The housing market

For four years, I have said housing was overpriced, and for four years, I have been proven wrong by the market.

As Bill Parcells says, "You are only as good as your record says you are." Yet, despite the interventions of friends and family members, I am not willing to admit defeat on this one.

Here's why.

There is something called Fundamentals. When the stock bubble was hitting it's highs of 1999 and 2000, Warren Buffet was sticking to Fundamental analysis, and writing articles in Fortune Magazine firmly stating that stocks were overvalued. Just as Alan Greenspan was being hailed as a Maestro and he proudly accepted the Enron Award from Ken Lay, Warren Buffet was being labeled as a washed-up has-been. But who was right in the end? The "you don't need assets" Ken Lay? Well, you don't need assets in prison. That's for sure.

While Fortune Magazine won't accept my articles, at least there is this blog to express my belief that Fundamentals apply to housing, too.

So, while my brother-in-law states that "housing prices could never go down in this neighborhood" and a good friend here in Boston claims "housing supply is too limited for there to be prices declines", I firmly state: "Malarkey!"

In my opinion, housing prices are driven by two main factors: interest rates and incomes.

What has changed significantly in this boom is interest rates, allowing people with the same income to afford larger principle payments and therefore more expensive houses.

However, if interest rates go up, principal payments will fall, as will housing prices. Already, the housing market is slowing, even as long-term rates have barely gone up.

The other part of the equation is incomes. There are several components to income: number of incomes in a society, amount of those incomes, and amount of those incomes being devoted to housing. Since the 1700's, housing expenditures as a percentage of income have not changed. I don't think they have in this boom, and I don't think they will in the future.

Nor have the number of incomes nor the amount of those incomes changed so significantly since 2000, 1995, 1990 or even 1980 to warrant a multi-fold increase in the price of houses. Certainly the incomes in America are not twice what they were in 2000.

So, what, I ask, has so fundamentally changed?

Interest rates. Of course, there is the very real possibility that the housing market will "correct" by simply staying at these prices for 5 to 10 years, while a politicized Fed keeps interest rates low and let's inflation go through the roof. Although Ben Bernanke says he believes in "inflation targeting", I find it hard to believe that he will continue to raise interest rates if the economy slows down and unemployment worsens, even if inflation continues to accelerate.

In either case - whether the Fed raises interest rates and housing prices decline significantly, or the Fed let's inflation go while housing prices stagnate - one thing is clear: there will be a correction in inflation-adjusted housing prices.

"Fine, but that won't affect this neighborhood!"