Jan 2011 5

U.S. Housing Prices Due To Decline?

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case shiller Case-Shiller data by Planspark

The Canadian housing market has experienced a pretty good performance since the recession began and prices are on a slow, steady move up. But our biggest neighbor and trading partner, the U.S., had some tough times since, and the prospects are gloomy at best. As discussed by Pragmatic Capitalism, while conservative analysts say the decline in prices on the U.S. housing market will be no more than 7%, others suggest a decrease by at least 20%. Now that’s pessimistic!

Before reaching the peak in 2006, the U.S. home prices had to climb a shocking 85% from the mean taken out of Case Shiller inflation adjusted housing chart which has been measuring the real prices of U.S. houses since 1890. Since the bubble burst, we experienced a cumulative dramatic fall of 40%, but there is still 23% to go if we want it to return to the long-term mean. With a bit of simplifying logic, some economists say, we can easily predict that the house prices will go further down to the mean. Firstly, the supply and demand is in deep imbalance with even gloomier prospects. The prices are in close correlation with inflation which by definition means they will tend to go back to the mean. The inflation in turn closely follows wages, which aren’t going up in recession. It makes sense to believe that this correlation stays tight because house purchases make up a lot of the household balance sheet.

The flat trend has held since 1890 through the biggest shifts in economy including the World Wars and the 1930’s Depression, population shift from cities to suburbs, the western and southern transfer of population and economic strength, the movement from renting to homeownership, etc., so there are arguments to support the belief that the market is currently reversing to the mean.

There are also other factors that support the 20% decline outlook for the next year. The current housing sales are at one-fifth of the 2005 peak and new-home inventories – while being at a 42-year old minimum – still represent an 8.6-month supply. An inventory of more than 5 or 6 months tend to decline towards this level. But the 8.6 number is at risk of rising further with the so-called shadow inventory which incorporates mortgages with a high risk of default. Adding these, the market could end up with a shocking two-year supply.

What do these numbers mean to a regular American? They should anticipate a second dip in U.S. home prices and shouldn’t take any mortgage loans. Maybe rental is a better choice in the U.S. now. What’s more important, nobody knows what could a catastrophic drop in U.S. housing market do with the steady rising, but still vulnerable Canadian market.

The point was stressed by Cullen Roche.

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