House Prices Might Never Recover

There’s a lot of confidence, even among otherwise pessimistic market watchers, that eventually housing prices will recover. Unfortunately, there’s not much evidence supporting that confidence.

What if our confidence that home prices will recover is just slightly diminished version of the optimism over housing prices that helped cause our economic crisis? It’s not as far fetched as it seems. While home prices were rising, fears of a “housing bubble” were often called irrational by all sorts of people. Housing prices, in the long term and for almost all short-terms, always went up, the bubble-deniers insisted. Any housing downturn was likely to be local, they said. A national downturn was considered the stuff of paranoid fantasy.

The work of Yale economist Robert Shiller indicated we were witnessing an abnormally large uptick in home values, the likes of which had not been seen since 1940. Still the lesson most people took from this was that we faced, at worst, a reversion to the mean. When prices were rising, people confronted with this data might admit that prices wouldn’t rise at the same rate they had been. When prices started falling, conventional wisdom turned to the belief that housing prices would slide down to levels in line with history and then slowly climb back up along with the historical trend.

But who says that a sustained fall in housing prices will ever turn around? Certainly not the data. As Mark Gimein writes in The Big Money, we have almost no relevant data on what happens after a sustained real estate price contraction. Indeed, in the last 100 years we’ve had only 1 period of declining home prices, which is hardly enough data to produce reliable results.

“Almost a century of experience has gone into reinforcing the conviction that even if the price of your home does not rise, at least it is not likely to fall for any length of time,” Gimein writes. 

Here’s his examination of the grim possibilities:

We have become accustomed to think of falling home values as a sign of a city’s slow death. (Think Detroit.) We think of cities and suburbs that remain vibrant as being immune from that kind of drop. The common assumption is that eventually, after a downturn, prices will swing back. But, in fact, the long-term data we have is very inconclusive. The centurylong view shows us exactly two periods of marked increase, and none of decline. But an even longer view does show a decline in the early years of the 20th century.

If home prices merely stop falling right now, then the price advance of the 1990s would still represent a dramatic jump from historical values of the sort that that we have seen only once before (in the 1940s). The home-price optimists, like the National Association of Realtors, persist in the idea that prices will “return” to the peaks of 2006. But there is no reason at all to think that they have to. They may return to where they stood in the late ’90s (which would mean that they still have a further to fall) or to some point in between. It’s even imaginable that the housing market could stagnate long enough to reverse some of the historic advance of the early postwar years.

Is this long-term downturn likely? Frankly, we don’t think anyone can tell you with any certainty. We’re engaged in an almost unprecedented social experiment with how people react to falling asset values. Will the generation that watched housing boom and bust conclude that housing has become cheap enough to finally start bidding it up again? Or will they be so scarred by the damage inflicted on our economy and individual lives that they’ll rent, buy cheap and avoid as much debt as possible?

We’re hoping he’s Gimein isn’t right. The confidence that came with ownership of appreciating homes no doubt helped create some of our past prosperity. There may actually be positive externalities to homeownership, although sceptics have a good argument that those are outweighed by the costs of increasing ownership. It would be a shame if this was gone for good.

(And, yes, we are aware that this article bears a strong resemblence to the classic “Death of Equities” BusinessWeek contrary indicator cover-story. Let’s cross our fingers and hope that kind of voodoo works this time.)

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