OUTSIDE THE BOX: Dealing With a Possible Housing Market Decline
November 1, 2006
Many real estate analysts and economists around the country keep warning about the impending collapse of the housing market, so it is important to understand what the fallout might be if this scenario indeed plays out. Recently the housing data has been showing considerable weakness versus the previous year as sales of existing homes are down 13 percent and new home sales have declined 17 percent, with prices starting to fall as well.
The fallout from these declines has many economists predicting a recession. The reason behind the dismal forecast is based on the fact that housing construction and sales directly account for more than 6 percent of the Gross Domestic Product. In the recessions experienced in the 1970s and 1980s, housing declined almost 50 percent. However, in this case, many think that the impact of a decline in housing will be much more severe.
The prices of housing have not only gotten out of line with fundamentals in some areas, but also this phantom wealth has contributed heavily to the consumption component of the economy. Owners of real estate in the United States have been tapping into $700 billion a year from the perceived equity in their homes. As a result, the savings rate in America has gone south and the ratio of mortgage debt-to-home values is at record highs. As home prices fall, people will not be able to borrow against their homes and some people will probably lose their homes since it will be very difficult to keep current with their mortgage payments.
Some forecasters believe that the impending housing bubble will have far greater impact than the last stock bubble in 2001. Economists claim that the wealth tied to real estate is much more evenly divided than stock market wealth because the majority of middle class families own a home; however, a much lower number possess significant wealth in the equity markets. In addition, housing helped the economy survive the stock bubble, but this time there more than likely will not be a different asset class that can play the same role.
To most analysts, the coming housing bubble should have been apparent to all. Housing prices typically had always followed the general inflation rate. However, since 1997 real estate prices have increased more than 50 percent and that is after adjusting for inflation. In addition, there was no obvious fundamental reason like the supply/demand factors supporting these large surges in housing prices.
Despite these inconsistencies, there were no warnings from the majority of analysts and economists at the time. In fact, many homebuyers were shoved into this high-priced real estate market, often times urged on by the U.S. government or even non-profit organizations attempting to promote wealth building.
These millions of families that entered into the market at these high prices are now staring at the very scary reality of watching their precious life savings being reduced significantly or totally disappearing. Much of the financial pain likely to be incurred with the bursting of the real estate bubble lay squarely at the feet of the economists, bankers, realtors and analysts that all possessed a blind eye to the current fundamentals and continued to cheer loudly for entering into the market despite the inflated prices. In the future, hopefully American investors will start to realize that any such price surges for virtually any asset class simply cannot be sustained over the long term, and thus it is generally not a prudent decision to buy into such hysteria.
Happy Trading.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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