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Housing Bust Will Get a Lot Worse

08/29/2007 12:00 am EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of Gary Shilling’s Insight, says home prices have a lot further to fall before they hit bottom, which he thinks won’t take place for at least another year.

Weakness in subprime housing is not new, but only recently are others joining us in seeing a long and deep housing slide, lasting beyond 2008 and involving big drops in sales and prices.

Interestingly, this is especially true for industry participants who have taken considerable blows but remained optimistic—until now. Just recently, Jeffrey Mezger, CEO of KB Home, said, “By the end of 2008, it [the housing market] will start to stabilize,” but that house prices would not increase until “well into 2009.” Richard F. Syron, Freddie Mac’s CEO, stated recently, “I think on a national level, the whole housing market has another year and a half of tough times ahead of it.”

Low-end homebuilder D.R. Horton is now assuming house price declines as high as 10%. Countrywide’s CEO Angelo Mozilo, who earlier this year said he’d never seen a soft housing landing in his 40-plus years in the business, was obviously not prepared for the leap in prime home equity delinquencies. Back then he expected recovery next year but now not until 2009.

He went on to say recently that house prices are falling “almost like never before, with the exception of the Great Depression.” Well, prices fell 24.3% between 1929 and 1933 and we continue to foresee a 25% peak-to-trough drop this time.

J.P. Morgan now expects a total decline in house prices of as much as 20% from the June 2006 peak before this cycle hits bottom, potentially two or three years from now. So our 25% fall in median single-family house prices nationwide no longer looks so extreme.

As we’ve noted many, many times, the earlier leap in prices was so exuberant that it would take a 50% fall to return them to the post-World War II norm, after adjusting for inflation and the increasing size of houses—the McMansion effect. And markets always overshoot on the downside, just [as] housing clearly has on the upside. House prices have a long way to go from here to meet our 25% decline target.

But note that dispirited homebuilders are slashing prices and effectively cutting them further with huge concessions to clear out excess inventory. That puts pressure on existing house prices, which are already feeling the heat from the end of the usual 18- to 24-month period of denial during which homeowners are unwilling to cut prices enough to sell their abodes.

As we’ve discussed in [the past], we believe two million extra houses remain from the 1995-2005 boom, and excess inventories are the natural enemy of prices. Our forecast of a 60% decline in existing house sales, peak to trough, is also considered extreme by many. But between November 1978 and May 1982, sales fell 55% in what was a much less severe housing slump than is ongoing today.

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