Housing Prices May Fall Further

Over the past few months, there have been suggestions that the U.S. housing market might finally be bottoming out. Since July, the decline in sales of both new and existing homes has moderated. Moreover, over the past three months, there has been a very modest increase in home prices at the national level as measured by the 20-city S&P/Case-Shiller home price index.However, the high inventory of unsold homes, continuing foreclosures, and double-digit unemployment could mean that housing prices have further to fall.

Despite small declines in recent months, the inventory of unsold homes at the national level remains at close to its historic high. A key indication of the degree of excess home inventory is that the number of vacant homes, in which neither an owner nor a renter presently dwells, exceeds its normal level by nearly 1 million units.

The United States is presently suffering from a foreclosure crisis that is further adding more homes to a market already characterized by excess inventories. Forward-looking indicators, such as the number of mortgages that are more than 90 days delinquent (i.e., behind payment) suggest that the pace of foreclosures could increase in the months ahead.

Next year, approximately $200 billion in “Option ARM” mortgages (adjustable rate mortgages) are due to reset to higher rates. This is likely to add to the foreclosure problem, since these resets will produce a sharp jump in debt service payments.

The Outlook: The present high level of unsold housing inventories, the poor state of the labor market and the current wave of foreclosures suggest that home prices may have a further 10% to fall (in real terms). This will add to the financial distress facing the banking sector, inhibiting a return to above trend GDP growth in 2010.