Is Flat the New Up?

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It's not time to give thanks yet for a recovery.

According to newly released data, home prices were essentially flat in September, taking the steam out of what looked like building economic momentum. Despite the resumption of growth in GDP (albeit lower than originally reported) and improved home sales and consumer spending, housing prices have stalled, causing some experts to warn of more price drops to come.

The Standard & Poors/Case-Shiller home price index, which tracks prices in 20 major U.S. housing markets, rose an anemic .3 percent in September, on a seasonably-adjusted basis, from the prior month. The increase, though smaller than expected, managed to eke out a fifth straight monthly gain for the closely watched index.
Still, 11 of the 20 Case-Shiller metro markets experienced negative or zero price movement. And the index is down nearly 10% in from last year.

The Federal Housing Authority, meanwhile, reported that prices of homes tracked by the agency remained flat from August to September.

Many observers took the news as a reassuring sign that we are on the path to normalcy -- aka, ever-rising real estate prices. But is that just so much irrational exuberance and wishful thinking? Are we still driven by a speculative mindset?

Some observers dared to rain on the parade. John Silvia, chief economist at Wells Fargo, told The Times he expected prices to fall by another 10 percent. Barry Ritholtz, CEO of Fusion IQ and a noted economic blogger, is even more pessimistic. In an interview with Yahoo!, he argued that national home prices are still over-valued by as much as 15 percent to 20 percent, when you take into consideration the oversupply of housing, depressed income levels, and artificial price supports in the form of low interest rates and tax credits.

Ritholtz noted that most of the sales activity has occurred in regions hardest hit by foreclosures. According to the National Association of Realtors, foreclosures and short sales made up 30% of sales transactions in the third quarter.

The fact is, home prices have traditionally been closely correlated to income (and inflation). Locals markets vary greatly, but generally, median home prices have historically averaged 2.5 to 3 times median income. At a multiple of 3.0 or less, housing is considered affordable. During the height of the bubble, some over-heated markets reached median price levels of ten or more times median income. (Two good discussions of the median home price to household income relationship can be found here and here). Home prices have tumbled by almost a third since their July 2006 peak. Still, prices may have a way to go before they are in line again with fundamentals.
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