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5 Trillion in Real Estate Loss To Home Owners

Posted Wednesday, May 28, 2008

The Case-Shiller indexes for March show that the rate of house price decline continues to pick up speed. The 20-city index shows house prices down by 14.4 percent from March of 2007 to March of 2008. The annual rate of price decline over the last quarter was 25.1 percent in this index. Since the peak of the housing bubble in July of 2006, the 20-city shows a drop of 16.4 percent. With inflation running at close to 7.0 percent over this period, this corresponds to roughly a 23 percent loss of real housing wealth over this period, which is close to $5 trillion ($70,000 per homeowner).

The newest data again show the West and Florida to be hardest hit. Over the last year, prices in Los Angeles, San Francisco and Miami are down by 21.7 percent, 20.2 percent, and 24.6 percent, respectively. In the last quarter, prices in these cities have been dropping at 37.6 percent, 37.3 percent, and 34.0 percent annual rates.

Perhaps the most noteworthy part of this report is the accelerating rate of price decline in the less-inflated markets. Over the last quarter, prices in Washington, D.C., Chicago, and Boston fell at annual rates of 26.3 percent, 22.1 percent, and 13.9 percent, respectively. Over the last twelve months, prices in these cities are down 14.7 percent, 10.0 percent, and 5.9 percent, respectively.

While prices in all segments of the housing market have been falling, the lowest cost segment has been hardest hit. In Washington, D.C., prices in the lowest tier (under $328,000) fell by 20.3 percent over the last year and were falling at a 39.2 percent annual rate over the last quarter. In Los Angeles, prices in the lowest tier (under $418,000) were down 30.0 percent over the last year and are now down 48.5 percent over the last year. Prices for the lowest tier in Cleveland are down by 31.6 percent over the last year and were falling at an incredible 62.9 percent annual rate in the last quarter.

This pattern of price decline is very interesting in light of the housing bailout bills being debated in the House and Senate. The rapid rate of price decline in Cleveland, a city which did not experience much of price run-up during the boom, suggests that the government could possibly play a useful role in setting a floor to the market. However, the bills being considered do not restrict funding to such markets.

Instead, the proposed mortgage guarantees are as likely to go to bubble markets that are still in the process of deflating as depressed markets where prices are likely falling below long-term trend values. In the deflating bubble markets, the guarantees are likely to do little to prevent the deflation of the bubble (not that this would be desirable in any case), which means that homeowners are likely to again find themselves underwater in their mortgages in two or three years, and the government will be forced to honor many of the guarantees.

The continuation of sharp price declines in so many markets should raise questions about the health of Fannie Mae and Freddie Mac. To date, the government-sponsored agencies have been viewed almost as though they had infinite ability to support the housing market. With the collapse of privately issued mortgage backed securities, Fannie and Freddie are dominating the market more than ever, guaranteeing or holding more than three quarters of the mortgages issued in the fourth quarter of 2007. 

To date, Fannie and Freddie have not been as hard hit as other actors in the mortgage market. This is due to their limited exposure to subprime markets or mortgages in the most-inflated markets, which were above its ceilings. However, the agencies cannot remain unscathed with such a sharp and broad-based decline in house prices. The real question is when the write-offs will start posing serious problems, not if. If their lending capacity becomes crippled, then it will be an enormous blow to an already weak market. Any increase in interest rates, which is likely if inflation picks up, will accentuate their problems.
By Dean Baker