Housing prices forecast to fall in 2010 -- and could keep falling for years

Fiserv, a financial information and analysis firm, is forecasting that national median home prices will fall 11.3 percent by summer 2010. The recent surge in home sales and new homes under construction have launched a feeding frenzy in the hardest hit Sunbelt and California markets as investors believe "the bottom is in." The Fiserv forecast -- and the fundamentals of supply and demand -- are throwing cold water on that confident enthusiasm.

Foreclosures are still rising as defaults rise in prime mortgages, which were once viewed as immune to the high defaults hitting subprime loans. As I have reported here before, the foreclosure pipeline -- not just homes that have been foreclosed, but those in default -- is bulging.
Banks are holding foreclosed and distressed properties off the market, hoping to sell them in a stronger economy. This stock of homes is called the "shadow inventory" because lenders have numerous ways to hide how many loans are in arrears and how many homes are foreclosed but not listed on the market.

While many of the investors buying discounted homes are paying all cash, many marginally qualified buyers are purchasing homes with little or no money down and loan-to-income ratios which require 50 percent of their net income go to pay the mortgage.

The Federal government is pumping up the housing market with unprecedented giveaways like the $8,000 new home buyer credit, --but unfortunately it appears the program is riddled with fraud and abuse. Some 100,000 of the 350,000 credit issued are being investigated by the IRS.

All of these data points suggest some pernicious drivers of the bubble haven't changed in the three years since the housing bubble popped. The Federal government is still underwriting low-down loans to people who are at risk of losing the home if their income falls even marginally, and abuse and fraud have simply moved to another corner of the market.

Some readers have charged me with wanting to deny people the opportunity at homeownership, but we have to ask: Is giving people mortgages which require half of their take-home pay doing them a favor, or are we simply setting them up for financial ruin? I would say the latter.

Though those in the real estate, mortgage and building industries are quick to claim that "housing is a unique asset and that it doesn't act like other assets," a strong case can be made that all bubbles follow predictable patterns, whether the bubble arose in tulip bulbs, raw land, gold, stocks or housing.

Historically, bubbles tend to rise and decline in rough symmetry, meaning that prices eventually retrace to their pre-bubble levels, and the length of time it takes to retrace is about the same as it took to reach bubble heights.

I have illustrated this in the following chart.

If bubble symmetry plays out in this bubble as it has in many other financial and credit bubbles, then we can anticipate a retrace to 1998 levels by about 2014.

Some observers claim that housing can't possibly return to 1998 levels because inflation will have boosted the value of all assets, housing included. But with producer prices dropping this month and the "owner's equivalent rent" part of the Consumer Price Index (CPI) falling for the first time in over a decade, the data is pointing to the uncomfortable reality that prices and rents can actually deflate.

In general, as rents fall, so does housing. Historically, housing prices and rents are correlated, for the common-sense reason that if it costs considerably more to buy than to rent, there is less incentive to buy -- especially if house prices are declining.

The Fiserv forecast and the foreclosure inventory data should provide a note of caution for those assuming "the bottom is in."

Charles Hugh Smith writes the Of Two Minds blog and is the author of numerous books, most recently
Survival+: Structuring Prosperity for Yourself and the Nation.
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