My former co-blogger, Winterspeak, muses on the problem with un-swelling the housing bubble:
Now that the air has gone out of the too-cheap credit that helped inflate the housing bubble, the question becomes how to undo the bubble with as little damage as possible.
When the internet bubble popped, this happened fairly rapidly: failed dot-coms closed down, their investors took a beating, and their employees moved onto other jobs, some of them still internet related but at better firms. Some went back to grad school. The end result was that the economy overall was fine, people who had invested in internet firms lost money, and the internet overall continued to grow apace, but now focused on better companies.
I think one inevitable requirement of unwinding the housing bubble market is that housing prices have to come down to fall in line with historic trends. In some areas this means very dramatic decreases -- maybe 40%+ in real terms? I'm not sure what a "deflated housing bubble" would look like if it did not bring prices back to historic norms. We are not going to see price declines of this magnitude unless we have very very motivated sellers, which means banks for older properties (which have been foreclosed on), and builders for newer properties. If prices do not fall, then transactions will dry up. I can see the government stepping in and helping owners (and their lenders) but I'd be surprised if builders will be helped that much. This means that areas that have had the most new construction should see the most dramatic price corrections.
That's good news for me, since Washington, DC was one of the most bubblicious areas. My new neighborhood is crowded with just-completed and partially finished condos.
But so far, prices have remained remarkably sticky. People are putting condos onto the rental market rather than take a loss. On a typical (non-August) day, the Craigslist real estate section is filled with ads touting "Brand new construction!" alongside demands that the renter accept a one-year lease with no smoking or pets.
There's no way to know, of course, but I've long wondered whether these rentals make financial sense. Are they covering their carry, much less the opportunity cost of the capital? Prices won't collapse until investors come to terms with the fact that their prior investment is a sunk cost, and pouring more money down the rathole won't make the problem go away.
That may take a long time . . . long enough that prices may never fall as far as they "should". Faced with selling their home at a loss, most people choose to stay put and pray. Instead, what we're likely to see is a very long period of stagnant prices. Inflation may have to do the work of bringing those prices back in line with historical values. In which case, I'd be better off taking advantage of those great rental deals . . .