Housing Still Casts a Long, Dark Shadow

10/07/2010 1:00 pm EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, warns investors not to underestimate the huge and continuing impact of the housing bust on homeowners and the larger economy.

Last spring, many believed that not only was the housing collapse over, but a robust rebound was under way. Investors were crowding into foreclosed house sales and bidding up prices in California. The tax credit of up to $8,000 for new home buyers that expired in April spurred buyers and promised to kick-start housing activity nationwide.

But then a funny—or not so funny—thing happened. The revival of home sales early this year proved to have less follow-through after the tax credit expired in April than did the previous expiration last November. Existing home sales subsequently fell to a new low, so the tax credits had only “borrowed” sales from future months, with no lasting impact.

Also, with almost a quarter of all homeowners with mortgages under water (their mortgage principals exceeded the value of their houses), many can’t sell their existing abodes even if they wanted to buy other houses.

At the same time, the house price collapse and subprime mortgage meltdown has led to a drastic tightening in lending requirements. Estimates are that almost a third of Americans can't qualify for a mortgage because of low credit scores.

The Obama Administration’s Making Home Affordable Program (HAMP), introduced in April 2009, has been a huge disappointment. Fewer than 500,000 survived their trial periods to gain permanent modifications. So much for the Administration’s target of three million to four million modifications.

But the bad news will persist. As that program unwinds, foreclosures will again jump in the slow-economic-growth, high-unemployment quarters that probably lie ahead.

Estimates are that a major share of the seven million houses that have delinquent mortgages or are in some stage of foreclosure, as well as those yet to come, will be dumped on the market, adding to the already huge excessive inventory glut.

This growing surplus inventory of houses will probably depress prices considerably—perhaps another 20% over the next several years. That would bring the total decline from the first quarter 2006 peak to 42%. This would return single-family house prices back to the flat trend that has held since 1890.

[And] just as they way overshot the trend on the way up, they may do so on the way down, as is often the case in cycles. A further 20% drop in prices will push the number of homeowners who are under water from 23% to 40%.

At that point, the remaining home equity of those with mortgages would be wiped out on average. That, in turn, would impair already depressed consumer confidence and their willingness and ability to spend—to say nothing of residential construction.

The earlier housing bubble has deflated considerably and painfully. Still, it was so huge that the full deflation will probably take at least several more years to complete. Beyond that, homes will probably be regarded as the expensive places to live that they are, not as wonderful investments.

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