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Charles Wheelan, Ph.D. The Naked Economist

Charles Wheelan, Ph.D., The Naked Economist

A New Real Estate Reality

by Charles Wheelan, Ph.D.

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Posted on Monday, March 31, 2008, 12:00AM

Housing prices dropped by over 11 percent at the beginning of this year, the largest drop in the 20 years that such data have been collected. Thank goodness.

Restoring Financial Sanity

Why are plummeting real estate prices good news? Because it's the first sign that sanity is returning to the market. And a sane real estate market -- one in which sellers recognize that they won't get as much for their house as Al down the street got two years ago -- is a precondition for a broader economic recovery.

Recessions, or any economic downturn, are always caused by the same thing: Something goes wrong. That may sound overly vague, but it's rarely the same thing that causes a shock to the system. In an agrarian society, it might be a bad harvest or a failed monsoon season. In a developing country, it might be a slump in the global price of a major export, such as coffee or copper.

In the United States in 1929, it was the stock market collapse. In the early '80s, it was the recession deliberately engineered by Fed Chairman Paul Volcker to break the back of inflation. (The Fed held interest rates high enough for long enough that the economic pain persuaded workers to stop asking for higher wages, and firms to stop raising their prices.)

Bad to Be Good

In all these cases, the recovery begins when either: 1) Conditions get better -- the rains come, the price of coffee rebounds, or consumers stop worrying about another terrorist attack. Or, 2) Things don't get better, but we adapt to the new reality. Coffee prices don't rebound, so farmers start growing something else.

The only route out of our current real-estate-bubble-inspired economic malaise is the latter -- a new real estate reality. Property owners must recognize that some of the prices we saw over the past couple of years were an anomaly, just like Internet stocks in the '90s.

The problem with the housing bubble wasn't just that prices got out of whack for a while. The bigger problem was that those crazy prices sent erroneous signals to the rest of the economy. Artificially high housing prices caused developers to build things that shouldn't have been built; consumers to spend money that they didn't really have; banks to loan money to those developers and consumers; and Wall Street to bundle those shoddy loans into products that most of us still don't understand.

Feeling the Heat

Normally, the beauty of a market economy is that prices convey important information. When starting salaries for engineers go up, more college students major in engineering. When the price of gas gets to $4 a gallon, people drive less (or buy fuel-efficient cars).

But the housing bubble sent bad signals all over the economy. It's as if we had a broken thermometer telling us it was 30 degrees, and now we're all standing outside in 90-degree weather wearing sweaters and ski parkas. The important thing is what we do next: We can either stand there hoping the weather gets much colder, or we can recognize that it's 90 degrees and start taking off the layers.

Falling real estate prices tell me that sellers are finally starting to do the latter. I recognize the pain. A lot of people are going to lose a lot of money; some will lose their homes. But realistically that's already happened. If buyers are only willing to pay you $300,000 for a house you bought for $400,000 two years ago, the $100,000 difference is already gone.

For What It's Worth

Listing the house for $400,000 and leaving it on the market unsold isn't going to get the money back, either. That's essentially just living in the house and hoping it'll appreciate in the future. The "For Sale" sign out front is decoration, something to keep the mailbox company.

Look, I bought 50 shares of Bear Stearns stock at $90 a share. There's nothing stopping me from putting a sell order in with my broker at $90. I can keep that sell order open as long as I want, just like the permanent "For Sale" sign.

But the market reality is that JP Morgan Chase has an offer on the table for $10 a share. If I really want to sell my shares, it'll have to be at a price someone is willing to pay -- which, sadly, has nothing to do with the $90 I paid in the first place.

True Value

If this were just about the price of real estate, I wouldn't care at what price people tried to sell their homes, or how long those properties stayed on the market. But it's bigger than that. Falling prices will help put the "market" back in the real estate market; it'll get us back to a point where sellers are asking prices that buyers are willing to pay.

We'll know the real value of real estate in different markets around the country. That'll give banks a sense of what their loans are worth. It'll also be a signal to buyers that they don't have to wait any longer for the deals that they know are coming.

Both will help stabilize the credit markets so that they can get back to the business of making sane loans based on realistic property valuations. And healthier credit markets will allow Wall Street to price the mortgage-backed securities that will remain illiquid as long as we have no idea which mortgages are likely to go into default and which mortgages aren't.

The Bottom Is Near

What good news am I looking for in the future? Another significant drop in housing prices, albeit smaller, say 4 or 5 percent. That would signal to buyers, sellers, banks, and Wall Street that the bottom is near.

Things have to get worse before they can get better. We're making progress.

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184 Comments

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  • Elliot - Wednesday, April 23, 2008, 10:49AM ET  Report Abuse

    • Overall: 5/5

    to the person in southern california - again, it is the market. Fewer people can now qualify for loans (or are willing to buy due to the instability of the market) so there are more people looking to rent - more renters (i.e. buyers), higher the price.

  • finance1 - Friday, April 18, 2008, 8:20PM ET  Report Abuse

    • Overall: 5/5

    YTS good info

  • Yahoo! Finance User - Friday, April 18, 2008, 11:36AM ET  Report Abuse

    • Overall: 4/5

    I am a home owner in So Cal, and I agree that the decline in home prices is not necessarily a bad thing. Too many people have been frozen out of the market over the last 6 years. However It is worth noting that rents have been increasing even as home prices have declined. It would be interesting to see that trend discussed in a future article.

  • Yahoo! Finance User - Thursday, April 17, 2008, 8:05PM ET  Report Abuse

    • Overall: 1/5

    All of our current problems can be traced to one thing: too many PhD economists with an opinion on everything. Traffic safety? Civil engineering? Healthcare? Real estate. It wasn't too long ago that Easy Al Greenspan (another economist) loosened loan regs and allowed the free market to do its magic. Let the free market decide who can afford to make/receive loans!!! No doc loans!! CDOs!!! SIVs!!! Free money from heaven!!! Wall Street will make us all rich!!! Get the government out of the way!!! All of the Ayn Rand, free market, econ types like Wheelan/Greenspan are putting on the same show that tent revivals and snake oil salesman once did. Faith can get you by for a while but sooner or later reality will catch up and prove what we should have known all along. When whatever was in the bottle you sold us didn't grow the promised hair on our heads, it only lightened our wallets and made us smell bad.

  • georgeg - Sunday, April 13, 2008, 8:13PM ET  Report Abuse

    • Overall: 3/5

    Reading the article an comment one thing the PHD. does not take into account is the cost to replace. When it is cheaper to buy used than build the resale home starts to sell. The supply side is builders have to slow down. In So. Cal. many homes are below the cost to replace. Also the Phd. does not note that money is so tight that even the banks will not loan money to sell their own R.E.O.'s This will drive prices down more and the Gov. knows this. Even let the Market Go McCain wants to stop the bleeding and the equity loss but starting to save properties and make money available. Watch the real market and take into consideration the two rules. Location Location Location and Equity overcomes all objections and the lesser know rule P.hd. means Piled high and deep.

  • Yahoo! Finance User - Thursday, April 10, 2008, 12:15PM ET  Report Abuse

    • Overall: 4/5

    I also believe another sginificant drop is in order. This crisis was not caused by the banks and mortgage companies alone, it was caused by those who bought homes they could not afford. It is insane to think that the buyers were not aware of that. This helped real estate prices to soar and any bailout will keep the prices artificially high. I feel sorry for those who wiated until they could afford the home they wanted, now they may never get it.

  • JTurn - Tuesday, April 8, 2008, 4:42PM ET  Report Abuse

    • Overall: 4/5

    The real issue is, when will the government stop bailing out financial institutions for making bad loans? They did it in the 80s with the S&L debacle, and they are doing it again with Bear Sterns, and will probably bail out more lenders as the crisis deepens. It must be nice to be in a business where you can keep all the profits, but get the taxpayers to cover all the losses. One of the key aspects of a free market economy is that you are just as free to fail as you are to succeed. Why should I, who bought a home in 1999, still live there, and had no involvement with this issue be expected to pay for the poor judgement of those who, through greed or ignorance, brought us to this brink? I agree with Dr. Wheelan that this is a necessary readjustment. But why should the taxpayers have to cover the losses of those who risked and failed? And if we bail them out this time, won't that just make it all the more likely that banks and investors will jump onto the next 'get-rich-quick' investment, secure that if they lose their shirts, the government will give them mine?

  • deepblue - Monday, April 7, 2008, 12:04AM ET  Report Abuse

    • Overall: 5/5

    Hey punk! He's not calling a bottom, where did you get that idea from?

  • masipopa - Sunday, April 6, 2008, 7:35AM ET  Report Abuse

    • Overall: 1/5

    Market declined a bit - time to buy. This is same advice as all American favorite slogan - buy more save more. I beleive that until price/rental ratio won't go down to about 120 or less, everyone who bought a house will lick later financial wounds. And there is still a long way to go down until normality returns to the real estate market.

  • Peter - Saturday, April 5, 2008, 1:12PM ET  Report Abuse

    • Overall: 1/5

    His central them both stated and implied: "It's time to buy stocks and real estate for the "bototm is in". Wrong. Real Esate is only 1/3 the way there at a minimum. That's according to present median income and interest rates. With the recent Fed fraud and promises to bail out big banks there is zero chance they will be able to keep interest rates this low. An 8% mortgage rate takes an additional 30% off the price of your house. Median inclome will also take a massive hit as much of our employment is related to the "usary" or "skimming" industry which is YET to be croaked; What nobody is saying is that these "financial services" jobs are indeed phantom jobs; they will cease to exist in the same way a $90.00 BSC price tag did. Mark my words. Without "inflation" (a recession means "deflation) this 30% of our economy has no reason to exist. So as median inclome gets devastated; then what will Americans be able to afford in terms of housing? It's amazing that one day after the "recession" is confirmed, this idiot is calling a bottom. This could easily be the one hundred year "big one" that got started in 2000 and got cut off by the cash out refi mechanism that turned your house into an ATM machine. Sorry folks, the "infaltion" solution never worked and it never will. Take out your hoe and learn to grow something so you don't starve.

  • spider - Saturday, April 5, 2008, 1:00PM ET  Report Abuse

    • Overall: 2/5

    Same old stuff-just a different "pundit" having to write something to get his weekly paycheck. G Spider

  • Yahoo! Finance User - Saturday, April 5, 2008, 7:20AM ET  Report Abuse

    • Overall: 5/5

    Excellent article and many excellent comments. I like how CW tries to appy econ so that the average person could understand. Many of the 1 star comments have obviously never even taken econ 101.

  • Yahoo! Finance User - Friday, April 4, 2008, 5:45PM ET  Report Abuse

    • Overall: 5/5

    Will this real-estate market recover? That's a very goo question. First we have a mortgage crisis. Then we have house prices dropping. Recoveries don't usually begin for at least 2 to 3 years. Then we have baby boomer retirement, and they have no savings. Will the housing market recover? The circumstances have changed. They call this the long-wave. http://www.longwavepress.com/Baby_Boomers_Generation_X_SCv1a.pdf

  • Yahoo! Finance User - Friday, April 4, 2008, 10:46AM ET  Report Abuse

    • Overall: 1/5

    What new reality??? Hopefully we are return to the orignal reality which was you buy something you can afford and take a few minutes to figure out you can since you will live with this decision for 20-30 years. The only people I feel sympathy are the ones who did the right thing and bought a home they can afford and now because of all the crooks are getting the value of their home massacred.

  • hank - Friday, April 4, 2008, 6:48AM ET  Report Abuse

    • Overall: 1/5

    tell me some thing new,.

  • Midwestern countryboy - Friday, April 4, 2008, 1:14AM ET  Report Abuse

    • Overall: 1/5

    Writing and stating the obvious doesn't make for much of a column. There really isn't too much anyone can do about the housing situtation. The perfect storm was created and now we are paying the price!! The housing prices will continue to crumble for a long time. Affordability is the key for any turnaround .

  • Yahoo! Finance User - Friday, April 4, 2008, 12:59AM ET  Report Abuse

    • Overall: 1/5

    You've covered the obvious in this article without going to the nature of the problem at all. When I bought my home 4 years ago in an extremely overpriced market, it was basically a warzone for me. It was obvious to me that conditions were unsustainable and I refused to take part in it, even though I had to have housing. The result was 9 months of painful searching while living in a camper, trying to find properly valued homes in the foreclosure/preforeclosure/distressed markets. It required going to battle with everyone along the way from my Realtor and Seller's Agents to the Sellers themselves. I let many homes pass by or be taken out from under me in the process, until I finally found the right home for the right price. Some of my acquaintances sort-of thumbed their noses at my choice, since they had nicer homes that they had paid top-dollar for. Well, ALL of those acquaintances have since lost their homes and left their mortgage company with huge losses in the process. Your article does not address the mob mentality idiocy that drives so many avoidable problems in our modern society. It isn't limited to homebuyers, by any stretch of the imagination. The main culprit is really the investment bankers who followed their own mob mentality of ratcheting up risk to progressively more insane levels, providing the loans that enabled all of this. My hat goes off to those of us who are under-appreciated and under-represented in this time of over indulgence, every one of us from the part-time working college student up to Warren Buffet himself, who can still recognize intelligence from looming disaster.

  • DelJ - Thursday, April 3, 2008, 3:56PM ET  Report Abuse

    • Overall: 4/5

    I saw the insanity firsthand when two of my younger brothers were looking at buying their first homes, one at the beginning of the real estate bubble and the youngest brother buying towards the middle. The younger brother was looking for his home along with a horde of other lemmings with no little, bad or no credit, homes in a newly "chain developed" subdivision that was a forest just 2 months earlier. They couldn't build houses fast enough as people like my brothers were paying the asking price, a crazy $100/sq ft, worried that the 3 others looking at buying the home would get it. I tried to talk sense to them, telling them the homes were worth maybe $70/sq ft max at the time (even that was high, but I factored in demand/supply). My youngest brother asked the real estate agent if she would take less and she just laughed and told him, "hun, If you want this house, you have to pay list". But everyone had to have their fancy homes then, just like the neighbors were getting, it was the "in" thing. The wives were berating the poor husbands to get them that home. I saw too many kids buying homes that had "Wants" confused with "needs". Now they look to the government to bail their stupid asses out? They bought it - let them pay for it.

  • Yahoo! Finance User - Thursday, April 3, 2008, 2:36PM ET  Report Abuse

    • Overall: 4/5

    Lower valuations on real estate might revive the market. If you live in NJ don't expect that lower evaluations on NJ properties will mean lower taxes. You will have to move out of NJ to state that realizes that lower evaluations should mean lower real estate taxes, and cut state spending.

  • Yahoo! Finance User - Thursday, April 3, 2008, 2:35PM ET  Report Abuse

    • Overall: 2/5

    It's hard to make blanket statements about real estate since it varies hugely from one region to another. I got priced out of the market here (SoCal) 3 years ago and am waiting for the sanity to return. I think the best way to call a bottom is an affordability measure. Divide median income into median house price and it history says it should be around 4. At the peak in my area it was 11 and now has dropped to 8. If it gets near 5 I'll be happy to stop renting.

  • Yahoo! Finance User - Thursday, April 3, 2008, 1:14PM ET  Report Abuse

    • Overall: 1/5

    It's pure water, trivial stuff that everybody knows. It's simply common sense. The word that is missing here is EVENTUALLY: "We'll know the real value of real estate"..., EVENTUALLY! Nobody knows WHEN this ends and HOW LONG it'll last! The author doesn't know it either. He also does not know if the Bottom is Near (unless he has a crystal ball) but he writes like he does. Disappointing...

  • Kevin M - Thursday, April 3, 2008, 12:47PM ET  Report Abuse

    • Overall: 1/5

    How can I listen to someone who that purchased Bear Stearns at $90 per share? What credibility could they possibly have?

  • Sudhir - Thursday, April 3, 2008, 12:30PM ET  Report Abuse

    • Overall: 4/5

    The fall in prices may be good news for the vultures waiting to pick up. How come the darned taxes aren't going down? Uncle Sam's taxing all too much (an understatement). We are getting scr*wed from all sides. Gas up, Stocks down, gold up, dollar down. The world for many is becoming stark and scary.

  • Yahoo! Finance User - Thursday, April 3, 2008, 12:24PM ET  Report Abuse

    • Overall: 1/5

    This person's ignornance about economics is obscene. The 1929 stock market crash did not cuase the Great Depression. Vokler poliices did reduce inflation, but had nothing to do with the big contraction that began in late 1978. They did moderate inflation.

  • Yahoo! Finance User - Thursday, April 3, 2008, 12:19PM ET  Report Abuse

    • Overall: 2/5

    He really didn't say anything else dozens of other people haven't already said.

  • DP - Thursday, April 3, 2008, 11:37AM ET  Report Abuse

    • Overall: 5/5

    It's a good generalization. Real estate IS local though. There are markets across the country that didn't go crazy and are still holding value or continuing on with their modest 3-5% annual appreciation. Some markets were just correcting from years of under appreciation and aren't dropping significantly. Generally speaking however, it's a good article.

  • Booba K - Thursday, April 3, 2008, 10:47AM ET  Report Abuse

    • Overall: 1/5

    "The Bottom Is Near?" 4-5% is "significant drop"? But 100% prices up were not as "significant"? LOL! Hey, Mr. Ph.D., wanna bet? So what about my monthly salary against yours? You are saying prices will fall 4-5% before they hit the bottom, right? I'm saying they must fall by at least 10% until they hit the bottom. And let's see if you are a real "expert", ok? ;)

  • Darren - Thursday, April 3, 2008, 10:24AM ET  Report Abuse

    • Overall: 5/5

    Ha, Ha, Richard has to be a realtor. All you care about is your 6%. Price of Lumber has dropped significantly, home builders like Centex has been dumping land at a huge discount. Cost for contractors are going down. Yes, the price of copper, gold and oil has spike. Unless you are building a house with gold. The cost of building a new house will drop. With inflation going crazy, more homeonwer will not be able to hang on to their house, which means more foreclosure, and lower prices in the future. If interest rate goes up significantly, the price of a house will collapse. Wait, and be patient.

  • hunter - Wednesday, April 2, 2008, 6:09PM ET  Report Abuse

    • Overall: 3/5

    pretty good read, except for one thing. commodity prices are still climbing. the materials alone to build the same house built 5 years ago have easily gone up 5-10% along with labor costs as well. it depends on the market, but in the next 2-4 years it will be much harder to own a home and as some have already mentioned, as home ownership becomes more difficult, rentals will soar, as we all have to live somewhere. unfortunately, we are entering a pretty tough time in the life of the average American consumer. a much greater percentage of income will be required for just daily expenses, including food, fuel, energy AND housing. if for no other reason, buy now, while you can still afford it. the rates will soon go up and the fed will likely have to fight inflation before we enjoy a total recovery from this anomaly.

  • josed - Wednesday, April 2, 2008, 5:27PM ET  Report Abuse

    • Overall: 3/5

    reversion to the mean sounds like a good idea, but you have to adjust for the price of building materials which have gone up significantly. Have you priced copper or aluminum or wood lately?. New houses will cost more due to material costs and stricter code regulations. Dr. Wheelan forgot to mention the tech crash at the end of the '90's when internet companies with a few servers and poor business plans had market values of several billions. People who got burned by the stock market shifted money to real estate. So, where is the next bubble going to take place?. Commodities??

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