Shiller on more home price declines

In this NY Times op-ed, Yale economics professor and housing market guru Robert Shiller splashes some cold water on the recent housing market fervor in such places as Arizona.

Why Home Prices May Keep Falling
HOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient.

A national home price decline of 48 percent would imply a decline of, what, about 80 percent in Phoenix? That may be a very efficient and rational market.

He goes on to explain why home price declines go on for much longer than most people really understand, especially those who think they're snapping up such bargains today.

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. First, many owners don’t have a speculator’s sense of urgency. And they don’t like shifting from being owners to renters, a process entailing lifestyle changes that can take years to effect.

Among couples sharing a house, for example, any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable.

It used to be conventional wisdom that, unless you were financially strapped, once you became a homeowner you would forever be a homeowner. If you were transferred from one town to another, you'd put your house up for sale, go out to the new place, look around for a few days, buy a house, and move in.

That seems to be changing and one of the most important reasons is that people can't sell their existing houses - at least not at the price they want.

It will be interesting to see if the U.S. housing bust fundamentally changes the way Americans think about home ownership.

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This week's cartoon from The Economist: