March 26, 2008 (Housing Market Monitor)

Housing Market Monitor

House Price Plunge Accelerates

March 26, 2008

By Dean Baker

"Most recent homebuyers would lack the equity for a down payment on a new home."

The Case-Shiller price data released yesterday showed that the rate of house price decline is accelerating. The composite 20-city index showed that house prices declined 10.7 percent over the last year. The annual rate of price decline over the last three months, compared with the price during the previous three months, was 23.2 percent.

Price declines were considerably sharper in many of the former bubble markets. Year over year prices were down by 13.2 percent in San Francisco, 16.5 percent in Los Angeles, 18.2 percent in Phoenix, and 19.3 percent in both Miami and Las Vegas. The annual rate of price decline over the last three months was 31.5 percent in San Francisco, 34.6 percent in Los Angeles, 35.2 percent in Phoenix, and 36.9 percent in Las Vegas. Prices declined at a 27.6 percent annual rate over the last three months in Miami.

Even less frothy markets are experiencing sharp price declines. Prices fell 10.9 percent year over year in Washington and declined at an incredible 23.5 percent annual rate over the last three months. Prices in Boston are down by 3.3 percent year over year, but fell at a 15.0 percent annual rate over the last quarter. In New York, prices are down by 5.8 percent year over year and fell at a 9.5 percent annual rate over the last quarter. With the plunge in employment and profits in the financial industry, this is undoubtedly just the beginning of the unwinding of NYC’s housing bubble.

This rate of price decline and its economic implications are enormous. The 20-city price decline, if applied to the whole country, would imply a year over year real price decline of 14.7 percent (inflation was 4.0 percent). This translates into a loss of $2.9 trillion in housing wealth, an average of $40,000 per homeowner. The massive destruction in wealth is undoubtedly the largest factor explaining the recent falloff in consumption that is pushing the economy into a recession. This impact will increase through time, as homeowners come to recognize how much the price of their home has fallen and are directly impacted by their inability to borrow against their home.

The even more rapid destruction of housing wealth in the former bubble markets has substantial implications for the future of these markets. With year over year prices down by close to 20 percent in these markets, most recent homebuyers are almost certainly underwater in their mortgages. This gives homeowners a substantial incentive to simply walk away from their mortgages leaving the mortgage holders with large losses. This phenomenon is growing rapidly by all accounts. With millions of homeowners with higher-priced prime mortgages, simply walking away from their mortgages, larger losses in the financial industry are a virtual certainty.

Given the realities on the ground, the notion that we have somehow gotten through the worst of the economy’s financial problems is bizarre. The worst is surely yet to come.

The loss of equity, especially in the former bubble markets, will also directly contribute to further price declines. The vast majority of recent homebuyers will have no equity from the sale of their home, especially if they pay a 6 percent realtors’ commission. In the former bubble markets, even current homeowners will have difficulty coming up with the 20 percent down payments now being required by many lenders. As a result, the buy end of the market is likely to be unusually restricted for the near future.

Those desperate to find evidence of a bottom in the market seized on the modest uptick reported in existing home sales for February. The bulk of the increase was driven by higher sales in the Northeast. This in turn may have been attributable to weather, which was better than usual in this region in December and January, the months when the contracts were signed for February sales.

Today’s data on new homes sales, which shows contracts signed in February, should remove any illusions of a bottom. Sales were down 1.8 percent from January and 19.8 percent from year ago levels. They stand 54 percent below the 2005 year-round average.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. (www.cepr.net). CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.

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