home prices

One of the most important aspects of recent economic growth has been the stimulus provided by soaring house prices. Their rapid rise over the last few years has enabled home owners to dip into equity to sustain consumption — I would argue ‘over-consumption’ with respect to wage growth, with the real problem being that wage growth alone is insufficient to support demand: hence the plunge into personal debt.

One result of the house price inflation has been to add huge distortions to the economy: e.g. more jobs have been added at realtor offices than in factories, so we have become a nation of home buyers and sellers rather than a nation of producers. Federal Reserve Board Chairman Alan Greenspan’s lax monetary policy contributed to rather than contained the inflation [note to you all: asset price inflation, such as we have seen recently in home prices, is not included in the official inflation measures that the government reports, so the Fed doesn’t have to react to it by increasing interest rates. As a result interest rates are currently well below where they would be if this were not the case].

Now, though, it looks as if the game is ending, and home owners will have to be more sensible in their outlook. The recently published report from the National Association of Realtors shows that existing [as opposed to new] home sales fell in October, and the inventory of unsold homes rose to its highest level in twenty years. That leaves the market with a backlog of unsold homes equal to almost five months of sales, which is also a recent high. In contrast the median sales price rose 16.6% in the last twelve months which is the fastest since 1979 when official inflation was also in double digits.

Those rates of price increase are history in view of the unsold inventory: buyers should sit and wait until sellers start to panic, and they should bid low. It looks as if the bubble is bursting, so now is not the time to buy: hang on while the unsold inventory increases and interest rates rise. The market is getting weak. What this means for the overall economy is anyone’s guess at the moment, but it probably will dampen consumer spending, which is two-thirds of the economy.

All of a sudden 2006 is looking murkier.