Dominoes and Housing

Since December, house prices across the nation have been following a near-vertical downward trajectory as the deflation mindset settles in, and data trickling in from February estimates price declines in California to be 40-50% off from peak. I suspect it will be at least a few months before prices begin to level out again, and after that a slow rate of price declines could persist for years. What we are seeing now is an abrupt return to fundamentals, and then a lowering of even fundamental prices as the severity of the economic downturn continues.

It was subprime resets that initially destabilized housing, though the real estate industry posited this would be contained to subprime. Though this isn't making the news anywhere near as much as subprime did, we are amid the Alt-A corrections now which extend to middle- and upper-end housing markets, which started at the end of 2008 and will last until 2011. Alt-A price resets will probably not be as dramatic as subprime though, since the Federal Reserve rate is at 0%, versus closer to 4-5% during the subprime resets.

Now, even if we weren't in a recession, and even if the Alt-A corrections weren't building steam, I'd like to spend a moment arguing against the containment of house prices from subprime to upper end.

Granted, people in the market for high-end housing probably would not settle for subprime areas. Those markets have no overlap. But, it is not either-or but a range of grays in between that connect in a domino fashion. People looking for a place in the Upper-Haight in SF would not be interested in Stockton, even if house prices there dropped 60% and prices in the Upper-Haight fell maybe 10%. But, someone in the market for a house in Tracy might consider Stockton instead, so declines in Stockton would put pressure on the Tracy market. As Tracy prices fall, people looking for a house in Livermore might take a hard look at Tracy, and as Livermore prices correct, they would attract attention from Pleasanton, and maybe even Hayward. The better parts of Hayward could attract some of the San Mateo market, and even the better parts of Oakland could capture the eye of parts of the San Francisco market.

And so, real estate corrections in subprime can spread to prime. On second thought, dominoes are probably not the best analogy; since a 50% price drop in Stockton, would not drive a 50% price drop in Tracy—but maybe 35%. Some of the price deflationary energy would be removed at each step, such that Stockton price changes may only have a miniscule effect on San Francisco.

Anyway, there are multiple downward pressures on house prices now: more joblessness, more foreclosures (triggered by both job loss and mortgage resets), tighter lending standards, a deflationary psychology, and most importantly a badly needed correction to fundamentals.