Home sales appear to have stabilised and inventories are coming down on some measures but there is still a major overhang of supply putting downward pressure on prices. Measures of valuation suggest prices need to fall another 20% on the Case-Shiller index to return to previous cycle lows. On an optimistic scenario for the economy and housing the bottom for prices may be reached in 2009 with the Case- Shiller indices down another 10-15%. There is a more pessimistic scenario, which remains a serious risk, that a downward spiral for the economy, house prices and the financial sector takes house prices much lower still.

How much have house prices fallen?
So far US home prices are reported to have fallen a cumulative 19% on the S&P Case-Shiller 20 cities index (CS20) but only 4.8% on the government’s OFHEO monthly purchase-only index. The truth lies somewhere in between. The government’s index includes only properties bought with “conforming mortgages”, the mortgages that are provided or guaranteed by Freddie and Fannie. It therefore excludes virtually the whole sub-prime and Alt-A sector, as well as high-end properties where the mortgage is above the conforming limit ($417,000 until recently). It also excludes properties bought without a mortgage. The net result is to underestimate both the rise in prices in the 2000-6 period, which was driven by the sub-prime, Alt-A and jumbo sectors, and the fall in prices since. In contrast, the CS20 index (and also to a lesser extent the quarterly national Case-Shiller index) over-estimate both the rise and decline. The Case-Shiller indices underweight “Middle America” especially rural areas and small towns. Also, they weight by value so recent declines in expensive properties in California, Florida and some parts of the North East pull them lower. However, neither index includes condominiums or new homes where prices have been particularly weak. Overall then, the reality for house prices is probably nearer the Case-Shiller estimates than the government estimates. But the pain has been quite concentrated so far, mainly in the sun-belt, notably California, Florida, Arizona and Nevada and in the rust-belt, notably Michigan and Ohio. Even there the large declines of 30-50% sometimes reported are very localised to areas where there is substantial new supply. These areas tend to drag down the averages, while good properties in good locations are down much less. The rust-belt is seeing declines, despite not having much of a boom before, because of the weak local economy. In August one-quarter of Detroit house sales were priced below $36900, little more than the price of a fully-loaded car.