When Will Housing Stop Falling in Price?

The Dow rose 89 points Wednesday. Oil rose to $118...and has almost reached $119 this morning. The reason given for oil's rise is a storm in the Caribbean, named Gustav, which threatens to shut down oil rigs in the Gulf of Mexico.

Gold rose $3.50 - to $831. We may have just had - and may still have - a great opportunity to buy into gold . The yellow metal seems to have bottomed out. Time will tell, of course...

"You never know what will happen or when, but things always happen the same way..."

We were trying to explain the mysteries of market cycles to a neighbor at last night's dinner. We might just as well have been trying to describe the Holy Ghost or tell him precisely where to find a photon. Our interlocutor was a practical man - a developer who had begun a huge project, building hundreds of new apartments on France's Mediterranean coast. He wanted practical answers.

"Is there enough demand for those new apartments?" we asked mischievously.

"Well, there used to be...until recently..."

Throughout much of the world the story is the same. Lenders are more reluctant to lend than they were a year ago. Buyers - who can't get ready credit - are less able to buy. Demand, and prices go down.

From the LA TIMES comes a report that prices in the Golden State have fallen 40% since the bear market in housing began. A year ago, the typical house cost $587,000, says the Times report. Now, you can buy it for $350,000.

A blogger on the Times ' website said that he had found a house marked down 77% - and still no buyer. We looked at the photo of the house. No wonder it had found no buyer. It is a shack, not a real house. Unfortunately, many of the houses on sale in California are shacks. At least, now they're selling for less money.

"We're going to have to cut prices," said our developer friend, "or just put the project on ice until this situation turns around."

Then came the obvious question: "When do you think things will return to normal?"

Our answer slipped out as easily as a silk handkerchief: "Things ARE normal now," we replied.

As we explained yesterday, the eagerness of lenders to lend and the value of their collateral tend to rise or fall together. When mortgage lenders compete to give out money so people can buy houses, you have to expect prices for housing to go up. Eventually, houses become so expensive that even though people can still afford to buy them, they can't afford to pay for them. This is when the lenders begin to have second thoughts. And once the lenders get scared, prices fall. All perfectly normal.

So far, everything is working just as it should. Boom follows bust, which follows boom. Over and over again, the same mistakes are made - but by new people.

But people don't like to admit they've made a mistake. So, when markets begin to turn against them, they imagine that the turn is just a fluke. They expect things to return to 'normal' quickly, not realizing that it is normal for them to make mistakes and lose their money.

When housing first began to go down, at first people didn't believe it. They'd learned that "property always goes up," or that "you can't go wrong with real estate." Naturally, they took the first signs of a downturn as a buying opportunity. Later, they realized that it was a selling opportunity - the last chance to get out before the roof collapsed.

Likewise, when banks, hedge funds and mortgage lenders began to send out alarums, the problems were thought to be temporary and modest. "Containable," is how Hank Paulson described the first little cracks in the sub-prime debt market. But the cracks widened. And now, some of the biggest financial edifices in the country - Bear Stearns, Lehman Bros., Fannie Mae and Freddie Mac - have either already fallen down or are leaning dangerously.

One in four junk bonds is in distress, says CFO.com. And the credit crisis is far from over. It has continued for more than a year, but with the value of the collateral still dropping, there are probably hundreds of billions in losses that have not yet been discovered, acknowledged and written off.

But maybe the collateral will stop falling in price...? And maybe, then, lenders will be more willing to extend credit...? And maybe the good times will roll again...?

"US home sales show signs of recovery as price declines ease," is a headline in yesterday's International Herald Tribune . The gist of the good news is that house prices fell less in June than they did in May (though the 12 months through June showed the biggest drop in housing in US history) and in July, sales of new and used houses actually went up!

At least 3 or 4 times over the past year, stock markets have rallied on news that "it's over." Eventually, of course, it will be over...but probably not before people have stopped looking for the end.

*** When will housing stop falling in price? Remember, housing is a consumer item, not an investment. It needs to be affordable. That is, the average fellow has to be able to buy the average house - and pay for it. Otherwise, prices must come down. How much must housing come down now so that the average person can buy a house? We saw estimates of about 30%-40%. And generally, there's a little over-shooting. Nationwide, prices are down about 18% from their peak. We'd expect about as much more.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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