Housing stall, after all?

Looking at the economy now, we have to go well beyond subprime, and consider the general value of housing. Karl Denninger repeats that, in the long term, average house prices are three times income, but at the same time observes that they are "sticky". No-one wants to crystallise a loss, and you have to live somewhere, so why sell now?

If the financial victim next door has to sell his house at a 50% discount, that's all the more reason for you not to sell yours. If no-one sells voluntarily, how do you determine a real, as opposed to forced-sale value? So one effect of the housing drop could be a general slump in sales - with maybe a rise in home swaps for those who need to go to a different geographical area, perhaps for job reasons.

But what about people caught in negative equity? Here in the UK, ditching the house for less than the outstanding loan could leave you being chased for the balance, for years, unless you opt for bankruptcy. However, in the USA, many mortgages are on the roof but not on the borrower, leaving the lender short if the homeowner mails the keys back. Denninger has said more than once that borrowers need to consider this option solely on its financial/legal merits, as he thinks many lenders lost the moral argument when they knowingly advanced far too much to people who they knew couldn't maintain the loans. Now this could really upset the applecart.

Michael Panzner features a piece by FT columnist Martin Wolf. Wolf wonders what may happen if a high proportion of negative-equity homeowners default. The economic impact may be closer to Nouriel Roubini's $3 trillion, than to Goldman Sachs' more sanguine $1 trillion (the latter itself is a massive increase on the sort of figures bandied about before Christmas). Wolf sees two options:

There are two ways of adjusting the prices of housing to incomes: allow nominal prices to fall or raise nominal incomes. The former means mass bankruptcy and a huge fiscal bail out; the latter imposes the inflation tax.

But either option is so unattractive that (despite Denninger's image of paddling furiously as we head for the waterfall) there is a very strong incentive for fudge and delay. We've seen central banks pump many billions into the system in the last few days; and the ratings agencies seem to be trying their best to help maintain the status quo by not downgrading lenders as quickly and severely as some think they deserve. But again, housing is intrinsically illiquid, and houses aren't turned over rapidly like shares, which is why we have "mark to model" instead of "mark to market". What's the rush to crystallise a terrible loss now? Better a Micawberish hope that "something will turn up" than a grim Protestant insistence on an immediate collapse which would benefit very few people.

Assuming wages continue to rise over time, the gap between prices and incomes will lessen. If the homeowners can somehow be reassured that the government is determined to support house prices, then the sell-to-rent speculators could be caught out in their attempt to "short" the housing market. Can they be sure that, having sold their nice house, they can buy another such in the right area for much less, later? What will they do meanwhile?

The real threat is this "jingle mail", and the potential consequences seem so dire that something creative may be done. Bankruptcy rules might be modified to protect lenders; maybe portions of recent loans may be written-off. How about part-ownership, part-rent, as with UK housing associations - having escaped the trailer park, many first-time homeowners may want to keep their foot on that first rung of the ladder. Not everyone will want to pour engine oil into the carpet and trash the light fittings.

So I think we will have fudge, delay and attempts at more creative solutions, and a long stall in the housing market. Unless there's another hammer blow that the system simply can't take, such as an explosion in the financial derivatives market, as arch-doomster Marc Faber expects and (in his inherited Swiss Protestant way) hopes. In that case, every sign we've seen so far is that our governments will run the money-presses white-hot rather than face major deflation. We all have an incentive to paddle away from the brink.