Green Shoots Watch: House Prices

This has been a fairly quiet week for news. Everyone seems to be headed for a break earlier than usual, maybe hoping that the entire recession has been a bad pre-summer dream. Undaunted I continue to scour the data for signs of those green shoots promised us by Ben Bernanke three months ago.

This morning’s home price release definitely falls into the category of a very small green shoot – green sprout may be a better description.

Standard and Poors puts together and index called the Case Schiller Index which measures the prices of homes as they are sold and compares that price with previous sales of the same home. It thus tracks very carefully the price history of housing. The index is compiled for large areas and cities across the country and has become the most reliable indicator of home prices in the US.

This morning’s news relates back to prices in April and compares them with both March of this year and April 2008.

It seems as if the price of homes is still falling, but that the rate of decline is slowing quickly. That indicates that the bottom of the market may be approaching later this year.

The ‘Twenty City Index’, which unsurprisingly covers that top cities in America, fell 18.1% over the year ending in April. That’s a very slight improvement from March when the equivalent annual decline was 18.7%.

The worst declines were in the usual suspects: Phoenix prices fell 35.3%, Las Vegas 32.2% and San Francisco 28.0%. Cities such as Charlotte and new York both experienced record declines this last year.

So the declines continue, but there is just a hint of a slowing effect. The regional differences are significant with the sun belt suffering almost calamitous declines: for example, since they reached a peak three years ago prices have fallen over 50% in Phoenix. Las Vegas is just as bad and had the worst decline last month as well.

For the country as a whole prices are back roughly in line with where they were in 2003, and have fallen about a third from the peak in early 2006.

The implied elimination of wealth has had a massive dampening impact on the economy. As wages or salaries failed to grow significantly over the past ten years, consumers increasingly turned to the equity in their homes for cash. They also felt comfortable spending a much higher percentage of their incomes, rather than saving, because they saw the value of their homes rise quickly. The collapse of home prices has thus cut off a major cash source and eliminated savings for millions of households. While the savings were always illusory – they don’t exist until the home is actually sold – the cash effect is very real. We now have a middle class that feels much poorer and is less secure than at any time in several decades. At the same time certain costs such as health care and college tuition are rising at unprecedented rates. The consequent pinch on consumption was a major contributory factor in the economy’s implosion at the end of 2007.

So getting a firm price footing for housing is essential to a rebound. But we should be careful about lauding a turn about in housing: the lost wealth will have a lasting impact and will tend to drag down spending for years. Anyone unfortunate enough to be retiring this past year is facing a massively impoverished life compared with what they imagined even two years ago. And anyone approaching retirement has to face the possibility of working longer in order to recoup their loss: if they were relying on the value of their home as a ‘nest egg’ the shock and disappointment must be immense.

So is this a green shoot?

I think so. As I joked: a very slight one. The housing market remains very sick and is likely to stay that way for a while. Prices are not about to rebound. There is simply no earnings strength to justify price increases much above the inflation rate for a few years. Couple that with much tighter credit conditions and higher mortgage rates – no more sub-prime loans – and the housing market won’t witness the frothy conditions of the mid 2000’s for a long while, if ever.

Having said that: housing is still heavily subsidized: mortgage interest and property taxes are still tax deductible. Even in our deficit riddled times I can’t see the political willpower to eliminate this welfare for the middle class, so the lost revenue to the government – about $40 billion a year – will continue. As will the skewing that the subsidy makes in the economy overall: we spend too much on housing because its cost is artificially lowered by the government. Were the tax deductions eliminated home prices would fall to an unsubsidized level. Conversely: the continued subsidy keeps home prices higher than they otherwise would be.

To sum up: the outlook for housing is improving very slightly: prices are still declining, but less quickly than before. This summer should be a great time for bargain hunting. By this time next year prices should have fallen as far as they are likely to go. But there will be no huge rebound, and there will still be bargains as people are finally forced to acknowledge the reality of the new price levels.