

The third source of solace is macroeconomic. For several years America borrowed money from abroad to make an investment that did nothing to expand its productive capacity or its ability to export. Residential construction in 2005 reached 6.3 percent of US national income — its highest level since 1951.

A more sober level can be gauged from the average since 1980, which is 4.5 percent. Rampant home building went far beyond the actual housing needs of Americans. Over the past five years around 8.9 million housing units were built and just 6.7 million new households were created, according to Harvard economics professor Edward Glaeser. The number of vacation homes jumped from 3.6 million in 2002 up to 4.8 million now.

An ever-growing number of U.S. homes were also vacant, as investors waited for tenants or buyers. Not only did houses become more numerous, they also got bigger. The average square footage of a U.S. family home expanded from 2,200 to 2,500 over the past eight years. “Mistaken beliefs about housing may have crowded out more productive investments,” argues Glaeser.

Since two-thirds of Americans own their homes, falling prices are never likely to inspire street parades. The economic loss has certainly outweighed the gains and the banking system may take years to fully recover. Even so, our loss is a hidden accounting gain for the next swath of homeowners. A more balanced economy and housing policy may now emerge. For more philosophically minded Americans, this is a cloud with a silver lining.

28 comments

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This is total BS. What is going to happen is that INVESTERS, NOT MIDDLE CLASS AMERICANS, are going to snap up these properties. Many from China trying to get rid of treasury dollars. And they will RENT these homes to middle-class Americans.

Or some homes will just be destroyed because the banks who now own them, can’t afford the property taxes. Unfinished model homes in California are being demolished by hired Caterpillar crews because of this reason alone!

Please be more factual with the REAL situation at hand!

Posted by octagon | Report as abusive

We have forgotten our roots! Psalms 15 clearly states a hand-full of conditions required to abide in the tent of our Lord which includes not putting our money out at interest. Corporate interests have found out that americans will pay and pay for all their lives to own their own homes and so become indentured servants for all their lives. If corporations were not allowed to give loans at interest we would then see the real value of a private home. The government did all the free thinking people a disservice bailing out these corporate entities. It would be better for the common citizen if the government took out the speculators and corporate ownership of private property.

Posted by Robin Pierce | Report as abusive

Why does everyone seem to think home prices are such a great deal now? Housing costs are only returning to normal values after a speculative bubble.

When they reach 2002 prices, plus some normal appreciation, they will be at the levels they would have been, if the bubble did not happen.

Posted by Gordon Richards | Report as abusive

There is a lot of truth in your opinion however I disagree with the opinion of capping the mortgage tax credit. Why penalize those who lived within their means and maintain their mortgage even as the value of the underlying asset continues to decrease? Wouldn’t capping the tax credit spur a new round of homeowners walking away from their mortgages? Its a bad idea.

Posted by Chris | Report as abusive

First comment doesn’t consider that investors have to have renters or their property deteriorates. So, either they drop the rent to reasonable or less, or they’re paying both maintenance and security for an empty house, a real money sink.

Posted by Ruth Woodcock | Report as abusive

There is no mention of the homeowners that consider their home a nest egg of investment. We have held back on selling our equity, live within our means and pay our mortgages on time. We are the majority, we are now ask to pay for the mistakes of automakers, financial banking, over spending by the government and people who can’t pay their mortgages. So we don’t love falling home prices.When this writer works and saves for most of his life, lives within his means while everyone else is going crazy creating debt and living beyond their means,and his wealth is gone because of it maybe he will love it too.

Posted by james morales | Report as abusive

My husband and I just bought our first home. We’re very normal people working class citizens in our late twenties who’ve been saving for a down payment for over 24 months. The bursting of this bubble has been a blessing to us, because we can afford to buy a home that is beautiful and spacious at a price that is reasonable. We’re not going to be in a fancy neighborhood, but we’re certainly feeling very lucky that we have been able to buy at the right time.

To the first comment, I agree that developers have the money to buy multiple homes, but I believe that ordinary Americans who have been living moderately and saving during the boom times can also get into the home buying action.

Posted by Mermaidian | Report as abusive

Good article and I agree with the sentiments. To Chris, you might note that it is a tax DEDUCTION, not a tax credit (I WISH the IRS would let me have a CREDIT for the interest I pay on my house, but they only let me avoid paying taxes on that interest). I think the impact is really dependent on how the rules are set up and how the math works out. Is the 500K to be spread over the life of the mortgage? Obviously you pay more interest in the early years, so the impact of the limit might be delayed until you are well into the purchase. What happens when you sell after 5 years? Do you start over with a fresh 500K cap on your new home (encouraging repeated buying and selling of homes) or is that a 500K cap for each individual’s lifetime?

Posted by DM | Report as abusive

Also keep in mind that buying a home right now may still be a terrible investment if there is a double dip recession or if we have a decade of stagnation. Look at the lost decade in Japan and what happened to their real estate prices over that period. It makes renting look like a pretty safe solution, even if you have the ability to buy.

Posted by Jocko | Report as abusive

I would say the vulture funds are getting ready to be used by now. There are profits to be had, both during a boom and a bust. Time for the buzzards to fly.

All that property will be going for a steal soon. The defaulting debtors of this year will be the making of next year’s property moguls.

Posted by Hmmm | Report as abusive

With the Administration spending like there’s no tomorrow, and Fed creating more and more money out of thin air, the tidal wave of money will raise the housing prices sooner or later. Only the dollars will be quite cheaper by then, but this is quite another matter. Housing may not be the best, nor the safest investment right now, but there’s no safe investment today. Even cash under your mattress isn’t safe from inflation, and inflation is inevitable because all the money printed in the last months can’t disappear overnight once the economy gets out of tailspin. Maybe even sooner than that – remember Jimmy Carter’s stagflation?

Posted by Anonymous | Report as abusive

Robin, virtually no one lives in accord with the Christian Bible–it is almost impossible to do so. The Vatican became rich and powerful by acquiring wealth–or have you forgotten? The Bible also allows women to be sold and punishes men who shave with death. Ridiculous.

Posted by digginestdogg | Report as abusive

I just purchased my first home in the San Francisco Bay Area. The prices in my neighborhood had fallen by about 30% (or more) and I was therefore able to purchase a very nice home which I can comfortably afford (<25% of my current income). I am still not convinced that I will come out ahead in the next 10 years versus renting, as I agree with the author that prices are likely to remain stagnant or rise mostly due to inflation over the next 5-10 years. For that matter, Robert Shiller (the Yale economist who accurately predicted both the stock and housing market crashes) has shown that in the long term, housing prices just barely keep ahead of inflation. But timing any market is a fool’s game (in my opinion) and at my present income my home, after all expenses and tax deductions, costs only slightly more than comparable rentals. This is how it should be, and with a fixed rate mortgage owning will probably cost me less if I live in the home for 10+ years. I believe it is a mistake to view your own home as a retirement investment or nest egg; that is what stocks, bonds, mutual funds and other liquid, diversified assets are for. Logic suggests that housing should cost about the same whether owned or rented with perhaps a premium upfront for owning (in exchange for “pride in ownership,” stability, predictable/lower long-term costs, etc.) and a premium in the long run for renting (in exchange for lower up-front costs, lower maintenance, increased mobility, etc.). I also agree that a good case can be made for eliminating or reducing the mortgage interest deduction. I believe comparisons with Canada (where this is no such deduction) have shown that the mortgage interest deduction does not significantly increase home ownership rates, rather it just acts to inflate home prices and mortgage debt. I admit that a reduction or elimination of the mortgage credit would be quite painful for me, since it would simultaneously increase my costs while probably reducing the value of my home. Hopefully such a reduction could be phased in slowly or applied to mortgages taken after a certain date (so that current owners would suffer only the probably loss in home value and not also the increased expense). Such a policy is also problematic at the moment, since further price decreases or increase in ownership costs are likely to prompt more foreclosures. To the previous post regarding the proposed $500,000 limit, I suppose Christopher was suggesting that mortgage interest deductions could be limited to mortgages of $500,000 or less (currently I believe the mortgage interest deduction can only be taken for mortgages of $1,000,000 or less).

I agree with Jocko…..stagnation and a real threat of deflation is out there. People don’t realize that The “ALT A” mortgages are going to start to reset this year and extend into the year 2012. This is larger than the 3 year sub prime market that we are just coming out of right now. And with the advent of job losses and a consumer that is cautious about spending and the middle class downsizing you will also see a collapse in commercial realestate to compound matters…..I see a lost decade coming.

Posted by Mr. Anderson | Report as abusive

The only people to make money from the property boom, certainly not the bankers or home owners, where the real estate agents. But don’t worry these people that told you to buy now because prices would only increase tomorrow are the sort of people that stupidly believed it. They probably had their money in investment properties.Looks like losers all round, give it a couple of years and you’ll all be making the same mistakes again, you can’t help yourselves. It’s human nature to be gulible, stupid and greedy

Posted by gd | Report as abusive

I think these housing prices and housing bubble was just a wonderful Ponzi scheme around the world and nothing more. It is abnormal to make people to pay enormous prices for a place to live in, but more abnormal to earn huge benefits from a piece of concrete.
House must be as cheap and available as an everyday’s piece of bread or a sip of water (except luxury ones, fo course).

Posted by Kom | Report as abusive

Digginestdogg, you completely missed the point and to address your comments if you have read the bible you would know that some people do live in accordance with the Christian Bible (the conditions are much simpler than you may imagine). What you say about the Vatican is true. Rest assured that to shave is not written as punishable by death. I shave but I know we would be a healthier society if we didn’t shave (and kept clean). This is a proven fact.
The point I will make again is if speculators and corporate ownership of private property was not allowed and if we simply paid cash for our homes we would see the real value of our homes, about one year’s income. Without the government bailout, home values would have fallen like corporate real-estate. As it is I agree that the government has sold us the people out and we only have ourselves to blame.
As a last note the bible is the best complete history book there is and has the longest concurrent history of any society by more than three standard deviations (for the astute this says volumes). You may revisit your conclusions; you might even consider reading the history book in its entirety. You will find every human condition there is in it and if properly applied you can even learn from it.

Posted by Robin Pierce | Report as abusive

Robin is correct.

There’s a reason that lending money at interest is a bad idea. And right now we are living the results of this idea. As everyone can see by reading the news, the implications of lending at interest suck out loud and cause much more harm than good.

The government should have bailed out the American citizen. But those in business cried foul and we let them. The government gave the money to businesses, instead. And now the consumer finds themselves being bled by the corporate/banking sectors while at the same time being financially bled by the government in order to keep these vampires alive so they can continue to suck what little you have out of you.

The government should do away with it’s poorly run social programs and instead return the money that would go to financing them to the people in equal share. This would provide a social financial safety net that citizens could rely on during times of market hardship like we find ourselves in now.

Some will say that this is a bad idea. But is providing a financial safety net for the average citizen some how less honorable than subsidizing failed/failing businesses that should be allowed to fail anyway?

Our systems are not human centered. And this is why they fail. And as long as the person is considered to be of lesser priority than the money they use, the system will fail regardless of the effort put in to save it.

After all, what good is a system of any kind if there are no people to participate in it?

Benny….I don’t agree with your plea to have the bailout money given to the people……..as Thomas Jefferson concluded… “A wise and frugal government, which shall leave men free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned – this is the sum of good government”……we are headed 180 degrees opposite of this……..

Posted by Mr. Anderson | Report as abusive

I think we’d be better off with high interest rates and low principal values like the early 80s. There is little tax benefit to buying a home these days and if you include the coming rise in property taxes and other home expenses in the future, its no longer an investment. Interest alone almost doubles the cost of a home. Meanwhile real wages have been stagnant or falling for males since 1975. Finally, why is the government incentivizing banks and real estate ? Remove any and all writedowns on all taxes and let the market decide what the home is worth along with interest rates. People will participate in larger numbers if they trust the system. That trust is what is missing right now from an economy that is solely based on government intervention for major industries like banking and real estate. Unfortunately, a productive industrial and manufacturing economy is what is necessary in order to grow this trust. Instead we get more bailouts for fire, insurance and real estate at the expense of a productive economy based not only on consumption but domestic production and self-sufficiency. Many people are going to be in for a rude awakening soon.

Posted by Sekar | Report as abusive

I find all of this fascinating. Everyone is pointing fingers at everyone else. There is plenty of blame to go around, however, who in there right mind ever thought they should be able to buy a $700,000 home when they are at a $70,000 per year salary level? This is where the foreclosures are greatest, not with people who bought a home which is within their means to pay the mortgage. As a country we have been living well beyond our means for years, and now the government is forced to bail out the system.

Posted by Keith | Report as abusive

Mr. Swann suggests a paradigm shift this country needs to embrace – government attempts to artificially prop up real estate values will not work, and detract from what should be their true focus: preparing the U.S. to compete in the 21st century global economy by incubating new technologies that can create jobs and goods the U.S. can export.

Obviously a stable banking system is needed, but pouring billions of dollars to bailout people who, unfortunately, purchased homes at the wrong time will do nothing to pull us out of recession. Better yet, let’s give scholarships to the 10,000 brightest scientists in this country, then have them mentored by our best venture capitalists. Let them create the next Google, the next Intel, Genentech, and yes, the next GM.

Posted by Dennis Kao | Report as abusive

Regarding Psalms 15 and the issue of interest, we must also compare other scriptures having to do with interest to determine exactly what type of loaning Ps 51 was speaking about. Compare the parable of the Talents (Matt 25) where a wicked slave was criticsized for not at least depositing the talent with the bankers so that the master could receive the monies back with interest!

Clearly the Bible doesn’t condemn charging reasonable interest in a business pursuit. It is only when it is charged to the afflicted or needy one or your brother. However, the Bible does completely condemn usury – excessive and greedy interest charged to anyone.

Posted by Warren | Report as abusive

With due respect to Richard of “Best Comment Fame” the Housing Bubble started in 1995 and unsustainable property appreciation took off in 1997 on a national basis. Housing prices will drop to 1997 adjusted for inflation/income if we are lucky.

The problem is that ALL the fundamentals which determine asset value are MUCH worse than in 1997. As such, there is no reason why property values should stabilize at the pre-bubble level. Don’t buy a house unless you don’t care about losing money.

I think the nation is finding it difficult to recover from one of the deepest downturns of the housing market so far. Despite a lot of federal efforts to improve the situation, the market is not showing very bright signs of easing. The recession in this market is still increasing every day as the unemployment rates are also reaching red alert.

There are very little chances of housing reviving. No signs of recovery

Posted by daveinfo | Report as abusive

Great Article Mr. Swann, My sentiments are with you across the breadth of the article.

Now a little context from me. On point one: My Wife and I were priced out of the market in Chicago from 2005-mid 2008. We made a conscious decision to sacrifice and rent a studio apt in a family owned building to save money and wait for the bubble to deflate. We consciously avoided taking out an option ARM in order to afford a nice house in a nice area as the prices were artificially over inflated and we did not buy into the lie that \”housing only goes up\”. Thankfully my wife and I chose not go down the dark path and are not in a bad situation.

Where is the empathy for people like us who had our dreams of owning a home delayed due to the bubble? This is why I have little empathy for many people who screwed themselves by buying too much or taking out that huge HELOC. Most of these people are getting what they deserve.

When we started actively looking in Sept 2008 on the northwest side of Chicago, when the liars were saying it was great time to buy(compared to the \”peak\” of the bubble) we found that this was not so. There was a lot \”junk\” relative to the price/location/features and the affordability just was not there. As of the end of April In 8 months we looked at 250+ properties on our MLS and walked thru 70+. Of the 250+ homes only 5 houses excited us as to the price/location/features. Thus only 2% of our listings we looked at have been good. You would expect under normal conditions to find at least 10-20%of the listings to excite us Of these Five listings: 2 went CTG before we could get a walkthrough, 1 went CTG before we could do a second walkthrough (shame on us), 1 was a short sale that we backed out of after a house inspection, and 1 we were outbid on by a cash buyer, and we are a strong buyer as we have golden Credit, can put 10-15% down and, have no contingency of having to sell a home.

It has been really frustrating to us as we want to own but until the prices correct more we are still looking. The good news is that now we can look in nicer locations, the houses are nicer needing less work and the listing prices have come down on avg 10-15% in the past 8 months and those that are overpriced are selling on avg 9-10% off of list vs. 4-5% off of list 8 months ago. This has translated into reductions of $40-75K on properties that we track for comparables.

In Chicago according to the Case-Shiller data (which is not perfect, but is the best index out there) the bubble went up to 168 in Sept 2006 and as of Mar 2009 it was 122. However many sellers want to ignore the other declines. Why is it they will accept positive news from an index to justify higher seller prices, but reject negative news that justifies lower selling prices?

I agree with Gordon Richards. I see that housing prices here in Chicago are still not a great deal. They are better than 8 months ago but still we need to see another 15-25% decline in prices to actually be good. Until then we will continue looking and waiting.

Posted by Tony Flores | Report as abusive

House prices should be 3-4x median household income in a given area. Period. Anything higher will lead to a correction. People were scammed into get rich quick schemes by “investing” in a liability, a house, which carries the loads of maintenance and taxes and interest.

Fellow Americans, you truly are mostly idiots, and you need to curb your debtor’s appetites. Do this for yourself, or brutal competition with India and China will make your living standards drop precipitously. Ron Paul doesn’t seem like a moonbat now, morons.

Posted by Mick Russom | Report as abusive

We bought our first home in Dublin, CA. We’ve been waiting since 2002 to buy into the SF Bay Area, and were accumulating the downpayment. I am glad we were able to buy a very beautiful home (no, its not a short sale or a foreclosure), with a very nice (not huge) yard for my daughter to play in. When I compare my rent (2 bedroom apartment, 1800) vs. my mortgage (3 bedroom SFH, 2209) with a 4.875 30 year fixed, I frankly do not care if the house value falls. We make mid-100k combined, and the conforming loan that we took fits our budget. The point is, housing is heavily driven by affordability more than anything. In the bay area, the homes in the 500-600k range are selling simply because they are competing with rents (provided the buyers put 20%+ down). I am hoping to get break even after 10 years. I have been renting for about 10 years, we raised our daughter for 5 years without a backyard to play in, getting nagged by our downstairs neighbors when she used to run or jump. Believe me, that is not a good feeling. Now that the prices have fallen about 30% from the peak in our area, and we can afford this house without any creative financing, we are happy. Will the prices fall further? Certainly. Will we find a house that we can afford and *like* to live in for 10+ years? Not so sure. Will we end up paying more in rent over 10 years? (216k if the rents stay at 1800/mo)? I’d think so. How much interest will the cash savings from renting generate over 10 years? Probably 1-2% after taxes. Is it worth it with even minimal inflation? Not for us.

Posted by Manish | Report as abusive