End Of The House Party

by Gary Shilling

The nationwide housing bubble, the first in the post-World War II era, has been propelled by low mortgage rates, loose lending practices, aversion to stocks after the 2000-2002 bloodbath and conviction that house prices always rise robustly.  Home prices and consumer inflation are normally closely related, but now the median price of existing houses nationwide is 35% above its usual link to the CPI, propelling the prices of these unstandardized, uneconomic, depreciating, illiquid, highly leveraged and lender whim-dependent investments well above the norms and making them vulnerable to declines at least that big.

I’ve been forecasting the collapse in the U.S. housing bubble for some time-and now it’s happening.  In July, existing home sales were down 4.1% from June and off 11.2% from a year earlier.  New home sales dropped 4.3% from June and declined 21.6% from July 2005.  Inventories have risen while housing starts have declined.  Homebuilders, from Toll Brothers to Lennar Corp. to Pulte to Hovnanian, have lowered their full-year earnings outlooks.  The National Association of Home Builders’ confidence index fell to 32 in August, the lowest point since February 1991.  And the National Association of Realtors’ index for pending sales of existing homes decreased in August to its lowest level since February 2003.

I am forecasting an initial slow downdrift in house prices starting in the fourth quarter, then a sharp drop that lasts until the first quarter of 2008 and is followed by a tepid recovery.  I foresee a peak-to-trough decline of 25%, a drop needed to bring prices back in line with the CPI, personal income and rents.

Such a nosedive in prices will wipe out the thinly capitalized speculators, subprime borrowers and the low ends of subprime debt as well as assorted other lenders, mortgage bankers and home builders.  Those folks will get the bulk of the media attention.  You can already picture the big busted real estate investor trading his yacht for a rowboat, and Joe Sixpack, standing on the sidewalk outside his foreclosed house, in the rain with his pink slip in hand, his earthly possessions piled on the curb, his wife in curlers and screaming kids as the TV cameras grind away to record his misfortune.

These unfortunates will depress national sentiment as they raise the question, Who’s next?, in many minds.  But they probably aren’t numerous enough or collectively important enough financially to do serious damage to the economy.  Instead, the main event will feature the many people who still have jobs and are still making their monthly mortgage payments, whether they have any equity left or lost it all through earlier withdrawals and house price declines.  Many of those folks have relied on their house appreciation to bridge the gaps between sluggish income growth in recent years and robust consumer spending.

A move from high to no or even low rates of house appreciation would probably force many to live within their incomes.  The 25% or greater decline in house prices I foresee will sire consumer spending retrenchment that almost guarantees a major recession.  And that is what declining stocks will anticipate.  Interestingly, a recent Barron’s poll of institutional investors found no asset managers saw problems in housing leading to a major stock bear market in the next year.

That bear market could well carry stocks below their 2002 lows.  As I’ve stated in the past, the 2003 rally and subsequent advances may well prove to be rallies in the bear market that commenced in early 2000 and won’t be completed for several more years.  Note that the 1982-2000 bull market lasted 17 years and eight months, and bear markets are usually one-third as long as the preceding rallies.

The housing collapse will also sever the links between a place to live and a great investment, to the ultimate advantage of rental apartments and factory-built housing.  It will probably also initiate a saving spree, replacing the borrowing and spending binge of the last 25 years.  The major global recession it will spawn may drive stocks to new lows, but also initiate deflation and a further attractive rally in Treasury bond prices.

Editor’s Note: Dr. Gary Shilling is president of A. Gary Shilling & Co. Inc., an investment advisory and economic consulting firm and publisher of the monthly INSIGHT newsletter.

Prescience has empowered Dr. Shilling to beat the stock market by a wide margin over many years while providing consistently accurate forecasts to his subscribers. Twice ranked as Wall Street’s top economist by polls in Institutional Investor, Dr. Shilling was also named the country’s No. 1 commodity trader adviser by Futures Magazine. And last year, MoneySense ranked him as the third best stock market forecaster, right behind Warren Buffett.

A regular columnist for Forbes magazine, Gary Shilling appears frequently on radio and television business shows and has written six books, including Is Inflation Ending? Are You Ready? in 1983 and, more recently, two books detailing his forecast for the new world order and its consequences for your wallet. For his very latest research, see:


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