Wednesday, October 08, 2008

The Sky is Falling!

One of the things that continues to amaze me is how many people extrapolate the recent past out into the long term. Too often this causes people to both become over enthused when the trend is up and to see nothing but calamity when it is down. We’ve seen it in the past with the fear of robotics causing the demise of USA manufacturing in the 60s, OPEC in the 70s, Japan in the 80s, the “giant sucking sound to Mexico” in the 80s, China in the 90s and housing today.

If you look at the history of housing, a house was always a depreciating asset until the 1950s (see graphic at right). When you bought or built a house, you expected it to go down in value much like we think of cars today. You don’t get upset at your car dealer when a one day old car is worth 20 or 30% less than the previous day. As a result few people buy new cars as an investment. They buy them to drive!

So it was with housing, at least until recently. The tax code, allowing the deduction of interest, and governmental assistance for home buyers has pushed American homeownership to almost 70%, a record. Efforts to push it even higher resulted in loans being made to people who didn’t have much of a chance of paying them back.

Housing prices increased at rates slightly above the inflation rate for much of the 80s and 90s. The Case Shiller Index, which measures housing prices in the top 20 metro markets increased at a 3.7% annual rate from 1987 (when it started) through 2000. However, in 2000 when the .com bubble burst, money flowed from the stock market into the housing market. From 2000 through its peak in 2006, the index soared by 11.2% per year, three times as fast! Suddenly, everyone was into “flipping houses”, never thinking that housing prices could ever go down.

But the bubble popped and down they went. Since peaking in the second quarter of 2006, the index has decreased by 8.6% for the past two years, a decrease but hardly a catastrophe. Prices today are equivalent to what they were in early 2000s. Granted, there are some areas that have decreased more than 8.6%/year but generally they are also the regions that increased at a much faster rate in the early 2000s.

I’m convinced that the housing crisis will stabilize in the next couple of years and slowly start to rebuild from a base that is much more solid than it was in 2006.

An aside:

If you want to see how your area has done on housing values go to this website and click on your state. You also can drill down and see how values have changed in the MSAs in your state. As an example, in CA the housing index moved from 40 in 1975 to 640 in 2006, a 16x increase! Put another way, a $100,000 house in 1975 was worth $1.6 million in 2005.

1 comment:

PersonalFinanceHacks said...

A great description of the history of the housing crisis. Thanks for posting it.