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October 27, 2006

Today's Housing Bubble Post -- Hitting The Economy Now

-- by Dave Johnson

Lots of stories in the news today:

Housing Market a Drag on Economic Growth,

Economic growth slowed to a crawl in the third quarter, advancing at a pace of just 1.6 percent, the worst in more than three years.

The latest snapshot of the economy, released by the Commerce Department on Friday, showed that the slumping housing market figured prominently in the economy's dramatic loss of momentum. Investment in homebuilding was cut by the biggest amount since early 1991.

.. "The housing bubble burst and that really knocked down growth," said Joel Naroff, president of Naroff Economic Advisors.

Bloomberg: U.S. Growth Slows to 1.6% Rate as Homebuilding Slumps,
The U.S. economy grew at a less-than- forecast 1.6 percent annual rate last quarter, the slowest pace in more than three years, as housing slumped and the trade deficit widened.

... Homebuilding declined by the most in 15 years. ... Residential housing construction fell at a 17.4 percent annual rate last quarter, the biggest decline since the first quarter of 1991, after shrinking 11.1 percent in the previous three months. The decline in homebuilding subtracted 1.12 percentage points from third-quarter growth, the most in almost 25 years.

But wait, there's more!

Signs it will get worse - much worse. Chicago Tribune: Adjustable rates may deepen housing trough,

Existing-home sales will decline 9 percent this year, drop 8 percent in 2007, and increase less than the inflation rate in 2008, Mortgage Bankers Association economist Doug Duncan said in Chicago this week.

Duncan, who has a reputation for solid predictions, notes that housing downturns take time to work their way out because of what he calls "the smarter neighbor theory." One neighbor looks at a neighbor who recently sold a home for $400,000 and thinks he's smarter and can sell his for $425,000. He puts it up for sale, but once curious neighbors trek through the house, it takes him about three months to accept that buyers aren't interested. At that point, he lowers the price. But the house sits. Several months later he decides he's getting nowhere and perhaps takes it off the market.

When many people reach that point, and start removing their homes from the market, the cycle begins to mend. But Duncan notes that so many people are listing homes, there is a hefty eight-month supply on the market; six months is considered healthier.

And how's this one? Housing prices plunge in U.S. as builders fret
Analysts fear deep discounting on homes may scare off buyers, making spiral worse
,
Faced with a growing glut of unsold homes, U.S. builders are resorting to unusually deep discounts that some analysts fear could turn off potential home buyers, feeding an even steeper downward price spiral.

"Falling prices deter buyers," warned economist Ian Shepherdson of High Frequency Economics.

"When the new home market goes south, the early buyers can get hurt," agreed Walter Molony of the U.S. National Association of Realtors (NAR).

That's because buyers may be reluctant to lock in at today's prices if they believe homes will be significantly cheaper in a month or two.
[emphasis added]

So the builders can't sell their homes, they lower prices, buyers realize that prices are dropping, so they wait. This is a classic crash scenario - a spiral down. Just like the stock market did. When does it stop? When prices reach the point they SHOULD be at in the first place - when you look at the VALUE of the house, not some idea of what it will be worth if prices rise! With stocks, prices had to fall until the stock was a good investment again - based on the value of the company, not some idea of making a quick buck by holding the stock for a few weeks and then selling it.

Posted by Dave Johnson at October 27, 2006 9:51 AM

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Tracked on October 27, 2006 10:27 AM


Comments

When does it stop? When prices reach the point they SHOULD be at in the first place - when you look at the VALUE of the house, not some idea of what it will be worth if prices rise!

Is that true or supported by evidence?

If open a spring-loaded door and let go, the door will close quickly and bang sharply against the door jam. If there was no door jam, the door would just swing back and forth. A spring loaded door doesn't stop at the door jam easily unless there is some form of damper installed. So it's not clear that a fall in housing prices will stop at the value price, and not just crash through that.

But also, it's not clear that the price will stop at the value price and not at a higher price. I don't follow the market, but I though P/E ratios are still significantly higher than they have been historically with no good explanation of why that should be.

Posted by: J Pierpont Flathead [TypeKey Profile Page] at October 27, 2006 10:46 AM

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