“But if we think home prices overshot on the way up, why can’t they overshoot on the way down too?”

From Fortune:

How bad is the mortgage crisis going to get?

Fortune: By year-end, 15 million Americans could have mortgages worth more than the value of their homes. What happens then?

Krugman: Actually, I think home prices will fall enough for us to produce about 20 million people with negative equity. That’s almost a quarter of U.S. homes. If home prices are rising, or if there’s positive equity, you can refinance or sell. But if you have negative equity, you can end up being foreclosed on, and then some people will just find it to their advantage to walk away. We’re probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there – $400 billion or $500 billion in losses – are too low. I think there’ll be $1 trillion of losses on mortgage-backed securities showing up somewhere.

How far do you think home prices will fall?

My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We’ll probably basically retrace all that. So that’s about a 25% decline in overall home prices. Only a fraction of that’s happened so far. Of course, it varies a lot. In places like Houston or Atlanta, where home prices have not risen much compared with underlying rents, the decline will be relatively small. In places like Miami or Los Angeles, you could be looking at 40% or 50% declines.

Is there a risk of a spiral too, where the more homes that are foreclosed on, the lower home prices go?

Not without limit. But if we think home prices overshot on the way up, why can’t they overshoot on the way down too? And to the extent that this all produces a recession, that’s also bad for housing demand. People at the Fed are talking about feedback loops. At the moment, most of what they’re concerned about is that falling home prices are leading to a credit crunch, which is actually driving up mortgage rates and making mortgages unavailable, which is causing home prices to fall even more. I’m not one of those people who thinks the Great Depression is coming back, but there’s lots of echoes.

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2 Responses to “But if we think home prices overshot on the way up, why can’t they overshoot on the way down too?”

  1. Nom Deplume says:

    because this is a housing blog, what effect of the Bear Stearns/Continuing financial services meltdown on NNJ real estate?

    Also, NJ Monthly’s “expert” was on NJ12 the other night, saying if you are going to sell, sell now, implying that NJ is in for a downward drift over the next couple of years.

  2. gio says:

    What abouth Monmouth and Ocean County. looking in Wall, Point Pleasant, it is immune to the down turn. We thought prices would fall but they have not. The country and NJ seem like two separate worlds. Renting and waiting…

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