Revisiting "Could U.S. Net Home Equity Fall to Zero?"
In June 2009 this forum observed the possibility that the net Home Equity value of the entire U.S. Housing Stock could fall to zero. If this interesting outcome seems farfetched, you might find the original article worth reading.
Doomsday Scenarios: Could the Net Home Equity Value of the Entire U.S. Housing Stock Fall to Zero?
In 1999 (18 quarters into the Housing Bubble) the country's Housing Stock was worth $10.1 trillion. Today there is $10.2 trillion in Mortgage Debt capitalizing houses. Based on the economic fundamentals which determine market price, houses should be cheaper (in real terms) than they were in 1999. If this reasonable possibility were to occur, the nation's net Home Equity could fall to $0.
Updating Home Equity Figures for the "Economic Recovery"
The following chart shows U.S. historical Home Equity and plots a trend line based on the rate of loss prior to the "Obama Mini Housing Bubble".
In general, I do not advocate trend lines for predicting the future, but given that housing prices remain wildly overvalued, the historical pace of equity losses seemed likely to continue but for the Government's orchestrated manipulation. The projection demonstrates why politicians were willing to distort housing prices by edict and unsustainable subsidies.
As of 1Q10 the nation's Home Equity teetered at $6.3 trillion compared to the $986 billion figure resulting from the trend line. Stimulus spending and housing subsidies have succeeded in temporarily preserving $5 trillion in paper Home Equity.
First Quarter Home Equity Figures Analyzed
During the 1Q10 Home Equity increased by $29 billion. This figure may seem impressive but in context it represents the last gasp of a failed effort to prop up housing prices. The gain declined in magnitude for the third straight quarter and appears likely to be negative in the second quarter.
Even less encouraging is the source of the equity gain. The value of the nation's Housing Stock actually declined in the first quarter down $65 billion. But the accelerating pace of foreclosures eradicated $94 billion in Mortgage Debt. Propped up, but falling, housing prices were sufficient to allow failing mortgages to create momentary, paper Home Equity gains.
How Low Can It Go?
TheAMD.com employs a methodology for estimating "fair value" of the nation's Housing Stock using pre Housing Bubble price levels. The December 1996 Housing Stock figure is grossed up for inflation, and newly constructed units are captured at an assumed 20% premium to existing houses. (A more detailed explanation may be viewed within the original analysis )
I view this figure as the bare minimum to which the U.S. Housing Stock must decline in order to reach a market determined equilibrium.
Sadly, market conditions which ultimately determine housing prices are much worse today than they were in 1997.
A quick review of the Case-Shiller 20-City Index demonstrates the likelihood that many housing prices will fall beyond 1997 levels. At present, there are 6 city indexes (30%) which have decreased below their January 1997 values. From current levels, Detroit and Las Vegas would have to appreciate by 59.9% and 20.7% just to return to inflation-adjusted, pre-bubble equilibrium.
Certainly both of these cities are experiencing acute economic problems... but so is much of the rest of the country. The point is that housing prices may easily fall below inflation-adjusted, 1996 levels given market conditions today which are worse than existed 15 years ago.
The Future of U.S. Home Equity
The following chart shows historical figures for Household Real Estate Assets and Mortgage Debt. Additionally, the graphic plots the pre "Obama Mini Housing Bubble" trend line through 2010. The analysis provides context for current values relative to the Housing Bubble and demonstrates the potential for future reductions in Home Equity.
The calculated maximum value of the U.S. Housing Stock and the unadjusted Dec. 1994 figure are also included for context. In my opinion, the sustainable value of housing lies somewhere in between the two.
While national, net Home Equity of $0 may appear unlikely (given mitigating factors described in the original analysis), the prospect that the "Obama Mini Housing Bubble" will maintain prices above sustainable, market-determined valuations is truly absurd.
Posted by Whitney Ross at 6/19/2010 11:22 AM 
Categories: Housing Market Analysis, Focus on Home Equity
Categories: Housing Market Analysis, Focus on Home Equity
I have just recentlty started following the articles on this site and am a little confused. I sold my home in the Phoenix area 12 months ago and have been waiting out the market downturn. However, it appears from this article that the Phoenix market has bottomed out. Based on current shadow inventory and current foreclosure rates this is not what I anticipated. Am I reading the data incorretly? I planned to hold off buying for another 6-12 months but, not sure if this data supports this plan.
Any help or clarificaton would be appreciated.
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Joe,
Thanks for reading and I appreciate the question. I can see why the Phoenix Case-Shiller data might be interpreted as a near-bottom. Prices are up 2.4% over the past 12 months and in inflation-adjusted terms houses are cheaper than they were in January 1997.
The year-over-year gain was the result of Government efforts to prop up housing prices. Those initiatives have largely failed and are expiring. But they did cause a 5 month long national price spike. The Phoenix index appreciated by 8.6% over 7 months.
But price are again falling now that economic fundamentals have overwhelmed temporary stimulus. Phoenix prices have decreased for 3 consecutive months and are down 2.6% since December. So while prices are presently falling, the year-over-year performance is positive due to the Government funded mini-bubble.
More encouraging is that prices, in real terms, have returned to pre-bubble valuations. If Phoenix market conditions were identical to those that existed in 1997, I would argue that prices are fairly valued. But the determinants of housing prices are much less favorable in AZ today than during the mid-1990s.
So while prices are not historically overvalued, they will continue to fall because the market forces which determine them necessitate it.
Keep an eye on quantifiable market conditions (unemployment, vacant units, units for sale, months of inventory, foreclosures, the percent of distressed transactions). Until these factors return to levels consistent with stable prices, even undervalued markets will continue to depreciate. Ignore price stability associated with Government intervention. Their efforts are unsustainable and do not change market conditions that must be resolved.
I note that on the same Case-Shiller analysis there are 5 other markets that have fallen below 1997 price levels. These demonstrate that pre-bubble prices are not sufficient to halt price declines if market conditions require further depreciation.
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Whitney,
I have a question regarding the following statement: "Ignore price stability associated with Government intervention. Their efforts are unsustainable and do not change market conditions..."
Assuming the government continues itseffective nationalization of the housing mortgage market, could we not assume that such adevaluation of lending standards made permanent would buoy home prices?
Although we are not talking about the exotic leverage of teaser rates, Option ARMs etc., during the blowoff phase of the boom, we are at minimum talking about a reduced barrier to entry via qualifications at the low end.
I think about this almost like a currency's devaluation relative to the 'nominal' price (rising) versus 'real' value (declining) of a stock.
Thoughts?
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I don't believe the Government can maintain effective nationalization of the housing market. Voters and taxpayers won't endure it for long. Especially since massive losses from price declines will only increase due to the Government's expanding market share and loosened lending standards. Fannie and Freddie are back in the news with losses even as they extend their operations. Soon enough the FHA will require a bail-out. I suspect the November election will establish a "time-table for withdrawal from the occupation of America's housing market". If not, it will be a material campaign issue during 2012.
Even if nationalization could be maintained, it is far from a guarantee of stable or rising prices. The Feds are the mortgage market today and prices keep falling.
Loosened lending standards make it more likely that prices will rise, but also increase the chances that they will fall by magnifying leverage and establishing the pre-conditions necessary for a self-sustained, foreclosure-driven, death-spiral.
Imagine how loose standards would have to be for prices to start rising sustainably? I argue such conditions would create a new bubble, temporarily masking problems, but amplifying them with even greater leverage. And as during the past year, prices would be totally dependent on fickle subsidies.
Regardless what the Government does, as long as transactions are being done with little or no equity, housing prices will be volatile and prone to declines.
A Government Solution to the Downturn
Slightly off subject, but 18 months ago I came up with a Government plan for ending housing price declines, the Depression and the credit crisis. I guarantee it would have worked immediately, have been totally effective and cost nothing relative to expenses incurred since. It also relied upon the kind of intrusive, command economy, price fixing and regulation for which politicians have shown such zeal.
I once had a Trade Secret stolen from me (Cisco Systems) despite filing a patent application and pitching the idea under a non-disclosure agreement. As such, I have never even written the plan down out of mortal fear it would be employed. I offer as my only credibility economic observations made since 2005 and a track record of solving unusual finance problems.
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W,
I'm not sure I follow: you have a guaranteed plan that could/could have prevented price declines, the credit crisis, and a global depression, but you withhold the plan out of "mortal fear it would be employed"?
Unless you have mistyped, we can only conclude one of two things: [1] you prefer the depressionary outcome replete with all the government malfeasance, or [2] you fear not being properly credited (monetarily or otherwise) for saving the world (fiscally)!
Am I missing something?
Also, you often refer to your forecasting track record dating back to 2005, but this blog started in 2008.
Again, am I missing something other than your 'word'?
B
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