Just as worrying is the possible recurrence of “payment shock” as interest rates on adjustable-rate mortgages reset higher. Resets on subprime loans have mostly taken place, but the worst is yet to come for some other loans, especially the “Alt-A” category between prime and subprime and a nasty type of mortgage called an “option ARM” (see chart 3). The impact may be muted, but only if the Fed can keep short-term rates very low for the next couple of years—or if the borrowers can refinance as the reset approaches.
Given these downside risks, the recent pop in house prices will probably fizzle. Most economists expect them to fall by a further 5-10 percentage points, to their long-term trend line at roughly 40% below their peak, and not to reach bottom until some time in 2010. The pessimists predict they will go crashing through the trend-line to as little as half their 2006 high.
Analysts at Goldman Sachs, no fools when it comes to housing, hint at several years of stagnation. They argue that the rate of home ownership, currently just over 67%, will fall back to the 64-65.5% level that prevailed before prices took off in the mid-1990s, cutting deeply into demand for properties. This view is supported by a recent Fed study, which found that more than half of the boom-era rise in ownership was due to “innovative” mortgage products, many of which are now history.
It could be even worse. Now that the myth of ever-rising house prices has been shattered, it may be time to embrace another inconvenient truth: that prices can take decades to recover, at least when adjusted for inflation. A study in June by the Federal Housing Finance Agency, a regulator, pointed out that in parts of Texas house prices still languish some 30% below their 1982 peaks in real terms. Mr Hefner may not have got such a bad deal after all.
The Economist
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