Summary
Wrote this a year ago, after some conference at Jackson Hole. It still has some merit. Might even make a few points about the timing of cycles. Real estate problems happen slowly. The magnitude of the problem is only partially reflected in prices. Accumulation of inventory is almost certain. Inflation is a political option to debt crises.
Analysis
Lovely picture of the Tetons (p.64, 9-1 issue). As an old and experienced outdoorsman and real estate market pessimist, am dubious about the 15-30% prospective drop in house prices predicted in your (The Economist) article. Let me count the ways. 1 - real estate problems happen in legal time, approximately the inverse of internet time. 2008 is way too soon. 2 - while only a small minority of households have a vested interest in the highest price of the last cycle, that has not always been a bad thing. The vast majority of households can find some way to hang on as long as employment remains reasonably strong. Many won't even seriously notice the difference in their home value. 3 - is related to 2. The demand side may be weak, arguing for a low price, but the weakness may simply express itself as an accumulation of inventory, or a withdrawal of properties from the market. The critical number here is five years, the length of time banks can hold property on their books. That clock of course doesn't even start to run until the banks take possession, see 1, above. 4 - whatever may be said now, inflation is the debtors' friend and pretty much in the control of any government that issues paper money. Did a few doodles* the other morning on purchasing power and housing costs. While a big drop is possible from those numbers, it doesn't look like the most probable outcome. If nominal income growth exceeds 3% annually, the likelihood recedes farther. Stand by for a reprise of the S&L bust. The problem assets will be sucked up by a new emergency agency and peddled out at auction. Like last time the hit will be big. My guess is on the order of a trillion. Like last time, a lot of the folks who know these assets very well, having created them, will profit from the process. And our honorable elected officials won't do badly for themselves either. Meantime, aren't mountains beautiful? Perhaps we should take up outdoor sports like climbing and skiing, even fishing. * spreadsheet available on request
