Home Prices Rise, But Is It Sustainable?

The Case-Shiller 20-city home price index showed a 0.7% gain for April, which is due in part to seasonality. Although the weaker markets such as Detroit and Las Vegas were down in April, the majority of markets in the 20-city index were up. There should be a bounce in home prices in the spring and summer months, perhaps followed by further declines in the fall. While we probably haven’t reached a complete bottom in housing, I think we are getting close.

The current real estate market is very interesting because investors account for about 25% of home purchases, and a large majority of these purchases are for all cash. Investors think about the housing market differently from the average person- they look at metrics that indicate value, such as the price-to-rent ratio. In the chart below taken from Calculated Risk, you can see that the price-to-rent ratio is back at 2000 levels. Rents should hold up pretty well as more people default and walk away from their homes. This is the rosy scenario for housing.

Unfortunately, there is a less rosy scenario for real estate. All bets on housing are off if Bernanke actually follows through on his plan to eliminate quantitative easing. While this is a low probability event in my opinion, it is certainly a possibility. In the event that Bernanke closes the money spigots for good, home prices would likely fall even in the normally strong summer months. I think with confidence where it is now, you would see protests and riots as the percent of underwater homeowners rose closer to 40%. I believe we are uncomfortably close to experiencing the all-out collapse in public confidence I’ve been speaking about for years.

With a Presidential election coming up in a year, Obama will do whatever it takes to get reelected, which means stimulating the economy. I’m not sure exactly when QE3 is coming, but it should be here before the end of the year, probably in the fall. Consumer confidence is at 7 month lows and unemployment is persistently high. The only real option from the government’s perspective is to keep on priming the pump. The dollar, after a brief countertrend rally, should fall substantially. There is still no viable solution to the problem of constantly paying interest on our debt to foreigners, which means stimulus will ultimately fail. We are not diagnosing the real problem.

I will be very interested to see where interest rates go from here now that QE2 is over. Greece had debt-to-GDP ratios in 2009 of slightly over 100%, which is just about where we are today in the U.S. Two years later, Greece is facing a huge crisis with riots on the streets and 2 year bonds trading at 26%. This is the type of scenario Americans should be preparing for- things can spiral out of control quickly.

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