Columnist Defends View on Housing Market

Just check out the comments section of last week's column. They don't just disagree with me, they're enraged at me. And believe me, you don't want to see the hate mail I get. Or hear the threatening phone calls.

The perma-bears want to burn me at the stake just because I noted that the sharp decline in house prices, in relation to per capita disposable income and prevailing mortgage interest rates, makes housing very affordable right now. So maybe we're somewhere near a bottom, I said. Is that so bad?

And I noted that the economy has already shed about 1.5 million housing-related jobs, returning employment in that sector back to the levels seen before the housing bubble got started. So maybe the slump in payroll jobs is somewhere near a bottom, I said. Is that so bad?

Apparently so. For perma-bears, it seems to be an article of absolute faith, that housing is in an ever-deepening crisis that will drag down the whole economy. And in a classic case of circular logic, they think that the bad economy is dragging down housing.

I don't want to be misunderstood as taking a symmetrically dogmatic position. I'm not pounding the table saying the severe housing slump really is at an end, right here and right now. The sector is obviously under tremendous stress, and it faces serious headwinds. But it can't keep going down forever, and when affordability hits all-time highs (which it has) and when housing-related employment goes back to preboom levels (which it has), one has to wonder whether the worst is over.

With that qualification, let me address some of the points made by my critics. My SmartMoney.com editor pointed me to an online rebuttal to last week's column, posted on the Market Oracle web site. The author of the rebuttal may disagree with me, but I appreciate that he refrained from ad hominem attacks and confined his arguments to matters of judgment. So I'll use his article to frame my response.

First, the author argues that housing has yet to correct from a very serious run-up. He says, "Housing prices rose 100% in many big markets from 2002 to 2006. Even more in some places. We have now seen a 30% decline. We need to see a 50% decline and that is just to get back to a point at which houses were already expensive."

He was likely focusing on those areas within the 20 that had the largest run-ups and the deepest declines. But if we're trying to judge the state of the overall housing market, we can't cherry-pick just the examples that tell the story we want to tell. We have to look at the whole thing. If we're going to cherry-pick, I can find individual areas where there is no housing crisis whatsoever (in fact, I live in one of them — Silicon Valley).

Furthermore, even using the author's numbers, I still don't accept his assertion that prices must correct all the way back to their 2002 levels, and further, that even if they do they will still be "expensive."

Next, the author refutes my affordability argument by saying, "Housing prices...compared to salary are still high. The argument that wages and incomes are rising on average ignores a monstrous skew. Real wages have been falling for the bottom 80% or so of the population, and dramatically for the bottom 50% of the population."

First, it's not a matter of "real," i.e., inflation-adjusted earnings. Houses are bought with nominal dollars, not real dollars. The author's wages numbers look worse because they're inflation-adjusted, while the housing prices look worse because they're not inflation-adjusted. Second, average incomes are the correct measure, because we are talking about buying the average house. Third, the lowest rungs of the income distribution don't buy houses anyway.

Fourth, I've yet to see any statistics that support his claim showing that the drop in incomes — properly measured in nominal terms, not real — occurred at a point in time that coincides with the housing bust. Income trends in place now have been in place for several years, during the housing boom and now during the housing bust. There doesn't seem to be any connection, or even a compelling-looking coincidence.

Finally, the author ends his article with a chart of Japanese land prices, which had a large run-up and then a large fall. The chart is annotated with witty remarks about the investor psychology, overlaid with markers indicating where the U.S. housing market is in the same boom-and-bust pattern.

This is the author's weakest argument. It is a pop-psych history of another time and another place, where the details are so remote that no one can know if his interpretation is right or wrong. Nevertheless, it's presented as though we are preordained to follow it as a train must follow its tracks.

Bottom line? I stand by my affordability argument. I still firmly believe that home prices today, given incomes and mortgage rates, are as cheap as they've been in over 35 years. We may not be right at a bottom yet, but there's one somewhere nearby. I now believe that all the more having had a taste of the backlash from the cult of bearishness. When so many people believe something with so much conviction, well, it just has to be wrong.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.