Falling Home Prices

This has actually been on my mind of late. Living in Georgia, one of my US Senators is Johnny Isakson. Recently he proposed some legislation that has the effect of keeping housing prices from falling too far. Here is a link. I think this is a bad, bad idea. It's akin to the government back in 2000 going out and buying billions of dollars of deflated technology stocks in an attempt to preserve everyone's retirement accounts. He's trying to artificially spur demand before the prices fall to reasonable levels. What does he think will happen, if this bill is passed, when the window of these tax credits passes? Demand will fall off again and we'll be in a situation similar to what we're in now.

Sooner Home Prices Fall, the Better -- from RealClearMarkets

"Gloom. Doom. Calamity. Home prices are tumbling. We're bombarded by somber reports. But wait. This is actually good news, because lower home prices are the only real solution to the housing collapse. The sooner prices fall, the better. The longer the adjustment takes, the longer the housing slump (weak sales, low construction, high numbers of unsold homes) will last...

To be sure, all this weakens the economy. No one relishes evicting hundreds of thousands of families from their homes. Eroding real estate values make many consumers less willing to borrow and spend. Some economists fear a vicious downward spiral of home prices. More foreclosures depress prices, increasing foreclosures as people abandon houses where the mortgage exceeds the value."

I talked about this earlier with respect to the need to let house prices come down. Yes; this is a very hard thing to propose. As the author mentions, no one relishes the thought of evicting all of those people. For many who are evicted, they will be in a better position because now they have the freedom to move into a place they can rent and likely pay less than they currently pay.

Now as far as a spiral down, I don't see that happening for a couple of reasons. 1) People got to live somewhere. I mean, these people getting evicted will move somewhere and help the market there by increasing demand. That leads to number 2) House prices won't fall below a certain floor imposed by the rents that could be charged to a renter.

An example. Suppose that your monthly payments are $2000/month and you can't afford them, so your evicted and the price of your (old) house falls. Further, suppose that in the current rental market, there is no way anyone could rent that house out for anything more than $1700/month. Assume that you and lots of other foreclosed on former homeowners all move to apartment complexes.

If all these people move to apartments, the rents at those apartments will rise (say from $1500 to $1700/month) as the would-be renters bid it up. Now I'd guess that all things equal, people would rather live in a house than an apartment, so some investor will notice that they can capture some of that demand by buying a home and renting it out.

What is the least they would pay for that house? Zero, of course. But they likely aren't the only astute investor, so they have to compete with the others who also see this opportunity and probably end up buying the house for a price that lets them charge the renters, say, $1750 or $1800/month. They will also be competing with some of the people who are renting for $1700/month because, again, those renters would rather live in a house and some would rather own a home than rent one.

The biggest losers in all of this will be 1) those who gambles with their homes and lost some equity and 2) the home builders. The home builders really made some hay during all of this, probably more than they would have made otherwise, and will likely see some major drawback as their excess inventories get purchased over the next few months and years.