Posted by: jhamon | June 13, 2009

Thinking The Unthinkable

Whitney Ross at The Affordable Mortgage Depression asks the unthinkable question: could the net equity of the entire US housing market fall to zero?  I highly recommend his Doomsday Scenarios piece.  Even if you differ with his conclusions, it’s worth following his line of reasoning.  It’s also full of interesting visual representations of the data that helps to make sense of it all.

As in other sources I’ve recently pointed to, Ross contemplates the possibility that, as is typical with post financial bubble contractions, housing valuations could not only return to trendline of the last decades, but actually undershoot to the downside.  This agrees with T2’s presentation I posted earlier this week (Housing’s Fallen Down And It Can’t Get Up).

Highlights from Doomsday Scenario:

Could Home Equity Fall Below the $2.5 Trillion Level Consistent with Sustainable Value?

Prices during bubble-cycles tend to rise above fundamentally justifiable valuations during the boom-time and overshoot fair value to the downside during the bust.  Traditionally, the higher the boom valuation the more the trough value falls below fair value.  It is entirely possible given the centrality of falling house prices to the economic downturn that prices could overshoot 1997 levels.

Furthermore, the market conditions which determine the price of houses have not reverted to 1997 levels, they are much worse.  These include:

  • Credit availability is reduced  
  • Credit terms are more stringent
  • Hybrid mortgages are no longer prevalent (ARMs, Option-ARMs, Alt-As, Interest-Only)
  • Demand for homes has decreased
  • Supply of houses has increased (Inventories are at record highs and total units have increased by 14.2%)
  • The perceived risk of owning a home has increased
  • Expectation for future home price performance has diminished
  • Unemployment is much higher and rising
  • Foreclosures are at record highs and will persist
  • Marginal mortgage interest rates are much higher (relative to bubble hybrid alternatives)

Given that the market conditions that determine prices are substantially worse than that which existed in 1997, it is entirely possible that the housing market could stabilize at a valuation that is less than this historical level.

P.S. Hawai’i’s starting to come unglued.

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