September 13, 2012

Update: Good News! House Prices Much Lower! (or What Would Really Help America)

Do Americans realize how truly expensive houses have been? Reading typical headlines, you'd think house prices are now low.

But they have only returned to the upper range of the 1990s (with inflation!), and are not cheap, not at all.

We know millions failed to realize they could not afford the houses they bought and millions speculated. But we have an presumption that a majority of families making a typical purchase in 2003 or 2007 were making reasonable choices, and just got unlucky.

I'm not referring to a family with $60,000 income buying a $280,000 house.  I mean the more mainstream purchase -- a family with $70,000 income buying a $230,000 home or a $250,000 home (or worse).

In short, what we have considered normal.

As a nation, we lost touch with reality in a profound way.  Many of us, not a few.

Careful analyses, such as this one, agree that buying a home priced above 3 times annual household income typically puts a household into a money squeeze, and endangers their financial future.  A maximum price of 2.5 times income is a better guide for affordability.

So what is it like living in a house that cost 4 times the household's annual income?  Something akin to living, financially, in a weak stone building in an active tremor zone -- setting up, practically asking for, a bad outcome over time.

That family with $60,000 income needs to be looking for a place under $180,000, or better, a place around $150,000 or less!

After all, might they want to have a new car every 10 or 12 years?  How well can a family save some money for modest purchases during retirement?

Might they want to be able to afford to have kids?

It's not a coincidence that the national savings rate declined as housing costs rose.

Let's look at a graph of real (inflation adjusted) house prices from Calculated Risk:
(click for larger image)

We are only close to the 1990s normal after adjusting for inflation.  But, remember? -- the 1990s were good times economically.

Why is such logic beyond the mainstream press and media?  Because our popular view on housing prices "improving" is really a psychological desire for retirement security.  People wish for El Dorado.

El Dorado has vanished, again.

You may have noticed the news that house prices have started "recovering" (rising) in recent months.
Suppose prices rise 5% year over year. We could expect headlines assuring us of happy consequences. We'd hear price increases are a reason to feel better about the economy.

Housing costs more -- good times are here again.

No matter if more careful reporting mentioned increased construction, the real subtext, even the open message in most media would amount to 'Hurray -- Houses Cost More!'

How imbalanced are we, mentally, as a nation?

We can't seem to fully accept that the wealth of the last decade was....truly, really, an illusion.

Fully, utterly an illusion.

But, let's think for a moment about what would actually be good for America.  What would be good for America is for house prices to be lower.   Lower would be encouraging for the economy.  Why?

More families could afford homes.  So, more would buy.

Then builders would employ more people than now.

Families buying lower-priced homes could afford to buy more goods and services instead of less, over time, simply because they would have more money to spend.

Most families would be less stressed, as the local economies and thus the national economy did better and everyones' earnings were higher.

Financial stress harms families.  The ills are many.

Higher housing prices harm America.


Past recoveries from "financial crises" -- such as major housing bubbles and busts -- typically take 7, 8, 10 years, or more. Japan's true recovery took about 14 years.

Will it take us 12 or 14 years to think a household with a $70,000 income should be shopping for something more like a $170,000 house?

Update 9-13:

While a very typical summer bounce in house prices has indeed led to endless headlines suggesting a "recovery" in housing (as if low prices were harmful), there are good reasons to expect yet lower inflation-adjusted prices in the coming years.  We've had a bounce from pent-up demand and some investor demand.  Neither of these will last.

The two strongest factors that will weigh down on future prices are:

A) Baby boomers will increasingly want to downsize and/or move to better retirement areas, while younger families frankly have less means to buy expensive homes, and less inclination.

B) The global economy is severely out of balance in demand and consumption.  Since population aging in Europe, China and Japan will continue to drive an impossible desire to save at a very high rate in ratio to workers' productivity for the next decade, the global imbalances likely won't improve without a overwhelming game changer, such as another Great Depression.
Since a Great Depression will be avoided with whatever spending is necessary, my expectation is for lasting economic slowness and income stagnation or deterioration around much of the world  (unless, for instance, the US takes bold action on trade fairness/manipulation).  Weak incomes will translate to weak house prices.  In inflation-adjusted terms, I expect house prices to be significantly lower in 10 years if the US continues to allow Chinese mercantilism to suppress our growth.


  1. These ideals sound great. But in reality, they are not only flawed but impossible. The primary issue is that not everyone would be better off owning a house. It is a naïve assumption to think that everyone is capable of it. It is a huge responsibility to say the least. And let's face it, not everyone is responsible.

    Next, you can't discredit 'market' prices. Home values are representative of what people are willing and able to pay. It would be great everyone could buy houses at a lower price, heck I don't want to pay hundreds of dollars for tires. But if I force the tire shop to take $50 instead of $400, they are going to suffer. Once they go out of business, the manufacturer stops producing. Then next time I need tires I have to trade a kidney on the black market because they aren't available anymore. Lowering home prices to accommodate some at the expense of everyone who earned it is flat out wrong.

    Back to the point... you are misguided in your understanding of what caused the whole mess, or why people were buying houses they couldn't afford. Think about it, why would homeowners suddenly start buying beyond their means? There are 2 factors: 1. The S&L crisis 2. Securitization of loans. Or further, gov't involvement in this. Fannie Mae and Freddie Mack were at the center of it all. Sub-prime mortgages and relaxed processes put money where it didn’t belong. This is what drove up prices. This is what led to high default. There was no cushion anymore. Prior to this, homeowners were required to put 20% down when they purchased. At 3.5%, homeowners have no stake in the house. Default becomes the smarter financial choice much sooner.

    So before you try to solve a problem that doesn’t exist (i.e. everyone becoming a homeowner) look back at history and see what has happened when similar ambitions have been implemented. And here are some words to live by: whenever you hear the word “fair” come from someone’s mouth, it is usually the opposite that they seek.

  2. Brian, you may wish to read the post. This post is not about the *causes* of the housing bubble, so you have ended up tilting at windmills. There are several causes, but most key, essential, is the global savings glut, without which sustained financing of easy-money mortgages would have been impossible. Other factors matter also. 2nd most key was the rating agencies rating various instruments AAA.

    But all of that is beside the point of my post. If you read it, you'll see that the post is not about the rate of home ownership or the cause of the bubble of any of a variety of popular talking points.

    No. It is about the psychology that makes people, today, after the bubble, willing to still overpay for houses. Many people will follow the herd and overpay, right now.

  3. And yes, I'm aware of the incomplete notion that the market is always correct in pricing.