What came first, falling home prices or a slumping market?
Chicken or the Egg?
While pundits galore will claim many different views, the answer is rather simple in economic terms. After years and years of record home price increases, the market simply couldn't support the increases anymore. Buyers could no longer afford the prices. House prices started falling first simply because no one was willing to pay the price anymore.
Most loan programs like to see debt ratios no higher than around 40% of income. FHA for example is 43% on a manual underwrite. Again, simple economics apply here. If the average wage in Minnesota (where I am at) is $784 per week ($40,784 per year), assuming no other debt (not likely), 5% down, PMI, taxes and insurance, this person could buy around a $180,000 home. Start throwing in debt, car loans, credit cards, etc., and the maximum home price starts sinking as fast as a rock in water.
As home prices increased, buyers started switching to high risk, short-term loan products to make homes more affordable. As we can see by today's market, that was a short sighted plan that didn't work out well for many.
Therefore there really is only one way to get demand up and people to start buying again. Affordable prices. Simple supply and demand economics. Too much supply because of too little demand forces prices to drop. As unsold inventory clears, the result will be higher prices, but fewer sales.
The higher price but fewer sales, the normal supply and demand cycle was dramatically upset the past ten years as people threw caution to the wind and kept demand artificially high. Everyone wanted in and was willing to pay whatever price was asked. Everyone figured you could make a killing in the housing market. This was especially evident in the investment property market.
A killing has occurred. Just not the one most people expected.
So what do we do? Nothing. The market will correct itself as prices drop, rates stay attractive, and housing affordability returns.
(C) 2008 Joe Metzler - www.JoeMetzler.com
