December 14, 2007

The housing slump will not end until prices fall, but many sellers are either delusional that their property is worth more than it is, or borrowed more than the market price for their home

From David Leonhardt in the New York Times:

"We’re going through that transition where sellers can’t accept that prices are falling. They’re still caught up in this idea that their property is worth more than it is. It’s just strange.” The slump can’t end until home prices come back in line with economic reality.

The Democratic plan is clearly more humane than Bush’s, but it would also end up subsidizing some wildly irrational home purchases and borrowing choices. Either way, the real estate bust will not be over until prices have fallen significantly more than they have so far. Just south of Los Angeles, there is a small city called Paramount where houses have all but stopped selling.

It’s a city of bungalows and manicured lawns, far enough from downtown to have long been affordable to working-class families. But as home prices rose ever higher in other parts of Southern California, Paramount became all the more attractive — and prices eventually soared there as well. By last year, the typical house sold for almost $500,000, up from $200,000 in early 2003.

Many of those sales depended on adjustable-rate mortgages with tantalizingly low initial payments, and now that those mortgages are much harder to get, there aren’t many buyers willing and able to pay $500,000. Yet sellers in Paramount haven’t adjusted to the new reality by cutting their prices very much. Instead, the real estate market has frozen.

On Sunday, Luis Perez and his wife, Hilda, held their fourth open house since putting their apricot-colored stucco home on the market in August. They have reduced the price once, by about 5 percent. They still haven’t received a single offer.

Since the summer, only about three homes a week — including houses and condominiums — have sold in Paramount. In the third quarter of this year, only 30 homes changed hands, down from 134 in the third quarter of last year.

That 78 percent drop is bigger than the decline in any other ZIP code in the country, according to an analysis that a research firm called DataQuick Information Systems did for me. The biggest declines can generally be found in moderate-income towns on the outskirts of major metropolitan areas, where adjustable-rate mortgages had become the norm. (In more affluent areas across the Northeast and California, the declines haven’t been so big.)

In parts of Florida, Arizona and Nevada, home sales have fallen more than 60 percent over the last year. In several ZIP codes in California’s Inland Empire, east of Los Angeles, the decline is greater than 70 percent.

But no other place can match Paramount, the capital of the great home sales bust of 2007.

This year has been filled with predictions that the bottom of the real estate cycle was oh so close. In January, Donald L. Kohn, the vice chairman of the Fed, said that housing starts “may be not very far from their trough.” They have since fallen an additional 21 percent and are well below where they were for most of the 1970s. In recent weeks, some Wall Street analysts hopefully guessed that the mortgage-related credit crunch was entering its final phase. Instead, the giant bank UBS, in need of cash, sold nearly 10 percent of itself to the Singapore government this week.

But the standoff between buyers and sellers in Paramount helps explain why we’re still a long way from the bottom of the cycle. No matter how big a mortgage rescue plan the federal government puts together, no matter how much further the Federal Reserve cuts interest rates, the worst housing slump on record is going to continue into 2008 and probably beyond. The slump can’t end until home prices come back in line with economic reality.

For decades, real estate values rose at roughly the same pace as incomes. Whenever prices got a little ahead of incomes, as they did in the late 1980s, they would quickly settle back down again. The recent boom was different: in just six years — from 2000 to 2006, even as incomes were growing slowly — the average home nearly doubled in price.

Now that housing has lost its speculative luster and mortgages are harder to get, homes sales are plummeting, down more than 30 percent over the last two years. And as Thomas Lawler, a real estate analyst based in northern Virginia, says, “Sales numbers tend to be a great leading indicator of prices.” But it hasn’t happened yet.

Nationally, home prices have fallen only 5 percent from their peak early last year, according to the S.& P./Case-Shiller Composite Home Price Index, the most accurate of the well-known measures. Instead of selling at reduced prices, sellers are holding out, hoping that the good times will somehow return. Paramount is simply an extreme example of the phenomenon.

“We got to a point in this area where the values far exceeded the capability of the median family,” said Gary Endo, a real estate agent with Duke & Associates in Paramount. “So people created a loan to bridge that gap. All they did was create a problem.”

Mr. Endo added: “We’re going through that transition where sellers can’t accept that prices are falling. They’re still caught up in this idea that their property is worth more than it is. It’s just strange.”

Some homeowners will do just fine by remaining in their homes. Maria Angel, another real estate agent, said she thought Paramount’s sales decline had been so large partly because the city attracts first-time home buyers who often decide to put down roots. If they can’t get the price they want, they’re happy to stay in their home. (Best piece of Paramount trivia: it’s where Zamboni ice-cleaning machines were invented and are still made.)

But other residents are refusing to sell for a grimmer reason: they’re facing a spike in their monthly mortgage payments, and their homes may not be valuable enough to pay off their loans. Mr. Perez, who is 43 and works as a machine operator, bought his house for $380,000 six years ago. He later refinanced his mortgage and took out a home-equity loan. As a result, the interest rate on his new mortgage reset in October, causing the monthly payment to jump $1,300, to $3,900.

If he can’t sell the house for something close to the asking price of $549,900, he expects the bank will take it from him. “The truth is, I don’t think my house will sell,” Mr. Perez said in Spanish, to my colleague, Ana Facio Contreras. “If in four months I’ve had no offers, I don’t see how I’ll get an offer now that it’s more difficult to sell.”

There are no perfect solutions at this point. Treasury Secretary Henry M. Paulson Jr. has decided to err on the side of caution, gently nudging banks to alter the terms of a small fraction of mortgages headed toward default. Democrats in Congress are pushing for a bigger rescue plan, one that puts more responsibility on the lenders that marketed all those ridiculous mortgages. The Democratic plan is clearly more humane than Mr. Paulson’s, but it would also end up subsidizing some wildly irrational home purchases and borrowing choices.

Either way, the real estate bust will not be over until prices have fallen significantly more than they have so far. That could happen quickly — starting with a 10 or 15 percent nationwide drop next year — or over many years, as inflation eats away at home values.

Mr. Perez, for one, thinks sanity will return sooner, if not soon enough. “I assure you that in two years things are going to change,” he said. “But that doesn’t help me now.”



"I do not think that I will ever reach a stage when I will say, "This is what I believe. Finished." What I believe is alive... and open to growth..." ~ Madeleine L'Engle

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