Robert Shiller is out with a fantastic piece in the NY Times today on the housing decline. Shiller writes:
HOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time. Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.
Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. Why would a sensible person watch the value of his home fall for years, only to sell for a big loss? Why not sell early in the cycle? If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.
But something is definitely different about real estate. Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.
Shiller is one of the few people who predicted the housing decline accurately and clearly understands the behavior of long-term trends. I hate to agree with Shiller’s rather gloomy housing outlook, but the history of large bubbles is simply not on the side of the bulls here. It looks like my housing projections are not all that far off from his. The crux of the issue is a massive long-term build up in supply that is now being met with very low demand. Like all bubbles, a supply glut builds for years and when demand drops off prices tank. The resulting turnaround takes years to work off because it took years to build the supply. A v-shaped recovery goes against the very law of supply and demand. Bubbles adhere strictly to these laws because they are such macro events. Throw in a recession and high unemployment and you have the recipe for a long drawn out housing decline (although the rate of decline will definitely slow as things progress).
The best example of such a scenario is Japan where unemployment soared and housing prices just continued to move sideways to down for almost an entire decade. As I’ve said before, the probability of a v-shaped recovery in housing is very low – especially with the unemployment levels we are seeing – my year end projection of 10%+ unemployment is now looking a little on the light side. This fantastic chart of Japanese home prices shows a disturbing similarity to U.S. home prices:
The scariest part of the Japanese scenario is that nominal GDP actually grew throughout the late 90’s as housing prices continued to decline. Their banking sector, as we all know, remained in the doldrums due to the cash flow problems related to housing assets. A similar scenario would not be surprising here. We could actually come out of a technical recession and still remain incredibly sluggish for years. It won’t be labeled a recession, but it could feel like one. As Shiller said:
Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.
Expecting a quick housing recovery? Don’t bet on it.