The national median housing price is down an unprecedented 16% from the 2d Quarter of 2006 through the 1st Quarter of 2008. This is a big deal. Not since the Great Depression have we seen housing price drops of this magnitude.

To add insult to injury, one in seven houses for sale today is owned by a financial institution or mortgage investor. These sellers are not going to hold out for the best price. They are going to sell for whatever number they can get, further impacting housing prices on the downside.

The problem gets even thornier when we add to the equation recently released information about the status of U.S. mortgages. Earlier this month the Mortgage Bankers Association of America reported that as of the end of March 8.8% of U.S. mortgages were either past due or already in foreclosure. And, just last week (June 13) RealtyTrac Inc. reported that 261,000 homes received a foreclosure-related filing in May (such as a default notice), up 7% from April and 50% from this time last year. Many of these mortgages in trouble will end with the lender owning the house securing same, again with an incentive to sell for whatever price it can get.

Finally, with pressure currently on the Federal Reserve to start raising interest rates so to ward off inflation and strengthen the dollar, there is concern about adjustable rate mortgages the rates of which are about to reset. This “rate shock,” when teaser rates expire and borrowers see rate spikes, is very dangerous for the housing world. We certainly don’t need more homeowners in trouble on their loans.

For these and other reasons, many knowledgeable commentators argue that housing prices are in a downward spiral which could push down values for several years to come (see, for example, James Cooper in the June 9 issue of Business Week: “Housing: The Recovery Wrecker”).

Still, notwithstanding some pretty negative information to the contrary, I believe that housing prices will stabilize by the end of the year. Here’s why:

1. Financial institutions and investors know that holding foreclosed property (called REO for “real estate owned”) is a very poor utilization of their capital. The lenders who “inherit” this property will move it through the system as fast as they can. Vultures and investors will buy these properties, most likely to rent for some period, but in any event taking them off the market quickly.

2. Although some in government resist a taxpayer bailout of homeowners who got themselves into trouble, political pressures – especially in an election year – are just too strong to prevent substantive government assistance. Last week I had dinner with a U.S. Congressman. Whereas he did not like the idea of helping out people who took on too much risk, he really hated the idea of seeing the economy suffer as a result of housing price declines. In my view, this congressman was expressing the perspective of many of his colleagues in the Congress: if we are going to save Bear, Stearns for gosh sakes, in the name of protecting the economy, aren’t we going to act similarly when the American homeowner is at risk?

3. Consumer confidence, albeit presently at a 16-year low, will rise with a new Administration. All seems so rosy at the beginning of a new Presidency, and whoever is elected will have made lots of promises – promises that people want to believe. This sense of change for the better will jump start the housing market which is really all about consumer psychology. The fact is that housing prices go up when people think they will go up, and vice versa. For most people a house is an emotional purchase and buying decisions are influenced greatly by a confidence about the future. If the prospect of a new Administration jolts consumer confidence upward, then housing prices will follow.

4. Sooner or later housing prices will decline to a reasonable “rent ratio,” (think P/E multiple) a price at which a house makes sense as a pure investment vehicle. In other words, where the net rental value of the house pays the buyer a reasonable return on capital invested (this analysis applies even if the purchaser intends to live in the house). Already house prices are reaching these levels in certain markets – for an excellent analysis of the rent versus buy decision, read New York Times’ reporter David Leonhardt’s story of how he finally bought a house after many years of telling his readers to rent instead of buy (NY Times, May 28).

5. Finally, there are already signs of some strengthening. The April “pending home sales” published by the National Association of Realtors, showed a 6.3% increase over March, and reached the highest volume in six months. A “pending sale” is a contract which, although still subject to contingencies (e.g. the obtaining of a mortgage), is a good sign. Most contracts do end up with a closing and that means housing sales may finally be picking up. While sales do not necessarily mean price increases, the fact that people are venturing back into the market is an indicator that some percentage of the population believes prices have hit bottom.

I forgot to mention that I am educated as an attorney. Attorneys learn to argue both sides of a fact pattern. If someone held a gun to my head, I could write a strong argument for prices declining another year or two. But, since no gun is in sight, this article is how I feel … at least today. return to front