Steep drop in home prices may help economy

Voltron says: Amen

 

 

The bottom should be hit faster, experts say. But the U.S. may have to lean on other sectors for a recovery.

 

By Maura Reynolds
Los Angeles Times Staff Writer

WASHINGTON — Nearly two years into a housing decline that has resulted in hundreds of thousands of foreclosures, frozen credit markets and dragged the nation's economy toward recession, many Americans hope the end is near.

Most economists believe the worst is yet to come.

"I see absolutely no signs of a bottoming, either nationally or in the regions," said Patrick Newport, who tracks the housing market for Global Insight, an economic forecasting firm in Lexington, Mass.

Elsewhere in the economy, some analysts find encouraging signs. Last month's gross domestic product numbers were a bit better than expected, while the consumer price index has risen relatively little since the huge price increases in oil, food and many other commodities that have occurred in recent months. And the financial crisis that paralyzed credit markets may have begun to ease.

If the country is to avoid a full-scale recession, however, as some analysts are beginning to consider possible, the economy is apparently going to have to pull itself back from the brink without help from the housing industry.

"The housing correction is still going to be with us this time next year," said Celia Chen, a housing economist at Moody's Economy.com in West Chester, Pa.

"The slowdown we've seen in the U.S. economy since late last year appears to be directly linked to the housing crisis and the self-reinforcing cycle of defaults and foreclosures, putting more downward pressure on the housing market and leading to yet more defaults and foreclosures," Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., said in a speech Friday. "We need to find better ways to help struggling homeowners."

When it comes to housing, the optimists are those who see the near free fall in home prices as encouraging: It may at least shorten the economic agony.

"Because the prices are going down so fast, we'll be hitting the stabilization point sooner," said Lawrence Yun, chief economist at the National Assn. of Realtors.

On Friday, the Commerce Department reported that housing construction rose 8.2% in April, the biggest increase in more than two years, but the gain was the result of a surge in new apartment buildings, while single-family home starts kept dropping. Demand for rental units typically rises when homeownership becomes more difficult.

And some analysts think the April gains were an anomaly.

The hard truth is that the housing correction is turning out to be deeper and longer than nearly anyone anticipated. And that's bad news, not just for homeowners and would-be home buyers but for pretty much everyone.

With every month of lower home prices, homeowners see their net worth decline. Potential purchasers are paralyzed by a lack of financing and by the fear that if they buy before the market hits bottom, they will lose money too.

Already, several major retailers tied closely to housing -- furniture chains such as Levitz Furniture and home improvement stores including Home Depot Inc. -- have gone out of business or suffered big losses. Smaller companies are feeling the crunch too.

In Brighton, Colo., Matt Edmundson says his family's wholesale nursery business has declined 30% in the last two years. His primary customers -- once accounting for 75% of sales -- were businesses installing new landscaping for newly built homes and businesses.

"Our largest customer three years ago was doing 8,000 frontyard homes a year," Edmundson said from his office at Arbor Valley Nursery. "Last year they were down to 3,000 and this year to 1,500 -- that's a pretty drastic decrease. We've shifted focus more into the commercial market, but now the whole pie is smaller."

And the damage has not been confined to those closely tied to housing. Economists estimate that the housing downturn has dragged the country's gross domestic product down by about 1 percentage point for the last year.

"It ripples in many ways and in many unexpected ways," said Michael Niemira, chief economist for the International Council of Shopping Centers. "Everybody is touched in some way, whether you are a high-end consumer with an investment in the stock market or someone who is just starting out and wants a loan for a house or a car."

Dean Baker, co-director at the Center for Economic and Policy Research, a left-leaning think tank in Washington, said the correction was taking a huge toll on consumer spending.

"People's ability to spend depends in part on their housing wealth," Baker said. "If we're losing more than $4 trillion in housing wealth in the course of a year, that's over $60,000 per homeowner. That has an enormous impact on consumption."

Economists say consumer spending is the economy's main driver, accounting for about 70% of GDP.

How much longer will home prices fall, and how much further?

In a speech Friday, Treasury Secretary Henry M. Paulson Jr. said the crisis was likely to last into next year.

"We didn't get here quickly. There were years of excesses. And this won't be resolved quickly," Paulson said in remarks at a business luncheon. "Housing is the biggest risk to our economy," he said.

Over the last year, index prices have fallen 12% to 14%, and Moody's Chen thinks they have an additional 10% or 12% to go.

"I think we're about halfway there," she said.

Yun of the National Assn. of Realtors said prices of existing homes had fallen about 8.5% since their peak in the summer of 2006 and probably had 10% more to go. "Peak to trough, we'll be looking at 20% or even greater," he said.

Baker thinks that's too optimistic. Before the mid-1990s, he said, house prices moved up roughly in line with inflation. But since 1996, they have gone up 170% -- well above the rate of inflation.

To bring them back to where they would have been without the bubble, Baker estimated, would mean a drop in real prices of about 40%.

"Given how fast prices are falling now, we could see the prices adjusted by the end of the year," Baker said.

Thomas Lawler, a housing economist who runs a consulting firm in Leesburg, Va., noted that in the last housing price correction, which occurred in the early 1990s, it wound up taking prices seven years to drop 20%. Compared with that protracted slump and recovery, he thinks the current free fall in home prices is a good thing.

"Do you want a slow bleed?" Lawler asked. "Wouldn't it be nice to just get it over with? It might be that that's what we're seeing."

The reason economists have trouble agreeing on the duration of the downturn is that in many ways, it's more a matter of psychology than economics. How long will homes need to be on the market before sellers are willing to drop their prices low enough to find buyers? And how long will it take for enough sellers to do that to work through the roughly 10-month backlog in sales inventory?

The question troubling policymakers is whether the government can or should do anything to contain the damage.

Lawler believes that the government should help ease the liquidity crisis facing banks but should stay out of the housing market itself. He thinks measures currently under consideration in Congress would interfere with the natural correction of the market.

Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said Congress' goal was to reduce the effect of the housing crisis on the overall economy. He has authored a plan that would greatly expand the availability of government-insured mortgages in an effort to limit the ripple effects of large numbers of foreclosures on local communities.

"We're not trying to stop housing prices from dropping," Frank said in a recent interview. But without his plan, he said, "the recession will be longer and deeper than it otherwise would be."

Nicolas Retsinas, director of Harvard University's Joint Center for Housing Studies, noted that a downturn in construction had already led to layoffs in related industries and that declines in house values were already draining local budgets for schools and roads.

In the end, he said, the longer the housing downturn lasts, the worse the knock-on effects for everyone.

"There are more and more reasons to be concerned that the correction will be deeper and have a contagion effect on the rest of the economy," Retsinas said. "I don't think the market self-corrects without substantial collateral damage to the communities they are in."