“And then everyone might agree on what a housing bust is.”

From the International Herald Tribune:

When does a housing slump become a bust?

Many Americans fear the consequences of a housing bust, but few know what one would really look like.

Think about it. How far do housing prices have to fall before a slump becomes a bust?

In the stock market, we have a pretty good idea what a crash is. Among stock market experts, there is a consensus that a 10 percent decline in a major index is a correction while a 20 percent decline is more significant: a crash or a bear market, depending on the time involved. For the macro economy, there is also agreed-upon terminology. For example, a recession means two consecutive quarters of declining gross domestic product.

But when it comes to declines in housing prices, there is no such framework. As experts debate whether we are headed for a housing bust, you would think that we should at least be able to define it.

The problem is that economists have not agreed on a definition. In part, that is because severe declines in housing prices tend to be rare events, not a common subject for discussion. The last really big decline in national housing prices occurred more than 70 years ago, during the Great Depression. Another reason is that the data measuring the housing market is far more opaque than that for the stock market.

But let’s work with the data we have. Start with the worst housing market on record. During the 1930s, housing prices fell sharply across the nation. According to the S&P/Case-Shiller home price index, a measure of national housing prices, the average price of a home fell 24 percent from 1929 to 1933.

More recently, there have been severe price declines in regional markets. The most severe was in the so-called oil patch during the 1980s. In the late 1970s, as global oil prices soared, oil-producing areas of Texas, Oklahoma, Louisiana, Colorado, Wyoming and Alaska experienced an economic boom. As oil prices collapsed in the early 1980s, those economies crashed, and housing along with them.

In the worst cases, nominal home prices fell 40 percent in Lafayette, Louisiana, and 33 percent in Casper, Wyoming, from 1983 to 1988, according to the Office of Federal Housing Enterprise Oversight. In Houston, prices fell 22 percent.

There were also sharp price declines in housing on both coasts during the early 1990s. At that time, a series of events, including the recession of 1990-91, the military downsizing after the Cold War and a commercial real estate collapse, led to a housing downturn.

Two economists with the Federal Deposit Insurance Corp., Cynthia Angell and Norman Williams, have studied housing cycles since 1978 and have come up with a definition of a housing bust. In a paper published in February 2005, they called it a decline of at least 15 percent in nominal prices, meaning not adjusted for inflation.
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Other economists, however, argue that 15 percent may be too restrictive a definition. Mark Zandi, chief economist of Moody’s Economy.com, says a better one would be a decline of 10 percent or more from peak to trough. “When you see a decline in home prices of 10 percent, you get significant credit problems, and it’s enough to wipe out equity in most cases,” he said.

Zandi also said that once prices have dropped 10 percent, there tends to be a self-reinforcing downward cycle. If borrowers can’t afford their mortgages and banks foreclose, their homes are generally sold at significant discounts to the market. That creates an added drag on overall prices, resulting in greater numbers of foreclosures, followed by even greater price slides.

Another reason Zandi argues for 10 percent is the tendency of housing-price measurements to underestimate declines. Sellers often provide discounts that may not show up in the measured price, but are still significant. Today, some homebuilders are discounting the sales price of new homes by an average of 5 percent, Zandi said.

So how far have prices actually fallen? The median price of an existing home has declined 4 percent, on average, since the peak in October 2005, according to the National Association of Realtors.