AEI Sees No Collapse Imminent for Housing

Despite a record number of foreclosures, housing price declines have been small and will remain so, according to a new paper released here last week by the American Enterprise Institute.

Cushioned by such other "fundamental factors" as employment growth and reductions in the housing supply, prices on average will slide by only 4.5% under the study's worst case scenario, said one of the study's three authors. Only 11 states will see prices drop by more than 6% by the end of 2009, he predicted.

"Foreclosures and home prices have negative effects on each other over time, but this does not imply a vicious cycle of housing price collapse," said author Charles Calomiris, a professor at Columbia University's business school and a visiting scholar at AEI,

"Our models predict that as foreclosures continue to climb in many states, house prices will remain flat or decline in those states, but prices will not collapse."

Peter Wallison, who heads financial policy studies at the conservative think tank, said that in light of the new research, federal policy makers may want to rethink proposals for a bailout of struggling home owners.

"If the effect of foreclosures on home prices is not substantial," Mr. Wallison said, "there is a good deal less reason for political Washington to be pressing for expensive government programs to prevent foreclosures."

But economist Mark Zandi of Moody's Economy.com argued that the study is flawed, and maintained that the impact of repossessions is "quite significant," especially on low-income households.

As Mr. Zandi sees it, the foreclosure problem is "extremely severe" nationwide and "it's not getting better; it's getting significantly worse.

"The problem now is negative equity," he warned. "Some 8.5 million homeowners owe more than their houses are worth. When you consider there are 52 million owners with mortgages, that means 16% - 17% of the nation's homeowners are underwater."

By "simple intuition," the economist added, "when a house goes into foreclosure, it goes into inventory, and the only way to reduce the inventory (of unsold houses) is to cut prices."

However, Jay Brinkman, vice president of research and economics at the Mortgage Bankers Association, lauded the study, saying that it captures the realization that the housing downturn is a local phenomenon.

"Any analysis of housing prices has to do what this paper has done, (which is to) go on a state-by-state basis," Mr. Brinkman said.

In concluding that the fear of big drops in house prices is "overstated," the study's authors point out that while the national foreclosure rate is "very high by historical standards," the rise in repos in most states is "not as high" as it has been in previous housing cycles.

They also take issue with the Standard &Poor's/Case-Shiller Housing Price Index, the measure cited most often by the media and legislators to show the sky is falling on housing.

Most recently, Case-Shiller said prices have nose-dived 14.1% over the last year, but Mr. Calomiris argued that the index is a "poor measure of what is really happening to the value of most American's homes."

The authors' issue with Case-Shiller 20-MSA index is that it is prejudiced towards the markets most susceptible to dramatic swings in prices. "Case-Shiller is biased towards bad news," Mr. Calormiris said.

The index has no data from 13 states which hold 11% percent of the nation's housing stock, and has only partial coverage in 29 other states which contain 79% of the stock, the study argues, noting also that the places omitted or only partially covered appreciated at a slower pace during the housing boom and, therefore, are less apt to see great price depreciation.

The authors also maintain that because Case-Shiller value-weights its transactions, it gives too much value to higher priced homes.

The paper contends that the indices published by the Office of Federal Housing Enterprise Oversight are "more representative" of housing price variations because they cover both small and large markets across the country and are more indicative of what is happening to the value of homes owned by middle-class families.

"The Case-Shiller index over-weights jumbo mortgages, making it a poor reflection of what is really happening to the typical American homeowner," Mr. Calomiris said.

With OFHEO as their measure, the authors conclude that even under the worst case scenario, their findings "remain the same: U.S. house prices just aren't going to fall by very much in the next two years."

Mr. Brinkman, the MBA economist, also argued that the Case-Shiller index is heavily weighted towards the four states hit hardest by foreclosures - California, Florida, Nevada and Arizona. The four states account for just 25% of all mortgages nationwide.

"It makes no sense to look at the whole country based on what's taking place in these four states," he said, pointing out that they account for 42% of all foreclosures. "There are substantial difference between the states."

But Mr. Zandi said the study erred in using the OFEHO index as a best measure of movements in house prices because it does not include sales of foreclosed properties. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/

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