New data shows that housing prices are not improving.

Nationally, prices have now dropped 34.4% from their peak in 2006.  Prices are now the lowest they have been since the end of 2002, according to the Case/Shiller index.  Robert Shiller, co-creator of the index and long-term researcher on housing prices, warns that risks remain and that we may be seeing a broad shift in consumers’ beliefs with regard to the desirability and risks of owning a house.  In fact, Shiller speculates that it may take decades for suburban single-family housing prices to recover.

A chart of the 20-city composite of U.S. house prices tells the story (below):

Case/Shiller 20-City U.S. Home Price Index, Seasonally Adjusted. Source: Standard and Poors.

Case/Shiller 20-City U.S. Home Price Index, Seasonally Adjusted. Source: Standard and Poors.

Nationally, home prices more than doubled from 2000-2006.  From mid-2006 to mid-2009, prices dropped as dramatically as they rose during the boom.  We experienced a slight bounce from mid-2009 to mid-2010, but prices started to decline again in 2010 and are now at their lowest point in a decade.

Implications of Weak Housing Values

Beyond the obvious impacts on homeowners’ net worth, what are the implications of weak housing values for the economy?

First, for many Americans, their houses represent most of their net worth.  What’s more, less wealthy households tend to have a higher percentage of their net worth in home equity.  A continued decline in house prices tends to increase wealth inequality, as well as reducing household net worth as a whole.  Given that fewer and fewer Americans have traditional employer-sponsored pension plans, reductions in household net worth translate directly into fewer financial resources available to fund retirement and other long-term liabilities.

Second, we have the wealth effect.  People tend to feel wealthier when the paper value of their assets is higher, and they tend to spend more.  This may be an especially powerful driver of consumption when homeowners can easily use home equity loans to fund purchases of consumer goods.  A number of studies have found that wealth in the form of home equity is a larger driver of consumer spending than other forms of wealth.

Third, we have the manifestation of de-leveraging among individual investors.  People who lose their homes to foreclosure are not likely to purchase new homes.  In addition, baby boomers who are saddled with mortgages they cannot really afford are likely to sell their homes to get out from under the risks that such leverage (e.g. mortgaged) creates.  Gary Shilling recently outlined this scenario.  With a smaller pool of ready buyers, this de-leveraging across the residential real estate market is a deflationary force.

Is There Any Good News?

Yes, some. Buying a house is looking more and more attractive relative to renting.  With low interest rates and lower prices, the cost of purchasing a house is lower than it has been over most of the last ten years.  Ken Johnson, a professor who studies real estate, and the buy-vs.-rent problem in particular, concludes that buying looks like a better bet than renting.  On the other hand, it is hardly surprising that potential home buyers, and especially first-time buyers, will be very wary of borrowing large sums of money to purchase an asset that may be hard to sell (liquidity risk) and that has the potential to drop as much as we have seen housing prices fall in recent years.

On the other hand, the implications of the most recent Case/Shiller numbers are not very positive.  The best that can be said is that housing prices have shifted from a dramatic free fall to a slower downward drift.  It is hard to tell whether this persistent declined in housing prices is a symptom or a cause of an ongoing economic malaise.  For wealthier Americans, the massive upswing in the stock market has offset declines in housing values.  For less-well-off Americans, the continued erosion of net worth suggests it will be a very slow recovery in terms of personal wealth and in terms of a sustained recovery in consumer spending, which has historically depended on the “wealth effect.”

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