The truth about the US housing market

Last week, the United StatesCase-Shiller 20-cities Composite house price index took an unexpected plunge,falling 1.3% in October from a month earlier. Prices havenow fallen by aroundone-third(see below chart).

Month-over-month prices fell in all metro areas covered by the index. And in six markets - Atlanta, Charlotte, Miami, Portland, Seattle and Tampa - house prices have reached their lowest level since the housing bust began in 2006 and 2007.

The destruction of household wealth since 2007has been shocking. According to the Federal Reserve, household net worth has declined $11 trillion from its peak in 2007. Relative to GDP, household net worth has fallen from around 470%in 2007 to around 375% currently. In fact, household net worth is currently near its long-run average level prior to the stock market and housing bubbles (see below chart from Calculated Risk).

Much of the destruction of household wealth is due to the decline in housing values. United States housing values as a percent of GDP have fallen considerably and are not far above historical levels. However, mortgage debt as a percent of GDP remains near historically high levels, suggesting more deleveraging ahead for households (see below chart from Calculated Risk).

As bad as the situation has become, it appears that US house prices have further to fall. A recent article by the Dallas Federal Reserve shows that United States house prices are still 23% above their long-term mean (see below Chart):

The Dallas Fed's paper notes that the United States' Government has artificially supported house prices through: purchases of Fannie Mae and Freddie Mac government-sponsored-entity bonds, which has eased mortgage rates; mortgage modification plans, which has deferred foreclosures; and tax credits, which boosted entry-level home sales.

The Federal Reserve's analysis is supported by Peter Schiff, president of Euro Pacific Capital. Writing last week in the Wall Street Journal, Shiff notes that house prices would need to "decline an additional 20.3% from current levels just to get back to the trend line". He also argues that the Government is artificially supporting home values through  "the home buyer's tax credit, record low interest rates, government mortgage-assistance programs, and the increased presence of Fannie Mae, Freddie Mac and the Federal Housing Administration in the mortgage-buying business".