Will Housing Market Decline Lead to Worst Home Price Fall Since Great Depression?

Nancy and Brian Christopherson are asking $389,900 for their eight-room Colonial-style home in Westford, Mass. Even at that price, they’ll lose $14,100.

Monthly price reductions since they listed it in May for $429,900 have yet to inspire buyers to make an offer on the house, purchased at $369,000 in 2004.

The sharpest slide in U.S. home price growth in decades is trapping owners with mortgage loans they can’t afford, pushing unsold homes to a record 4.42 million and gutting profits for home builders.

As discussed earlier this month, the U.S. median home price next year may fall for the first time since the Great Depression, says Gabriel Stein, chief international economist with Lombard Street Research in London.

Economists warn that the reduced sales may push the U.S. economy into a recession. The Fed plans to reduce its U.S. benchmark lending rate, and last month, the U.S. central bank ended a two-year streak of 17 increases that pushed the rate to 5.25 percent, citing cooling home sales.

THE WEALTH EFFECT

Five years of record home sales and price gains supported the U.S. economy through an Internet stock plunge, the 9-11-01 terrorist attacks on New York and Washington, bankruptcies at Enron, Worldcom, etc., U.S. invasions of Afghanistan and Iraq, and a surge in energy prices. Crude oil futures this month averaged $63.48 a barrel, up from $28.81 on Sept. 17, 2001.

The boom lifted the U.S. median home price by 49 percent in the five years ended in 2005, the National Association of Realtors says, adding to the net worth of homeowners and creating a so-called “wealth effect” that spurred spending as homeowners refinanced and took on more Florida mortgage debt.

Now the U.S. Treasury predicts that higher wages, strong company profits and business spending will offset a weaker housing market and continue to power the U.S. economy. But many are less upbeat, believing that a significant possibility of a slowdown is looming so large that it falls into the category of a recession.

DECELERATION

Economists estimate that the median U.S. price for an existing home hasn’t fallen since the Great Depression in the 1930s, though the oldest set of hard data only dates back to 1968.

U.S. average home-price growth slowed to 1.17 percent during the second quarter from 3.65 percent a year earlier, the Office of Federal Housing Enterprise Oversight (OFHEO) said in a Sept. 5 report. That’s the sharpest plunge since the agency began keeping records in 1975.

The National Association of Realtors are likely to report on September 25 that existing home sales have declined for the fifth straight month, says David Lereah, the group’s chief economist. The Commerce Department reports new-home prices and sales on September 27.

PRESSURE ON SELLERS

“For the next couple of months, we’re probably looking at between zero to a five percent drop in prices. The only way for home sales to come back, and for inventories to start to diminish, is for sellers to start to bring prices down,” Lereah said.

While some sellers are getting desperate, not all homeowners are willing to accept less. Many can afford to stay put if they don’t like the condition of the market, and are either too stubborn or too apathetic to accept lower than their list price.

Peter Francisco, who owns a three-bedroom ranch in East Harwich, Mass., on Cape Cod, has fewer options. The U.S. Coast Guard lieutenant transferred to Norfolk, Va., in July and put his house on the market in August at a listing price lower than he wanted: $379,900. The house across the street, similar to his own, sold last year for $425,000.

BURNING HOME EQUITY

“If you have to go, you have to take what you can get,” says Francisco, 29. So far, he has no offers.

Americans have already spent much of their new-found equity, making them vulnerable to slumping prices. Through cash-out mortgage refinance activity, owners took out a whopping $243.9 billion of home equity in 2005, adding to $483.5 billion extracted in the previous four years, Freddie Mac said.

RECESSION WORRIES

Housing demand is important to overall U.S. economic health, and nowhere is that more so regionally than in the Florida housing market.

• The industry contributed about $2 trillion to the U.S. economy last year, accounting for 16 percent of growth as sales of previously owned homes rose to a record 7.08 million.
• Locally, a streak of record low Florida home mortgage rates spurred five years of astronomic sales from 2001-2005.
• When related purchases such as furniture and appliances are included, the housing sector accounted for 23 percent of 2005’s gross domestic product, according to the Joint Center for Housing Studies at Harvard University in Cambridge, Mass.

The housing slump may have consequences beyond U.S. borders. The Bank of Canada left interest rates unchanged on September. 6 in part because U.S. spending may “slow more rapidly than expected.” Economic data shows that the slump is deepening, as well.

THE MORTGAGE INDEX

An index measuring mortgage applications from people who are purchasing homes stood at 410.2 for the week ended Sept. 8, ticking up 5.3 percent from the previous week, though down 20 percent from the 513.4 a year earlier, according to the Mortgage Bankers Association.

“It’s called ‘How low can you go?’” says Doreen Kelly, 52, who has dropped the price three times on her Westport, Conn., farmhouse to $799,900 after listing it in May for $938,000. “The gains the real estate market made in the last three years just got wiped out on this particular house.”

As Florida home loans continue to get pricier, economists believe the housing slowdown will be exacerbated and cut 1.5 percentage points from the state’s growth next year.

Hindering the economic outlook in 2007, as builders cut back on labor and materials and homeowners spend less as home values erode, means forces are at work in which the extent is not yet known. Construction spending dropped in July by the most since 2001, the Commerce Department said in a September 1 report, and home builders continue to feel the heat.

IN A PICKLE

Not all parts of the U.S. are suffering. Home prices rose in the second quarter from a year earlier in areas such as Ocala, Florida; Portland, Oregon; Port Arthur, Texas; and Farmington, New Mexico.

Some sellers across the U.S. must reduce their expectations, even those who don’t move. Edward Brown, 47, a Florida real estate investor, says he’s financially overextended and needs to sell a three-bedroom house in Cape Coral, Florida. He’s asking $579,000 — $20,000 less than he paid for the property a year ago.

“No one expected the market to drop so quickly. There are a lot of people like me who are caught in a pickle,” he said.