The epicenter of the global financial crisis was the US housing market.  As aftershocks from its collapse ripple throughout the global economy, attention has shifted to fears the US economy’s consumer foundation will crumble and to the possibility of an imminent worldwide recession.

But housing remains a critical variable in projecting the duration and severity of any recession. On October 30, a panel of experts addressed the question of whether the housing market is near its bottom.  At the same time, the panelists addressed the broader economic picture and its implications for investors.

The discussion, billed as “The Deflating Mortgage and Housing Bubble, Part IV: where is the Bottom?” was sponsored by the American Enterprise Institute for Public Policy Research (the AEI).

The five panelists, whose presentations are summarized below, offered only the faintest glimmer of hope.  Their consensus was that housing prices will continue to fall, perhaps by as much as 20% beyond today’s levels, and there are clear and obvious policy interventions that could prevent this.  

The AEI is a conservative think tank, but the presenters represented a range of ideologies. 

Desmond Lachman

Lachman is a resident fellow at the AEI who previously served as a managing director and chief emerging market economic strategist at Salomon Smith Barney.  He has also been deputy director in the International Monetary Fund’s (IMF) Policy and Review Department.

Lachman began by showing the all-too-familiar graph of the Case-Shiller housing price index.  Even though prices have already fallen about 18% peak-to-trough, the data show, they have about another 10% to go before they return to the long-term trend line.

But, setting a somber tone for the ensuing discussion, Lachman said that there is “no logical reason why the housing market will not undershoot this trend line” and fall even further.  The only hope of preventing that undershooting is a massive government intervention.

Lachman identified five factors that are creating downward pressure on housing prices:  a deepening economic recession, rising unemployment, a huge amount of inventory overhang, widespread foreclosures, and scarce mortgage financing.

Early on in the credit crisis, many claimed it was not as severe as the S&L crisis of 1986-1995.  Lachman debunked this myth with the following data:

Whether measured in absolute, inflation-adjusted dollars or as a percentage of GDP, this crisis already “dwarfs all others,” said Lachman.

Lachman noted that futures markets in the Case-Shiller indices imply 15% drop in housing prices from today’s levels, but he was hesitant to endorse that forecast.  He noted that inventories are still at a record 11-month supply (approximately two million homes) with demand declining.  Supply is surging due to foreclosures, with approximately one-third of houses with mortgages now underwater.  Defaults are occurring at an annual rate of approximately 3 million units, as shown in the graph below:

Lachman said that “stabilizing the housing market is a necessary condition to stabilizing the economy, but it is nowhere near a sufficient condition.”  He suggested a general outline of policy alternatives, including buying home mortgages, resetting the terms of mortgages, a large fiscal stimulus and monetary easing.  Without such actions, he cautioned that the current crisis will “morph into something a lot more horrible to contemplate.”

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