Mendo Island Journal — Timely. Useful. Sometimes Cranky.

How much further will Mendo home prices fall?

In Around the web on December 23, 2010 at 9:05 pm


Zillow.com: Ukiah 10-Year Drop

From THE AUTOMATIC EARTH

[You won't see the above graph in our local Friday Real Estate supplements... -DS]

[...] Our economies run on credit, it’s their lifeblood. Take it away, and they will stop running. Not altogether, but to a very large extent. Shipping letters of credit are getting harder to procure; the Baltic Dry Index is once more tumbling as we speak. Nearly everything you find in your stores is bought with credit; if storeowners would have to pay in advance for what they haven’t sold yet, they wouldn’t be able to.

Now imagine that coming to a grinding halt.

Similarly, real estate purchases practically all involve the use of credit. For anyone to be able to afford a home with the cash they have, home prices will have to come down a lot. Which is precisely what they will do. However, by that time, those among us who do have the cash will think twice before using it to buy a home. Home purchases will never go down to zero, but they can come down a lot. Like prices, purchases can also fall by 90%. There’s a solid link between the two. What we have been predicting for the past five-odd years is first and foremost a credit crunch and collapse, across the western world. That is, available credit will decrease ever more, until there’s hardly any of it left. And that in turn will have grave consequences across economies, including real estate markets…

In the US, the picture is deliberately kept as murky as possible. Official U3 unemployment is at 9.8%, but when tens if not hundreds of thousands of workers every single month are moved into the “no longer in the workforce” category, following the U6 number, which is 17-18%, might paint a more truthful picture.

The problem that emerges form this is that even if the banks would be willing and able to lend, which they’re not and they won’t be because they’re broke, and therefore dead without incessant infusions of public funds, there still would be a severe housing crisis, simply because the pool of borrowers has been diminished below the level that could potentially keep “healthy” borrowing numbers intact. And don’t forget that, moreover, a growing part of the working population greets you at Wal-Mart or flips your burgers at Wendy’s, and those folks too, along with the jobless, are out of the real estate market for a long time to come, if not forever.

In Canada, 20% of GDP is construction related. It can’t possibly be much less in the UK or US. In Spain, it was even higher until recently. And you can’t take 10-15% or more out of an economy that already struggles and not feel a sharp pain. Moreover, you will see a snowball effect. Less real estate purchases, less jobs in construction, in banking, and eventually at those sectors that catered to them. Which leads to less real estate purchases, and so forth.

This can’t go on forever. You live on the money your governments have borrowed from your own children (90% of which went to the banking sector to begin with). Now, I don’t know how many children you already have or are planning for, but there will be a perceived limit to what your offspring can service in debt, and when we cross that limit, the international financial markets will either make us stop it altogether or force us to pay interest rates we can’t afford.

That is to say, borrowing from ourselves to keep our illusion alive of a “normal” life must and will stop. That will lead both to major jumps in unemployment, and, as stated above, that in turn will lead to even worse housing markets.

This is inevitable. We must come off our credit “sugar” high, and we can’t do that by applying more credit. That will mean scores of jobs created by that sugar high will disappear as well. The jobs that were not have all been moved elsewhere in the world. No healthy job market, no healthy housing market. Period.

So when do we see this come to fruition? Well, price discovery in a housing market, which is always prone to inertia, since people can stay put and fool themselves about the true value of their homes, can take a while to develop. But it will come. US banks will at some point need to offload foreclosed properties, They play a delicate game between the marked-to-whatever value they carry the homes for in their books, which makes them appear solvent, even as they get no income from the homes, and, on the other hand, getting that income. Banks are desperate for cash-flow, but for now, who cares if the Fed provides cash at 0.0078%?

The way we at The Automatic Earth see it play out is that the entire house of cards will fall within 2-5 years, and, within that timeframe, sooner rather than later. While there can be any number of inside and outside factors that can speed it up, we see practically none left that could slow it down. Of course there can be people in a few years time who claim by hell and high water that their homes are still worth $500,000, but they will have neighbors who sold for $100,000, $50,000 or less. Price discovery can be in the eye of the beholder, until you must urgently sell.

There are people in many countries and regions who feel that their particular place is different, and they do so for a variety of reasons. But nine out of ten of them are wrong. Even in China and Brazil, which today look to be relatively healthy economies, the western credit collapse will cause unequalled mayhem. Russia may fare a little better, but only for the richest part of its population; then again, that will be true around the globe.

For the remaining 99% of the population, the combination of deleveraging and depression, a double barrel that guarantees a self-reinforcing positive feedback loop, will be gruesome and cruel.

People have complained about the fact that we have warned last year about what 2010 would bring, pointing at the stock markets, which appear just fine and normal. But, as we’ve always maintained, it’s better to be a year early than a few minutes late, and moreover, if you look at the numbers of foreclosures and long-term unemployed, and the number of Americans who are on foodstamps today (1 in 7), maybe it’s time to realize that what we think of as normal is something we left behind years ago. Even to ponder that from the very beginning of this now closing decade, with the huge run-up in real estate prices through out the western world, things have never really been normal.

It’s perhaps just that when you can go out and buy homes and cars on credit, and iPod and iPads for Christmas, it is mighty tempting for the fickle human brain to see that as “normal”. Meanwhile, your home values will return to what they were in, say, the 1970′s, or even before that. It might be a better idea to see that as “normal”. Then again, prospects for economic growth were much better back then. Maybe try 1950.

The human brain is lousy with diminishing returns and receding horizons. It excells at perpetual growth. Great at the impossible, bad at reality. So bad we’d rather invent our own reality than face the one we must face. Until we can’t. In the end, what we’ll be left with is a small group of rich people buying up real estate for pennies on the dollar. Which is of course no different from what happened in the 1930′s.

Nothing new, nothing special there. What we fear will be new and special is the degree to which we will see our economies and societies crumble; there are precious few signs that it will be better, let alone different, this time. And that’s why the only disagreement Stoneleigh and I have is between an 80+% and a 90% decline in home prices. Across the western world. On average.
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