A rotting foundation for US housing

With house prices in much of the US now at their lowest point since mid-2006, fears are growing, despite Wall Street's optimism, that the country has entered a new period of decline.

The US sharemarket faced a stark reality check overnight, with new data showing that housing prices in 20 major US cities dropped in December to the lowest level since the housing crisis first began in mid-2006.

As the Dow closed above 13,000 for the first time since May 2008, investors were optimistic that consumer confidence data released overnight, which showed the strongest sentiment in over a year, was indicative of a strengthening US economy.

But according to the S&P/Case-Shiller index, home prices in the final three months of 2011 fell 4 per cent from the same period a year earlier. Nineteen of the 20 cities measured saw a year-over-year decline in housing prices, with Atlanta recording a 12.8 per cent drop. Detroit, where prices rose 0.5 per cent, was the only bright spot.

On a monthly basis, house prices dipped 0.5 per cent in December from the prior month after adjusting for seasonal variations. As S&P’s David Blitzer noted, "if anything, it looks like we might have re-entered a period of decline as we begin 2012.”

Although US house prices have already fallen around one-third from their peak, the market looks set for further troubles. An estimated five million houses in the United States have been lost to foreclosure since 2006. But banks look likely to seize more than one million US homes this year. The foreclosure process had been jammed since 2010, but the Obama administration’s recent $25 billion settlement with major home lenders over foreclosure abuses means the banks are now free to resume repossessing houses. As a result, the housing market looks set to be flooded with even more distressed sales, which will drag US housing prices even lower.

But as Robert Reich, the former US Secretary of Labour under President Bill Clinton, points out, the fall in the housing market has dire effects for America’s middle class, which is already squeezed by falling real wages and rising petrol prices. And with consumer spending making up 70 per cent of the US economy, any robust economy recovery must involve America’s vast middle class.

In an article in the Financial Times, Reich points out that because houses are the major assets of the middle class, most Americans are now far poorer than they were six years ago. At present, almost one in three homeowners with a mortgage is now 'underwater', meaning that they owe more to the banks than their homes are worth.

Reich points out that we’re seeing a huge shift in how Americans view their homes. From the end of WW2 on, houses were seen as safe investments, because housing prices rose continuously. In the 1960s and 1970s baby boomers took out the largest mortgages they could afford, and watched their homes grow in value.

As he points out, in the housing boom, homes morphed into ATMs, with Americans using them as collateral for additional loans. Most people assumed their homes were their retirement savings. When the time came, they’d sell up, move into a smaller unit, and live off the capital gains.

But plunging housing prices has changed all this. Young people aren’t buying homes anymore, instead they’re renting. They’re no longer confident that they can get, or hold, jobs that will allow them to reliably meet their mortgage payments. Middle-aged couples are underwater, or unable to sell their houses at prices that would enable them to recoup their initial investment. They can’t move to find employment. They can’t retire.

Reich notes that so far the Obama administration has tried to rectify the housing market’s woes by relying on low interest rates, and by making it easier for homeowners who have kept up with their mortgage payments to refinance their underwater loans. But he argues that, in the current circumstances, these steps are simply not enough.

As a result, Reich argues that "the negative wealth effect of home values, combined with declining wages, makes it highly unlikely the US will enjoy a robust recovery any time soon.”