Why Are Home Prices Still Falling?

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The long and winding housing recovery (photo:Joshua Lott/REUTERS)

Employment is rising again. Consumers spent more in December than they have ever done before. And perhaps most importantly, for the first time in three years there seems to be a broad confidence that the economy will recover in 2011. So why are housing prices still falling?

On Tuesday, one of the most reliable readings of the housing market, the Standard & Poor’s/Case-Shiller 20-city home price index, showed that the housing market is still headed in the wrong direction. Overall, the index showed that home prices dropped 1.6% in November in major US cities. More depressing was that in eight of the cities house prices are at their lowest level since the start of the recession. It seems clear that whatever momentum the housing market got from the home buyer tax credit stimulus spending is long gone. What is also clear is that housing prices don’t seem to be getting much of a lift from the emerging economic recovery. Here’s why:

I have argued a number of times that I think housing prices are set to rebound. Based on incomes and interest rates, houses are generally rather affordable these days. And the economy is improving, so you would think that home prices would slowly start to rise again. But that hasn’t happened. So why is the housing market taking longer to thaw than the rest of the economy, or than you would think? There are a number of possible reasons.

First of all, there is still a massive foreclosure problem. The large number of homeowners unable to make their mortgage payment is confounded by the fact that many banks didn’t keep the proper documents inorder to complete foreclosures. According to CNBC, Bank of America put foreclosures on hold last month even in states where banks don’t have to go to court to take a house from a borrower who isn’t paying. Some have argued that delaying foreclosures is good for housing prices. But I think that is wrong. Markets hate uncertainty, and that’s what foreclosure delays add. Three of the four cities where housing prices rose in November were in California, where there have been the most foreclosures and the fewest delays.

More than anything else, though, housing prices tend to follow jobs. While employers are starting to add jobs again, hiring is slow. The problem is the unemployment hole we are in is much larger than it usually is. With over 14 million unemployed people in the US, that takes a lot of buyers out of the housing market. I would like to chart the unemployment rate and housing prices. They are not a direct correlation, because housing prices, continued to rise, though at a slower pace in the early 2000s, while unemployment was rising. Still, high unemployment rates tend to drag down housing. Starting in 1990, housing prices fell as the unemployment rate rose. But that time unemployment topped out at 7.8%. So while the unemployment rate is coming down, it is still over 9%. In the 1990s, housing prices didn’t start rising again until 1994. By that time, the unemployment rate had dropped to 6%. The unemployment rate probably doesn’t have to get that low again for housing prices to start rising again. But if it does, we might not see a real estate rebound for another few years.

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