My colleague Dr. Mark Skousen and I have been having a long-running, good-natured disagreement about the direction of the national housing market.

He calls buying real estate “the investment of the century.” I think it’s more likely to be “the disappointment of the decade.”

He thinks housing prices are about to rebound. I say rebounds (in the price of anything) only come off a genuine bottom. And, despite the precipitous drop in some areas, we still haven’t seen a bottom in home prices.

This week the media reported that the S&P/Case-Shiller National Home Price index fell 19.1% in the first quarter.

Bear in mind, that is not the fall from “the top” but just in the first quarter from a year ago. Moreover, the plunge is picking up speed. It was the biggest drop in the 21-year history of the index…

The Housing Market – One of the Greatest Financial Bubbles of All Time

As I’ve been warning for five years now, we’re witnessing the unwinding of one of the greatest financial bubbles of all time – the housing market.

Yet home prices will not simply “pop” like Internet stocks. It’s going to be a prolonged, gradual deflation.

I’ll explain why – but let me start with my standard disclaimer:

Yes, all real estate is local. Yes, some areas of the country will hold up better than others. Yes, outstanding properties in primo locations will hold up best of all.

With that out of the way, let’s also note that virtually no market is experiencing appreciation right now. Even homes in the New York area – a former bastion of strength – plunged 11.9% in the first quarter.

Trust me, this is not just a result of a weak economy.

Housing Market Prices Peaked At Ridiculous…

Prices at the housing market peak were ridiculous. Ask yourself why home values tripled in many areas from 1995-2005.

• Was it population growth? No.
• Was it inflation? No.
• Was it the cost of building? No.
• Was it sky-high rental income? No.
• Was it a huge leap in discretionary income? No.

It was three things:

• Rock bottom interest rates,
• E-Z credit,
• And an unshakeable conviction that real estate “always goes up.”

It doesn’t. And now everybody knows it.

When Will The Housing Market Reach Equilibrium?

The reason it will take years for the housing market to reach equilibrium – where buyers and sellers can easily meet – is that the market for newer homes is clogged with three types of sellers:

• The first is those who bought in the past few years and owe more on their house than what it’s worth. (No seller relishes the idea of showing up at the closing and writing a big check.)
• The second group is those who bought before prices peaked but pulled the equity out of their homes. Like the first group, they’re stuck.
• The last group comprises unmotivated sellers who can’t get out of their minds what their house was worth a few years ago and – seeing similar homes listed at sky-high prices – won’t reduce their asking price in a meaningful way.

Moreover, banks and mortgage companies – stung by their own lax policies – are now requiring bigger down payments and better credit ratings from borrowers. This further diminishes demand.

The Housing Market – It’s Not As Broad-Based As We Thought…

So, if the housing market is not a broad-based buyers market as transaction-starved realtors keep telling us, then how come average home prices are down so much?

• In many markets, up to half of all sales are foreclosures.
• Short sales – transactions where the lender allows a distressed seller to unload for less than the mortgage balance – often make up another 20%.
• If you attend a foreclosure auction – or can get a bank to accept a short sale – you can indeed find bargains in today’s market.
• But if you have a realtor driving you around showing you a bunch of new listings, get ready for disappointment. They will tell you it’s a buyer’s market. You’ll keep asking “where?”

In some places, of course, it is. Miami, Detroit, Orlando, Las Vegas, Phoenix and Sacramento are a few good examples. Average home prices in these distressed areas are down 45% or more from the peak.

But, in other areas, homes aren’t down nearly as much as they will be in a few months – or a few years.

How can we know this? Because the inventory just keeps piling up. The Associated Press reported this week that the backlog of unsold single-family homes just rose to the highest level in more than two decades.

I’m not gloating about this, incidentally. I own two homes myself and am fully aware that we won’t see a genuine recovery in the economy or the banking system until the housing market stabilizes.

Alas, that day is not here yet.

And – are you’re listening Dr. Skousen? – It won’t be here tomorrow either.

Alexander Green
Investment U