Housing: a long way to the bottom

Peter Schiff expects another one-third drop in house prices:

If we assume that the bubble was artificial, we can instead imagine that home prices should have followed the more typical path during that time. When you do these extrapolations, a very sobering picture emerges.

The authors of the Case-Shiller index had assigned the index a value of 100.0 in January of 2000. This figure does not represent a dollar value for home prices but is simply a benchmarking tool. In December 2008, after a severe 28% decline from its June 2006 peak of 226.29, the Case-Shiller 10 City index stood at 162.1. However, if home prices had followed the 3.4% annual 100-year trend line from December 1997 (when the index was at 82.3), then the index would have arrived at only 118.92 in December 2008. This would suggest that the index would need to decline an additional 27% to get back to the historical trend line. Extrapolating along the sunnier 50-year annual average increase would put the index at 132.2 by December 2008. This would still put the trend line 18.5% below current prices. A cursory look at the chart below should disabuse anyone of the notion that home prices have now hit bottom. Policymakers and economists should by no means rely upon projections that see home prices turning around in the near term.

However, the story by no means ends there. Given the current conditions in the real estate market, with bloated inventories, growing unemployment, nonexistent consumer credit and shattered illusions of real estate riches, it would be logical to assume that prices will fall below the trend line. How much is anybody’s guess, but 10% would be conservative. Given that we are entering uncharted territory with price declines much sharper than those seen in the Great Depression, I would argue that the 100-year price trend would be the better projection to use. In such a scenario, the index would bottom out at around 108 if a 10% overshoot on the downside is seen. That leaves another 34% decline in home prices on the table.

That would indicate a median existing home price of $115,632 at the bottom, although given the way in which the scenario thus far has played out closer to the way the deflation hawks predicted, I wouldn’t count on the mass inflation that he’s expecting to provide a higher nominal price.