Existing Home Sales Dive

Wow.  The headline number is shocking, but the intellectual analysis is not.  Existing home sales drop 27.2%.  Big number, but what does it mean?

The Federal government subsidized home purchases with a tax credit.  The tax credit subsidy expired.  The existence of a tax credit pushed forward purchases of homes.  Some people that were in the market purchased a home sooner than they would have because of the credit.  The tax credit didn’t create new buyers of homes. It didn’t increase the size of the home buying pie.  The subsidy skewed the marketplace-created what economists call “dead weight loss“.  This is Microeconomics 101.

Erik Hurst is a professor of Economics at the Booth Graduate School of Business.  He has done a lot of research on real estate.  Over time, family home real estate returns about 1% in real return.  If you cut slices of time, it can be shown to return more or less-but over the long haul the family home really isn’t a place to earn return on equity.  Micro forces also cause returns to be skewed, like building restrictions. But, as Erik says, as long as there is vacant land we can build homes!  Supply curves can shift.

I attended a lecture by Hurst in December 2008.  At that time he said there was a 100% probability that the US housing market would decline in price by at least 20% the next year, and a very high probability that the market would further decline another 20% the following year.  Hurst further said there was virtually nothing anyone could do about it.  He was not using the Case-Schiller Index.  He is proving to be correct.

The US housing market will not improve until we work through the supply issues that confront us.  The quickest way to do that is get unemployment lower, but that trend is not happening.  Prices need to drop to a point that demand will start to clear out the market. Government subsidies so far have not allowed that to happen.

However, there is some positive news.  When Building Permits or Housing Starts are announced, they have generally been down.  This is good because it shows new supply is not being created.  Eventually, economic forces will take their toll, supply will be chewed through and we will begin a building phase again.  Prices will stabilize, and start to rise.

If the government tinkers with the market via outright subsidies, or through operations from Fannie, Freddie, HUD or any other government organization; the tinkering will delay the ultimate outcome.   Letting market forces to work is the correct way to deal with this nationwide problem.  Unfortunately, government usually sticks their finger in the pie.