Home Prices Flatten Out

Ho hum.

One of the great mysteries of recent times, OK I am guilty of a little hyperbole, is that the financial media gets itself into such a lather over home prices. Actually we all do. We cheer each uptick in home prices as confirmation of boom times and our unbelievably sensible decision to buy this house as opposed to that one. We watch as values soar and spend any other money we may have secure in the knowledge that home prices just never fall. ‘Safe as houses’ became a financial statement rather than an engineering one during the great housing bubble that so lamentably burst two years ago. But home prices do fall. That we now know.

In fact they plummet. Good. Exuberance, to use a word immortalized by one of the chief architects of the bubble, has no place in a sensible market.

According to the Case-Shiller index home prices fell 32.6% from their peak insanity of July 2006 to the bottom of the trough back in April 2009. Since then they have edged back somewhat – bolstered by the government’s yet further subsidy of home owners – and are now down ‘only’ 29% from that ridiculous peak.

Doing the quick math on those two numbers tells me that since April we have regained 3.6% of home values. That’s above the general inflation rate for the year, but isn’t sufficiently silly for us to become alarmed that we are setting ourselves another trap. Yet.

The interesting aspect of this month’s Case-Shiller report is that prices have flattened out since the slight recovery I just noted. There was no change last month, which signals the end of the summer’s brief bounce back. How much of that bounce was attributable to the first time buyer credit is difficult to tell, but I assume at least part of it was. Plus at prices off around 30% since the insanity some buyers must have been tempted to jump in and chance their arm in what still remains a murky market.

With about a quarter of all mortgages in America under water – home equity values less than mortgage outstanding – the home market is a long way from being stable, and there seems to be no real impetus for it to recover sufficiently to get those mortgages back into the black.

This implies a long period of housing imbalance: those folks unfortunate enough to have bought at the top of the market will have to suffer through a few years of negative equity or under water mortgages. This will have the knock on effect of limiting those people’s spending habits and even career opportunities. This latter impact is less discussed than it should be. As people dig out from the bubble one of its effects is to ‘freeze’ those who owe more than their house is worth in place. They cannot afford to move. So they lose the ability to relocate for a better job, and if enough households fall into this category – and with 25% of mortgages under water I assume there are plenty – then the job market is also less flexible than we are used to it being. This could hamper the recovery by making it more difficult to locate and hire workers.

So our obsession with real estate, unhealthy at the best of times, has an even more insidious impact than most commentators think.

I had hoped that the bubble crashing down and the enormous damage being wrought by real estate would help cure us of our housing addiction. But given the continued breathless way in which each home price report is written up in the media I fell, somehow, that we are missing a golden opportunity to put real estate back in its box.

Housing is not an investment. It is a consumable item. We use houses. We do not invest in them. We can rent them or buy them. That decision should be based upon rational analysis not hyped up expectations. Over the long term the relationship between earnings and the cost of housing should be stable: indeed it was for decades before the bubble years. The illusion of a home being an asset is simply a function of inflation. Summed across the economy home price inflation produces nothing: it is a massive transfer of wealth from younger non-home owning people to older home-owning people. The ‘investment’ produces no long term wealth increment to GDP in real terms.

But we still bestow huge favors on home owners who reap unearned rewards like the Federal tax deductibility of mortgage interest and local property taxes. This subsidy costs us massively by adding to the Federal deficit. It should be abolished. This would both be fiscally conservative for the nation and help stabilize the real estate market. This latter impact being due to the removal of the subsidy that currently skews the rent/buy choice towards buying. This skew, in turn, induces some people to buy a home where they might not otherwise do so. Demand for homes becomes bloated and thus drives prices artificially higher. It is a rare conservative who calls for the abolition of this costly subsidy, but any sensible long term deficit reduction plan should contain such a move. We are the last country left subsidizing its middle class with a real estate welfare plan, and it is time to rid ourselves of it.

Having said that, I have beating that drum for the last three decades so I hold out no hope for a change any time soon. But just for the record: I certainly hope that no one reading this and claiming a tax deduction for mortgage interest objects to any other form of welfare program. Fair’s fair after all.