Are we there yet? The real estate market’s wild ride

In 2004-2005, when the real estate market was said to be “slowing,” and the papers were raising alarmist cries about an imminent bear market, I hoped that the market in fact was slowing for a few years to digest the unsustainable gains made in the preceding eight years. A soft landing at that level would be much preferable to a harder fall from a higher level. But this was not to be. The “slowing” market was still expanding at an annual rate of 6%-7% in our area. How awful! The market was just taking a breather before one final mad, overheated double-digit rise from 2005 to 2006. It was that last spurt that appears to contain the worst of the bad teaser loans and other ill-advised debt arrangements with unqualified borrowers as easy money had exhausted the supply of available good loans and chased increasingly overvalued real estate and bad creditors.

Since then we have been deluged with bad news about the real estate market. Those pundits who acted as if the boom market might never end are now falling all over themselves with the latest gloomy prediction of the week. As I drive through my neigborhood and as I get mailings from realtors, I notice two things. One, prices have fallen back to levels around 2003. Mind you, that still incorporates a tremendous run-up in value for the preceding six or seven years. Two, there are very few houses for sale, and those that are, mostly sell rather quickly. So things may not be quite as bleak even in California as writers who want to get their articles published (Gloom is “in” this election year!) would have you believe.

I listened to an interview with Larry Kudlow a few days ago, and he was discussing this very point. Barring any further and still unknown disasters, the market may be sniffing bottom, with a gradual recovery around the corner. Kudlow mentioned this article in Barrons. I agree with the writer’s very guarded optimism. The market will clear economic excesses with a brutal efficiency if left to its own devices.The wave of foreclosures on untenable loans to unqualified customers hit quickly and hard. The rate of delinquencies has been dropping. Therefore, the rate of foreclosures is likely to drop in the future. Once that happens, prices will stabilize. (NOTE: Look at the table in the article that shows the increase in value of real estate just since 2000, even after the price drop of the last year-and-a-half.)

Government involvement, however, is usually like the desanguinization fad in medicine. It may kill the patient, and any improvement in the patient’s condition is despite, not because of, the treatment. So, though this is an election year, it would be best for the government to avoid “saving” unqualified borrowers, as that will just delay the day of reckoning. Those that can afford the true loan rates don’t need saving. If the borrowers get to keep their teaser rates permanently, they will get an advantage for their avarice and/or stupidity that more responsible debtors don’t. That sends the wrong message. If the article is correct, the government’s “cure” would be too late and unncessary.

While the Fed’s action in regard to Fannie and Freddie may be justified on an emergency basis, I agree with those who think that those companies went off the road when they began to act not as market facilitators but as market investors in holding on to loans for their own portfolios. Their presence in the market and their privileged position distorted the normal competition that might have triggered an earlier response from a more decentralized and competitive market. In the longer term, that should be addressed, but not through a “bailout” or de facto government control of real estate lending. I think that having the government buying stock in companies that control such a large share of the country’s real estate loans sets a bad precedent of political economy.

UPDATE: For more on the Fannie/Freddie issue, here is an article by Larry Kudlow.