May 6, 2008; Page A23

The dire headlines coming fast and furious in the financial and

popular press suggest that the housing crisis is intensifying. Yet it is

very likely that April 2008 will mark the bottom of the U.S. housing

market. Yes, the housing market is bottoming right now.

How can this be? For starters, a bottom does not mean that prices are

about to return to the heady days of 2005. That probably won't happen

for another 15 years. It just means that the trend is no longer getting

worse, which is the critical factor.

Most people forget that the current housing bust is nearly three years

old. Home sales peaked in July 2005. New home sales are down a

staggering 63% from peak levels of 1.4 million. Housing starts have

fallen more than 50% and, adjusted for population growth, are back to

the trough levels of 1982.

Furthermore, residential construction is close to 15-year lows at 3.8%

of GDP; by the fourth quarter of this year, it will probably hit the

lowest level ever. So what's going to stop the housing decline? Very

simply, the same thing that caused the bust: affordability.

The boom made housing unaffordable for many American families,

especially first-time home buyers. During the 1990s and early 2000s,

it took 19% of average monthly income to service a conforming

mortgage on the average home purchased. By 2005 and 2006, it was

absorbing 25% of monthly income. For first time buyers, it went from 29% of income to 37%. That just

proved to be too much.

Prices got so high that people who intended to actually live in the houses they purchased (as opposed to

speculators) stopped buying. This caused the bubble to burst.

The Housing Crisis Is Over - WSJ.com

http://online.wsj.com/article_email/article_prin...21003604494869449-lMyQjAxMDI4MTAwNjAwMzY2Wj.html (1 of 4) [5/6/2008 4:36:37 PM]

The Housing Crisis Is Over - WSJ.com

Since then, house prices have fallen 10%-15%, while incomes have kept growing (albeit more slowly

recently) and mortgage rates have come down 70 basis points from their highs. As a result, it now takes

19% of monthly income for the average home buyer, and 31% of monthly income for the first-time

home buyer, to purchase a house. In other words, homes on average are back to being as affordable as

during the best of times in the 1990s. Numerous households that had been priced out of the market can

now afford to get in.

The next question is: Even if home sales pick up, how can home prices stop falling with so many houses

vacant and unsold? The flip but true answer: because they always do.

In the past five major housing market corrections (and there were some big ones, such as in the early

1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home

sales bottomed, the pace of house-price declines halved within one or two months.

The explanation is that by the time home sales stop declining, inventories of unsold homes have usually

already started falling in absolute terms and begin to peak out in "months of supply" terms. That's the

case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000

homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high

it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines

within the next six months.

Inventories are declining because construction activity has been falling for such a long time that home

completions are now just about undershooting new home sales. In a few months, completions of new

homes for sale could be undershooting new home sales by 50,000-100,000 annually.

Inventories will drop even faster to 400,000

in inventories will have a significant impact on prices, although house prices won't stop falling entirely

until inventories reach five months of supply sometime in 2009. A five-month supply has historically

signaled tightness in the housing market.

Many pundits claim that house prices need to fall

they've been historically. This is usually based on an analysis of house prices adjusted for inflation: Real

house prices are 30% above their 40-year, inflation-adjusted average, so they must fall 30%. This

simplistic analysis is appealing on the surface, but is flawed for a variety of reasons.

Most importantly, it neglects the fact that a great majority of Americans buy their houses with

mortgages. And if one buys a house with a mortgage, the most important factor in deciding what to pay

for the house is how much of one's income is required to be able to make the mortgage payments on the

house. Today the rate on a 30-year, fixed-rate mortgage is 5.7%. Back in 1981, the rate hit 18.5%.

Comparing today's house prices to the 1970s or 1980s, when mortgage rates were stratospheric, is

misguided and misleading.

This is all good news for the broader economy. The housing bust has been subtracting a full percentage

point from GDP for almost two years now, which is very large for a sector that represents less than 5%

of economic activity.