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Sunday, May 04, 2008 12:31 PM

Rebuttal To SmartMoney Housing Bottom Call

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Donald Luskin at SmartMoney is making a case that Housing Prices Near or at Bottom

I'm not here to tell you that home prices are at absolute bottom this very moment. But I can argue pretty persuasively that they might be. Or that they are close.

What establishes value in a home price? Like anything else, it's a question of historical norms. So how do we determine the norms? Try this way on for size.

Let's think of value in terms of affordability — the ability of people to buy the home they want. That has three elements. First, home prices — the lower, the more affordable. Second, mortgage rates — again, the lower, the more affordable. Third, personal income — the more of it, the more affordable.

Let's look at the history. For home prices, we'll use the National Association of Realtors' index. It's showing about the same price decline as Case-Shiller, but I like it for this exercise because the data goes all the way back to 1972 (Case-Shiller only goes back to 1987). For mortgage rates, we'll use the Freddie Mac's 30-year fixed rate index. And for income, we'll use the Commerce Department's estimate of per capita disposable personal income.

And guess what? Today home prices have fallen so much, mortgage rates are so low, and personal income is so high — that homes are more affordable today than at any other time, ever — with mortgage payments on the average home eating up about 40% of income. (Keep in mind, disposable personal income is after-tax income; also, this is calculated on an individual basis, not a household basis.)

With houses more affordable than ever before, why should we expect prices to fall much further from here?

Let's put it in concrete terms — jobs. Since the housing market started coming apart two years ago, jobs in the housing sector — broadly construed, to include everything from bricklayers to mortgage brokers — have already declined by over 1.5 million. That's about 1% of the whole national labor force, and it takes housing employment back to where it was in 2000 before the so-called "housing bubble" even got started. Which begs the question: How many more jobs are there to lose in this sector?
Persuasive To Whom?

Housing prices rose 100% in many big markets from 2002 to 2006. Even more in some places. We have now seen a 30% decline. We need to see a 50% decline and that is just to get back to a point at which houses were already expensive. Inventory is still rising, and people are walking away from homes. With Condos, the situation is even worse. There is a 16 year supply of condos in Florida. There is enormous condo overbuilding in many areas.

The housing bust in Japan went on for 18 consecutive years. The bust in California is less than 2 years, Florida far more advanced than CA is still less than 3 years old.

Housing prices compared to rent are still high, compared to salary are still high. The argument that wages and incomes are rising on average ignores a monstrous skew. Real wages have been falling for the bottom 80% or so of the population, and dramatically for the bottom 50% of the population.

If Bill Gates, Microsoft CEO, walks into a bar in a slum on the South side of Chicago, average income in that bar will shoot up dramatically. Will that event make houses more affordable for anyone in that bar?

When it comes to construction jobs, it's important to note that the bust in commercial real estate is now just picking up steam. Inquiring minds will want to consider Vacancies Soar In Commercial Real Estate Bust and the Shopping Center Economic Model Is History.

Wal-Mart, Starbucks, Target, Sears, Pizza Hut, Home Depot, Lowes, etc etc ect are all cutting back growth plans. It was the overbuilding of all these stores that provided job growth over the past 6 years. They were low paying jobs, but at least they were jobs. Where is the job growth going to come from now? I have been asking that question for years and no one has been able to answer it.

April Jobs Bizarro World

The last four months the economy shed jobs. See April Jobs - Another Report From Bizarro World.

A recession has just started and people are still in denial over that. There will be even more inventory and even more walking away as the recession picks up steam. I outlined this possibility in Walking Away: The Next Mortgage Crisis.

People are severely underestimating this recession. I made the Case For An "L" Shaped Recession.

Social Attitudes Have Changed

The changing of attitudes is also crucial. Inquiring minds may wish to consider Cool to Be Frugal and The Pawnshop Society. There is clearly an attitude change when it comes to spending. Less spending means less hiring. Do we need more Pizza Huts, Wal-Marts, nail salons, Home Depots, anything? What?

Baby Boomer Demographics

What about the boomer retirements and the Demographics Of Jobless Claims. I made the case that structural demographics are poor and that boomers will be competing for low paying jobs with their kids and grandkids. With that in mind, exactly who are baby boomers going to sell their McMansions to? At what price?

When Will Housing Bottom?

Finally, nothing blasts off like housing did, just to return partially to the trendline and start rising again. The trend will overshoot and that is still years away.

I am sticking with 2012 at the earliest although there could be a bit of an uptick in 2009. My reasons were outlined in When Will Housing Bottom?, Housing - The Worst Is Yet To Come , and Housing Bottom Nowhere in Sight.

From the last link above, here is how I have called the housing bust in real time.

An Alternative Viewpoint

Using the Japanese land bust model as my guide, here is how I have called things in real time.

click on chart for sharper image

The Spring 2008 arrow was just added. The arrow is one notch closer to its final destination.

Flashback March 26 2005

The initial data point was established in the post It's a Totally New Paradigm on March 26, 2005. Here are some excerpts from that post.
  • Ron Shuffield, president of Esslinger-Wooten-Maxwell Realtors says that "South Florida is working off of a totally new economic model than any of us have ever experienced in the past." He predicts that a limited supply of land coupled with demand from baby boomers and foreigners will prolong the boom indefinitely.

  • "I just don't think we have what it takes to prick the bubble," said Diane C. Swonk, chief economist at Mesirow Financial in Chicago, who was an optimist during the 90's. "I don't think prices are going to fall, and I don't think they're even going to be flat."

  • Gregory J. Heym, the chief economist at Brown Harris Stevens, is not sold on the inevitability of a downturn. He bases his confidence in the market on things like continuing low mortgage rates, high Wall Street bonuses and the tax benefits of home ownership. "It is a new paradigm" he said.
We are only on the reality phase of the adjustment, and that phase still has more life in it. The despair phase is coming up.

Housing Near Bottom?
Who made an in depth case who didn't?
Who has the more persuasive arguments?

Mike "Mish" Shedlock
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