Jan012008

Predictions for 2008

When I started writing for this blog, I wrote a series of posts culminating in Predictions for the Irvine Housing Market published on March 11, 2007. It seems only fitting to take this opportunity to take a look ahead at 2008 and make some predictions for 2008 based on the events we have witnessed in 2007.

original_versus_actual_2013

The first stages of a decline are are always slow to register on the median home price because the low end of the market collapses first leaving only the more desirable, high-end property transactions in the market. We have documented on this blog numerous individual properties sporting 15% to 20% declines, and housingtracker.net has documented a drop in asking prices in Orange County from $651,225 to $569,900 (12.5%). Foreclosures are up almost five-fold since April of 2007. With the ongoing tightening of credit, there are no signs that any of these trends are reversing or will reverse any time soon. In fact, foreclosures are likely to continue to pile up dramatically as adjustable rate mortgages continue to reset and more homeowners are underwater and unable to refinance.

March 2010 ARM Reset Schedule big

In short, 2008 will likely see more declines. I will make the not-very-bold prediction that 2008 will see the worst single-year decline in the median house price ever recorded, and quite possibly the largest single-year decline we will witness in our lifetimes (although 2009 could be even worse.) My original prediction was for a 12% decline in 2008, I will stand by that number, although it could be even greater. Between 2008 and 2009, I believe we will see a 28% decline in the median home price. Am I crazy to think such a thing? Not if you ask Christopher Thornberg formerly of UCLA and now with Beacon Economics.

The cold, hard truth is that foreclosures are serving only to hasten the painful process of shifting housing prices back to a level the market can sustain. Prices must and will fall. Everywhere. Probably 25% to 30% from their peak.

Now I will give a caveat. The FED will likely continue to pursue its wreckless course of lowering interest rates causing rampant consumer price inflation in an attempt to provide enough liquidity to the financial markets to stop a string of catastrophic failures of several of our large financial institutions. If this liquidity somehow finds its way into residential mortgages (something I doubt,) then house prices may not drop in nominal terms as far as I have predicted. In inflation adjusted (real) terms, the drop will still be large and unprecedented. This caveat leads to another not-very-bold prediction for 2008: one or more of our major financial institutions and one or more of our major homebuilders will fail as a result of the collapse of housing prices.credit-crunch

Banks are not willing to loan money: period. They have lost all confidence in the ability of borrowers to repay loans. Is this throwing the baby out with the bathwater? Sure it is, but that is what happens when you have a credit crunch. The ratings agencies gave AAA ratings to a steaming pile of mortgage manure, and banks have lost all confidence in everyone’s credit worthiness as a result. This is what the FED is trying to combat by providing as much credit as they possibly can. Of course, it isn’t just lender psychology at work here. They are also hording cash to prepare themselves for the onslaught of bad loans and write-downs they are going to experience as house prices continue to fall. The combination of fear of the unknown and fear of the known is causing a dramatic decline in lending: a credit crunch.

Am I being an alarmist and a worry-wort? If so, I am not alone. Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years. If you need a refresher on what happened to Japan and what Ben Bernanke would have done about it, click on this PDF link to Bernanke’s writing on the subject. You can see the current course of FED action outlined in this paper.

So what does all this add up to? My next not-so-bold prediction: a severe local recession. Huge amounts of money used to flow into our local economy through the subprime mortgage business. This business model is dead. It is not going to return. Yes, it may still survive, but it will shrink down to the 2% of the market is used to have rather than the 20% it enjoyed at the peak. This is a huge loss to our local economy. Also, the decline in house prices is going to shut off the housing ATM another huge source of unsustainable local spending. Then of course, there are the realtors who used to feast on all this borrowed money that is no longer flowing into residential housing transactions and the local homebuilders who are no longer building and selling many houses. Basically, our heavily real estated dependent economy is going to tank — badly.

For my final not-so-bold prediction for 2008, I predict we will see many more angry homedebtor’s troll the blog. As denial turns to fear and acceptance, it often detours through periods of anger. It will be extremely embarrassing for the many sheeple who got caught up in the financial mania to admit they made a huge mistake, particularly the most arrogant and willful of the the bunch. Since people generally do not want to take personal responsibility for their mistakes, many will come here and blame the “negative media” for the decline. We may report on the market, but we don’t influence it, and we certainly don’t control it. We will be a convenient place for many to vent their frustrations.

Financial manias have a way of deluding even the most intelligent of people. Sir Issac Newton was rumored to have lost £20,000 of public funds in the market — a substantial sum of money at the time. He is quoted as saying “I can calculate the motion of heavenly bodies, but not the madness of people.” This financial mania infected many intelligent and successful people, and it will be the ruin of many of them.