Friday, June 20, 2008

US House Prices fall at Rate quicker than Great Depression

Source: Economist

US house prices continue to drop like the proverbial brick.

One of the most respected house price indexes - S&P/Case-Shiller national index reported house prices fell by 14.1% in the 12 months to April 2008.

Why are House Prices falling faster than in Great Depression?

Bubble and Bust: Prior to the Great Depression there wasn't really a housing bubble; the housing market was more stable and less prone to fluctuations. Recently, more people have viewed the housing market as an investment (and a one way bet at that).

Irrational Exuberance.

It is easy to be wise after the event, but, even Alan Greenspan will probably regret making this prediction about US house prices in 2005:
“A DESTABILISING contraction in nationwide house prices does not seem the most probable outcome...nominal house prices in the aggregate have rarely fallen and certainly not by very much.”
There was a strong feeling that house prices were bound to keep rising, therefore, it was a no brainer to keep investing in housing. However, now the irrational exuberance has reversed and prices have reversed.

Over Supply

The boom in house prices caused a mirror boom in building; the consequence is that falling demand for housing has occurred simultaneously to a substantial rise in supply. Even the slowest economic student will realise this is a basic recipe for falling prices.

Credit Crunch

The well documented credit crunch has hit mortgage availability. From eager, irresponsible lending, banks have had to retreat and become very cautious about lending. The result is many would be home buyers have pulled out of the market as they are unable to receive finance.

Negative Multiplier Effect and lower confidence.

With house prices falling so rapidly, if seems to make sense to wait, rent and buy when house prices recover. If house prices are falling 14%, waiting 1 years could save you $28,000 on a $200,000 house - that's a pretty big incentive to 'wait and see'. In the great depression, people's attention was focused on plummeting share prices and rising unemployment. There wasn't even a national house price statistic at the time. In fact towards the end of the 1930s, the housing market was one of the strongest sectors of the economy. Low interest rates encouraged homebuilding as a new generation of people considered buying a house.

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