When Will the Housing Decline End?

Economist Irwin Kellner gives his opinion:

As the economy rounds the Labor Day turn, it continues to grapple with three crises.

Three years ago, the housing bubble burst. That set the stage for a pullback in new-home construction and consumer spending as home sales and prices began to fall.

When it became apparent that many home loans were not held by the banks, but turned into securities and sold, a financial crisis developed, since holders of these securities had no way of knowing their value. This led to a credit crunch, and a severe pullback in bank lending.

In an effort to ameliorate the effects of this credit squeeze, the Federal Reserve pumped loads of liquidity into the financial system, eventually producing the third crisis: inflation.

Now the question is when will these three crises end?

Investors need to know in order to time their reentry into the markets.

Policymakers have to know so that they may set the fiscal and monetary dials appropriately.

Most important, the American people would like to know because their jobs and living standards are at stake. ...

Since this whole mess started with housing becoming irrationally exuberant, it must end with a return to sanity in this key sector of our economy. And in spite of what you may have read or heard about the "unprecedented" decline in home prices, normal housing prices are still beyond the horizon.

According to the latest data from the Census Bureau and the National Association of Realtors, median home prices in July equaled 3.6 times median household incomes. This may be down from the peak of four times incomes set back in 2005, but it is still far above the 2.9 times of the 1980s — when housing was more affordable and sales and construction grew at a steady pace.

In the halcyon days of the early 1970s, when home sales and construction were at their peaks both in absolute terms and relative to the size of the population, the ratio of home prices to incomes was less than 2.5.

To get back to the average of the 1980s, home prices would have to fall another 20%, on average. Add another 10 percentage points decline for housing to be as affordable as it was in the 1970s.

These numbers are for the U.S. as a whole. The declines needed in bubble markets would be greater. The declines needed in non-bubble markets would be less.