Thursday, December 6, 2007

Analysis: What Should Median Housing Price Be Today?

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I was reading a post on Toro's blog regarding Ben Stein v Goldman (fun stuff!), and I came across a very interesting chart which is simply the historical ratio of median housing value vs median household income.

As you can see from the mid/late 1970s to 2001/2002 the ratio was consistent in a tight range between 2.6x to 3.0x. Essentially this means the median home price in this country was 2.6x - 3.0x median household income. And it's been right around 2.8x for most of that time. That's 30 years....

Then in 2002+, we had innovation.... great innovation... and 1% interest rates. Easy money. No mortgage regulation. Happy times. And crazy housing prices that detached from reality. In 2006 at the height of 'innovation' (where were these politicians 1 year ago? seriously), the ratio went "off" the chart, it appears 4.0x. After the 'correction' we've had, that ratio has fallen all the way to.... 3.8x.

What bugs me most about the 'plans' the politicians are doing is this will only slow down (to some degree) the inevitable - prices coming to a point AVERAGE Americans can afford. Well I should not say that bugs me the most - all of these bailout plans "points" bug me the most. But this is one that the politicians don't get. Once again they sacrifice the long term, for short term. As with everything. (I will spare you the soap box for the 100th time)

But let's take a back of envelope analysis and see what housing prices REALLY need to fall to before they make sense with historical ratios.

In July 2006 at the height of insanity the median price of a home was $230,200
It has already fallen in less than a year (October 2006) to $207,800

Pain over, correction done - time to party. Right? Wrong.

What are median incomes nowadays? As of 2006 the median household income was $48,201.

$48,201 x 2.8 ratio (historical average for past 30 years) = $134,962

Folks that is still nearly $73K away.... or a drop of 35% from October 2007 levels. And a drop of 41% from peak levels in July 2006.

Correction over? Not by a long shot.

Now that's assuming we return to historical norms. I am fully confidant that by the time this is all said and done NEW financial innovations will be introduced (along with bailouts) which will keep prices elevated above where they 'should be' without the 'not so invisible hand' propping things up.

So let's assume household income rises 4% each year (I would argue this is generous considering wage pressure coming as corporations see profits drop)
And let's assume inflation is imaginery (I mean, it works for the government) and we are not paying 5-12% more for food, energy, et al and that does not stress people's budgets - so therefore all this 4% yearly gain in income will be diverted to buying homes and not paying for necessities of life.

Then in 2008 median incomes will have risen to $52,134
And let's assume instead of returning to the 2.8 ratio that is historically where median house values vs income falls, but instead we can now subsist at say 3.2x because of 'the invisible hand', this takes us to

2008: $52,134 x 3.2 ratio = $166,829

That's still a $40,971 drop in median pricing or just under 20% from today's levels.

And again the above assumes we don't return to historical norms.... and we have no inflation, and we have no pressure on household incomes from growing credit card debt, and we don't go into recession, and people don't start losing jobs, and ... and... and...

Well you get the picture. 20% drops SHOULD be expected at a minimum. 35% WOULD be expected if all was fair in love and war. But I truly think the plan is to get interest rates on mortgages back into the 5% world on fixed, and some ungoldy low number in adjustables so we can repeat this mess all over again in a few years. All these bailouts and freezes again miss the main point - homes in MAJOR URBAN AREAS are NOT AFFORDABLE under traditional mortgages to REAL PEOPLE with REAL JOBS and not in the upper 5%. Due to INFLATED pricing (that politicians want to protect) people are forced to pay 40%, 45%, 50% of their income just for a roof over their head. So by "helping them" you are "destroying them". Slowly but surely. But anyhow, that's small stuff - we have banks to bail out.... that's the important thing.

Welcome to the jungle.

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