Housing Voodoo

A number of months ago my wife and I checked out a condo for sale near where we lived. Not surprisingly the sales woman not only indicated that it was a "good buy" but that housing prices were likely to recover soon. It was a strange moment for me because I realized at that point I had no idea what housing prices were going to do and more importantly I had heard this before.

It's funny how everyone I know who has shared their two cents on home prices have always employed the same logic: well its gone down so much it's gotta go up soon! But is it really? Gamblers fallacy?

So while I'm no economist, I'm tired of hearing everyone's opinion and wanted to check what the numbers would suggest. Earlier today I came across data from the Census Bureau that shows household income in 2009 dollars going back to 1991 and home prices across the U.S. provided by the Federal Housing Finance Agency over the same period. Now I'm sure there's multiple different types of data to use that shows other perspectives, but this is what was available to me on my quick search.

The data suggests the following story. From 1991 to 2001 household prices gradually increased with household income. I guess this makes sense all else being equal. If everyone makes more money, everyone is going to pay a little more for their home. What's a little surprising is that home prices actually grew slower than household income during this period.

But then, as some would suggest (and I tend to agree), the tech bubble popped and the Federal Reserve lowered interest rates due to fears of a prolonged and deep recession. This in turn encouraged both more lending and lower loan standards. You can see this as home prices dramatically overshot the growth in household income from 2002 and ultimately peaked during the 2H'06 / 1H'07.

Since then U.S. home prices are down ~35-40% through 1H'11. While I don't have the household income data for 2010 and 2011 I'd seriously doubt that it's increased significantly since 2009 which means between 1991 to 2011 home prices AND household income have increased about the same ~75-80%. 

I think this is significant because it means that the price declines of the last few years have only wiped away the excess home price growth that occurred from 2002 to 2007. If home prices were indeed depressed, wouldn't they decline relative to household income?

Conclusion - Where to from Here?

So based on this data I think its actually far from certain that home prices should bounce from here. I'm not saying they're going to collapse, but I honestly think up OR down is possible.

After all, if home prices could overshoot on the upside (relative to income growth) why can't they undershoot? Couldn't a weak economy, more cautious lenders, and potential overhang of foreclosed properties result in a truly depressed housing market in the future?