Searching for the Bottom in Home Prices

A substantial percentage of many households' net worth is comprised of the equity in their home. With the beating home prices have taken since 2007, existing and soon-to-be homeowners are keen to know: Are prices stabilizing? Will they begin to recover from here? Or is the "knife" still falling?

To understand where housing prices are headed, we need to understand what drives them in the first place: policy, perception, and price discovery.

In my December 2011 look at housing, I examined systemic factors such as employment and demographics that represent ongoing structural impediments to the much-awaited recovery in housing valuations and sales. This time around, we're going to consider policy factors that influence the housing market.

Yesterday while standing in line at our credit union I overheard another customer at a teller’s window request that her $100,000 Certificate of Deposit (CD) be withdrawn and placed in her checking account because, she said, “I’m not earning anything.” The woman was middle-aged and dressed for work in a professional white- collar environment -- a typical member, perhaps, of the vanishing middle class.

Sadly, she is doing exactly what Ben Bernanke’s Federal Reserve policies are intended to push people into doing: abandoning capital accumulation (savings) in favor of consumption or trying for a higher yield in risk assets such as stocks and real estate.

It may strike younger readers as unbelievable that a few decades ago, in the low-inflation 1960s, savings accounts earned a government-stipulated minimum yield of 5.25%, regardless of where the Fed Funds Rate might be. Capital accumulation was widely understood to be the bedrock of household financial security and the source of productive lending, whether for 30-year home mortgages or loans taken on to expand an enterprise.

How times -- and the US economy -- have changed.

Now the explicit policy of the nation’s private central bank (the Federal Reserve) and the federal government’s myriad housing and mortgage agencies is to punish saving with essentially negative returns in favor of blatant speculation with borrowed money. Official inflation is around 3% and savings accounts earn less than 0.1%, leaving savers with a net loss of about 3% every year.  Even worse -- if that is possible -- these same agencies have extended housing lenders trillions of dollars in bailouts, backstops and guarantees, creating institutionalized moral hazard on an unprecedented scale.

Recall that moral hazard simply means that the relationship between risk and return and has been severed, so risk can be taken in near-infinite amounts with the assurance that if that risk blows up, the gains remain in the hands of the speculator. Another way of describing this policy of government bailouts is “profits are private but losses are socialized.” That is, any profits earned from risky speculation are the speculator’s to keep, while all the losses are transferred to the public.

While the housing bubble was most certainly based on a credit bubble enabled by lax oversight and fraudulent practices, the aftermath can be fairly summarized as institutionalizing moral hazard.

Policy as Behavior Modification and Perception Management

Quasi-official pronouncements by Fed Board members suggest that the Fed’s stated policy of punishing savers with a zero-interest rate policy (ZIRP) is outwardly designed to lower the cost of refinancing mortgages and buying a house. The first is supposed to free up cash that households can then spend on consumption, thereby boosting the economy. With savings earning a negative yield, consuming more becomes a tangibly attractive alternative. (How keeping the factories in Asia humming will boost the American economy is left unstated.)

This near-complete destruction of investment income from household savings yields a rather poor return. Plausible estimates of the total gain that could be reaped by widespread refinancing hover around $40 billion a year, which is not much in a $15 trillion economy.

There are real-world limits on this policy as well. Since the Fed can’t actually force lenders to refinance underwater mortgages, millions of homeowners are unable to take advantage of lower rates. From the point of view of lenders, declining household incomes and mortgages that exceed the home value (so-called negative equity) have lowered the creditworthiness of many homeowners.

As a result, the stated Fed policy goal of lowering mortgage payments to boost consumer spending has met with limited success. Somewhat ironically, the mortgage industry’s well-known woes -- extended time-frames for involuntary foreclosure, lenders’ hesitancy to concede to short sales (where the house is sold for less than the mortgage and the lender absorbs a loss), and strategic/voluntary defaults -- may be putting an estimated $80 billion in “free cash” that once went to mortgages into defaulting consumer’s hands.

The failure of the Fed’s policies to increase household’s surplus income via ZIRP leads us to the second implicit goal, lowering the cost of home ownership via super-low mortgage rates, which serves both as behavior modification and perception management. If low-interest rate mortgages and subsidized Federal programs that offer low down payments drop the price of home ownership below that of renting an equivalent house, then there is a substantial financial incentive to buy rather than rent.

The implicit goal is to shape a general perception that the bottom is in, and it’s now safe to buy housing.

First-time home buying programs and FHA (Federal Housing Authority) and VA (Veterans Administration) loans all offer very low down-payment options to qualified buyers. This extends a form of moral hazard to buyers as well as lenders: If a buyer need only scrape up $2,000 to buy a house, their losses are limited should they default to this same modest sum. Meanwhile, lenders working under the guarantee of FHA- and VA-backed loans are also insured against losses.

The Fed’s desire to boost home sales by any means available is transparent. By boosting home sales, it hopes to stem the decline of house valuations and thus stop the hemorrhaging of bank losses from writing down impaired loan portfolios, and also stabilize remaining home equity for households, which has shrunk to a meager 38% of housing value.

As many have noted, given that about 30% of all homes are owned free and clear, the amount of equity residing in the 70% of homes with a mortgage may well be in the single digits. (Data on actual equity remaining in mortgaged homes is not readily available, and would be subject to wide differences of opinion on actual market valuations.)

Broadly speaking, housing as the bedrock of middle class financial security has been either destroyed (no equity) or severely impaired (limited equity). The oversupply of homes on the market and in the “shadow inventory” of defaulted/foreclosed homes awaiting auction has also impaired the ability of homeowners to sell their property; in this sense, any remaining equity is trapped, as selling is difficult and equity extraction via HELOCs (home equity lines of credit) has, for all intents and purposes, vanished.

The Fed’s strategy, in conjunction with the government-owned and -operated mortgage agencies that own or guarantee the majority of mortgages in the US (Fannie Mae, Freddie Mac, FHA, and the VA), is to stabilize the housing market through subsidizing the cost of mortgage borrowing by shifting hundreds of billions of dollars out of savers’ earnings with ZIRP.

Since roughly 60% of households either already own a home or are ensnared in the default/foreclosure process, then the pool of buyers boils down to two classes: buyers who would be marginal if not for government subsidies and super-low mortgage rates, and investors seeking some sort of return above that of US Treasury bonds. The Fed has handed investors two choices to risk a return above inflation: equities (the stock market) or real estate. Given the uneven track record of stocks since the 2009 meltdown, it is not much of a surprise that investors large and small have been seeking “deals” in real estate as a way to earn a return.

Recent data from the National Association of Realtors concludes that cash buyers (a proxy for investors) accounted for 31% of homes sold in December 2011. Even in the pricey San Francisco Bay Area, where median prices are still in the $350,000 range, investors accounted for 27% of all sales. Absentee buyers (again, a proxy for investors) paid a median price of around $225,000, substantially lower than the general median price.

This data suggests that “bargain” properties are being snapped up for cash, either as rental properties or in hopes of “flipping” for a profit after some modest cleanup and repair.

Price and Risk Premium Discovery

There is one lingering problem with the Fed and the federal housing agencies’ concerted campaigns to punish capital accumulation, push investors into equities or real estate, and subsidize marginal buyers to boost sales at current valuations. The market cannot “discover” price or establish a risk premium when the government and its proxies are, in essence, the market.

By some accounts, literally 99% of all mortgages in the U.S. are government-issued or -guaranteed. If any other sector was so completely owned by the federal government, most people would concede that it was a socialized industry. Yet we in the US maintain the fiction of a “free market” in mortgages and housing.

To establish a truly free and transparent market for mortgages and housing, we would have to end all federal subsidies and guarantees/backstops, and restore the market as sole arbiter of interest rates -- i.e., remove that control from the Federal Reserve.

Everyone with a stake in the current market fears such a return to an open market, because it is likely that prices would plummet once government subsidies, guarantees, and incentives were removed. Yet without such an open market, buyers can never be certain that price and risk have truly been discovered. Buyers in today’s market may feel that the government has removed all risk from buying, but they might find that they “caught the falling knife;” that is, bought into a false bottom in a market that has yet to reach transparent price discovery.

So, the key question still remains for anyone who owns a home or is looking to soon own close are we to the bottom in housing prices?

In Part II: Determining the Housing Bottom for Your Local Market, we tackle that question head-on. Because local dynamics inevitably play such a large role in determining fair pricing for any given market, instead of giving a simple forecast, we instead offer a portfolio of tools and other resources for analyzing home values on a local basis. Our goal is to empower readers to calculate an informed estimate of "fair value" for their own markets -- and then see how closely current local real estate prices fit (or deviate) from it.

Click here to access Part II of this report (free executive summary, enrollment required for full access).

This is a companion discussion topic for the original entry at

This quote caught my eye:
"and restore the market as sole arbiter of interest rates – i.e.,
remove that control from the Federal Reserve."
In the absence of a predictable value for money, the market is unable
to estimate the time value of money.
I prefer to call it the "quasi-Federal non-Reserve" to be more accurate.

Since I really doubt we will see the end of the Fed anytime soon and that leaves equities, precious metals, and real estate as vehicles to improve wealth.  Seeing what happened to the clients of MF global I think it will be easier to steal digital wealth vs tangible assets.  I’m not saying that it will be impossible to steal tangible assets but it will be easier to steal 1’s and 0’s first.

Thanks, Charles.  Nice job.  If you’re willing to take a crack at it, here’s a question from the other side of the tracks. In early ’06, my wife and I purchased 25 acres of exceptional residential land in the northern Rockies.  Amazing views, lots of trees, lots of water (a creek, several springs), tons of wildlife, good soil, 10 minutes (by car) from one of the state’s nicest towns (population 5,000), 25 minutes from the area’s economic center (population 35,000), 35 minutes from the airport, 45 minutes from one of our most spectacular national parks.  Good rainfall, low elevation (3000’), and the area is well suited to agriculture.  It’s a truly exceptional spot for long term human habitation, and prices have long reflected the area’s generous gifts and incredible scenic beauty.  
Our original plan was to sell off 10 acres and keep 15, so we put 10 acres on the market after a few months.  We had a substantial offer right away (more than $30,000 an acre) that didn’t work out, and then we turned down a slightly lower cash offer.  At which point things crashed and we took the property off the market.

So now I’m trying to come up with the best possible strategy to move forward.  In general, land and home values have dropped at least 30% in the area, and very little is moving.  Holding on to the full 25 acres entails continued debt and some financial hardship.  Selling off 10 acres would help the financial situation, and would allow us to build a small, energy efficient home, but would also diminish our holdings by 40% at a point when good land may well be the most valuable assets we can own.  I’m not looking for a “sell” or “don’t sell” recommendation.  Instead, I’d love to hear what factors you’d take into consideration if you found yourself in a similar situation.

Thanks, and I’ll look forward to any thoughts you may be inclined to share.


[quote=Charles Hugh Smith] It may strike younger readers as unbelievable that a few decades ago, in the low-inflation 1960s, savings accounts earned a government-stipulated minimum yield of 5.25%, regardless of where the Fed Funds Rate might be. [/quote]  One of the most famous pieces of banking regulation to emerge from the Banking Act of 1933 (the Glass-Steagal Act) was Regulation Q. 12 CFR 217.  Regulation Q was so famous because it capped the interest rate that banks could offer on savings accounts at 5.25% for many years, although the Federal Reserve adjusted this ceiling from time to time.
Regulation Q also prohibited the payment of any interest on demand accounts, and provided for a floating ceiling on interest rates on other forms of accounts.
I was not aware that there was another regulation which also provided a minimum rate of interest of 5.25%.  The existence of such a rule would be particularly interesting because, taken together, the rules would have completely eliminated any leeway in bank interest rate decisions.  If Charles could provide some reference to that regulation, I would be fascinated to read about it, and he will also have my apology for doubting his research.
If he cannot provide a reference, then I am going to stop reading his reports altogether, because this would be only the latest in a constant pattern of small mistakes and oversights that reveal a slipshod, "good enough" approach to research.  Where a person doesn’t care to make sure that what they put in writing is correct – where there are mistakes that you can see – then you can bet your bottom dollar that there are other mistakes that you aren’t seeing.


I haven’t read the article yet, but searching for "Canada" didn’t come up with any matches, so I’ll ask right way:

Any thoughts on Canada?



Housing is set to fall 70%-80% considering hyperinflation will remove the easy credit because the printing press will be rendered worthless, the Fed will be ineffective in backing mortgages, and American’s will become much poorer because hyperinflation is economically devastating. In order to save on housing maintenance and utility costs, more people will will living in each household. In addition, many will altogether leave the country, which will further expose the overbuilding of housing that cheap money and government backing of mortgages has created.

Now is the time to take the equity out of your home if you would like to keep that equity. The best way to save is with silver. Gold is a great option too. If you’re looking to save in USD, nickels now have a melt value of more than $.05.

Seems like simple demographics to me. I could get silver dollars at the bank for one dollar in 1963. Same silver dollar today is $30 bank debt notes and buys twice today what it bought in 1963. Dow in 1963 was $700. Dow in 2012 in real silver dollars is $600. I think that is about right. 
The baby boom caused the run up from 1971 to 2000, the bubble in stocks and real estate, and the bust. The future is politely telling baby boomers they can not be supported in the style of living they have become accustomed to.

My two teacher friends, married to each other, who are retired at age 59, will get about $10,000 a month for the rest of their life from age 59 to 89, both are in excellent physical condition. My father in law, retired teacher is getting $6,000 a month at age 89. He hit the jack pot getting millions of dollars for doing nothing. Millions of teachers, police, fireman, federal, state, regional, county, city, and public school employees have over promised pensions they call "under funded".

It’s all demographics. The baby boomers had double incomes, no kids. No one to buy their houses. My house is down 40% in the past four years and I live in conservative mid west Minnesota. My property taxes have not dropped a penny. I call that a tax increase. Government employees refuse pay cuts or adjustments.

My wife, privately employed, has had all her benefits reduced and now gets paid less if customers cancels on her as a health care provider. Something has to give. A depression is the solution, not the problem.

I hate seeing my net worth wiped out. Zero return on stocks. Bonds in a bubble. Real estate down 40% costing us $250,000, I invested in a lake shore home and a rental property, down from $800,000 total to $550,000, soon to be $400,000 total. Our mortgages do not drop a penny. Our taxes do not drop a penny. 

Debasement benefits bankers, brokers, owners, and government. Debasement wipes out children, families, renters, and employees. Women raise corporations instead of kids. Kids suffer. Marriages collapse. Why hang in there? My daughters college cost $160,000 for four years and she can’t get a job. The system is a rip off and it’s breaking down. 

We will survive but our quality of life, along with millions of Americans, is eroding to subsidize banks who should be allowed to collapse and government employees who should be fired. The tail wags the dog. What to do? The banks and government are in charge in a can’t lose bubble. Debasement accelerates. I made $100,000 investing in precious metals but lost $250,000 holding real estate. Interest rates are zero to subsidize banks and government. I will be asked to pay back this new TEN Trillion dollar debt created in the last decade with higher taxes to subsidize banks and government employees. Why?  

I say default. Walk away from the Ponzi scheme.  If it’s up to me I will default on US public debt. It’s a fraud. Facebook is worth $100 Billion as a bulletin board? Google is worth FIVE Ford motor companies? No. It’s fraud. The future is telling America it can not continue on the path it’s on. I believe that is Chris Martenson’s conclusion. I agree.

I think we will see housing drop a total of 50%, same at the 1929 depression. Printing presses will subsidize all bankers, brokers, owners, and government employees. Where is the shame? I dont’ recognize this nation anymore. I am so glad I don’t have a job and don’t have to pretend to be nice to people who caused the problem. A pox on all their houses. Protect yourself. I see $4,000 to $8,000 gold and $4,000 to $6,000 Dow by 2018. That will also require some massive defaults on public schools, cities, counties, states, and the Fed. It’s the cure, not the problem.  

Good luck to us all. 

I believe Jack nails it insofar as he goes, unfortunately. Pension Ponzi is a big, often-unspoken (relatively) part of the debt ponzi we’re facing.Sadly, my best options track with this perspective and Charles’ analysis – we sold our home as the slide began but before the big drop-offs; got out still slightly in the black on home equity and got into a rental situation. Now, we can again buy a better place than we’re renting for less fiat on a monthly basis.
With the potential for financial collapse in the mid- to near-term looming ever larger, I more and more like a play that  1) takes assets out of a 401k before they are walloped and/or confiscated; 2) moves us into a rural, brick structure with two wells and more than an acre of highly fertile soil; 3) reduces our monthly housing costs to the lowest number possible.
We’re debt-free now, but we’ll take this on at 20% down with a total purchase price that we could eliminate via remaining retirement accounts at a later date. In the short term, non- retirement account $$ and the increased FCF will be increasingly directed toward raised beds, rainwater barrels, fruit trees, seeds, PMs and other preps.
Any other perspectives out there on how you’d play it as a debt-free renter prepping for impending societal breakdown? I’m always open to anything that will improve my strategy.
Anthony Schiano

I live in Seattle where the housing market has been slightly recovering, due to the ongoing "the bottom is in" propaganda which is published in local newpapers at least once a week.  Prices are at to 2002 levels, but at least there are buyers now.  I just put my small house on the market and it sold in a month. In my (lower) price range the buyers are mostly young first-timers.  My house, which I bought in 1995, is still worth about $75k more than I paid for it, and I have a ton of equity still, thanks to having made a 40% downpayment when I bought it, and the fact that I never borrowed heavily against it. The young gal who is buying is getting the FHA 3% downpayment deal ($8000 downpayment on a $200k house)… I feel sorry for these 20-somethings because they are being lead astray in my opinion. 
I consider myself very lucky to be able to get out in relatively good shape, even though if I had sold it in 2007 I would have been up by about $100k, I’m still alright & we will be debt free with a modest nest egg. We are both boomers with no kids, we plan to do a little travelling, looking around to asses our next move, where we might like to live, and the possibility of settling outside the USA – in the meantime, I’m putting at least half of the money from the sale into hard shiny assets.

The banks are making it really hard for investors. I have a friend who has been speculating successfully in local real estate for years, buying fiixers and flipping or renting them.  He is now out there looking for bargains, rents are rising while prices are dropping – the numbers are good for being a landlord. He recently found a nice duplex in a desirable part of town for $420,000. Yet even with his excellent credit rating, and a 30% downpayment of $126,000, his bank will not finance him. This even though the combined rent on the duplex comes to $2600 a month which easily would pay the note. This is a guy with $300k cash in the bank & he’s been with this same bank for years. The banksters are not helping anyone but themselves. They were wrong when they were giving money away, and now they are wrong by not lending to people like my pal.  At the same time, the FHA is allowing first-time buyers to take out loans that will be underwater in a year or two… it’s crazy.