Housing Prices Still in Steep Decline

According to data from Zillow.com, home prices fell 3% in the first quarter of 2011.  This is the largest decline since 2008, and, says the Wall Street Journal, is causing some economists to take a more pessimistic view of how far we are from the market's bottom.

Four years on, why is the housing market still falling?  The obvious culprit is the homebuyer's tax credit.  Even as it was enacted, a lot of people were complaining that gimmicks like this (and the Cash for Clunkers program) weren't providing useful stimulus; instead, they were distorting the market by pulling demand forward from future years.

That seems to be even truer than most people expected.  In DC, this actually caused an uptick in prices, because the buyers were concentrated into a pretty short time frame.  A lot of the properties coming on to the market were short sales and foreclosures, which take a very long time to close.  That meant that a lot of people were getting into bidding wars over the relatively small number of properties available.  The bidding war was frantic enough to cost them money--but not to clear the short sales, which were often more than $100,000 underwater.  I myself got caught by the tail end of it--because the comps that we were using were inflated by the tax credit, we probably overpaid for our house.

In most other places, the tax credit was simply keeping prices from falling too much further.  But the mechanism was ultimately the same: we crowded a larger number of buyers into the market without enough time for supply to really respond, because too many of the houses that needed to be sold were encumbered by underwater mortgages.

After the credit, it all collapsed again.  There were a few months of confusion, because it took a while for prices to adjust to the new reality: supply was higher, but all the buyers were gone.  Almost everyone who had intended to buy in the next few years had moved their purchase forward in order to get the tax credit.

The tax credit was no doubt a fine thing for people who managed to sell their homes in that narrow window.  But of course, there are parallel losses--the people who have lost jobs, or gotten transferred, or gotten a divorce, in the intervening year, and need to sell their houses, and face a market with virtually no buyers.  It's hard to argue that the program improved much.  I mean, you could posit that it somehow allowed us a more orderly transition, but we still have a large backlog of foreclosures, and judging from the recent declines, we simply moved moved some of the pain into the future.  We didn't actually make the process less painful.

As this graph from Barry Ritholtz shows, house prices are still well above their historical levels. The government cannot legislate that imbalance away. You don't have to be a "Work the rot out" liquidationist of the Andrew Mellon school to think that eventually, prices have to fall to market clearing levels, and that slowing the process down might not improve it much.