Houses and Tulip bulbs

2 years ago I was looked upon as a complete whacko when I told people I thought house prices would crash back to where they were in 2000. Last year they didn't laugh as hard but instead insisted that prices would only fall a little. This year I look like a freakin prophet and I take great pleasure when I read articles like the following. Unfortunately they are still few and far between but as the fog clears and people start to clearly see what happend over the last decade we should see many more articles like it.

Let Home Prices Fall

(CBS) This column, Other People's Money, is written by CNET's Declan McCullagh. It appears each Wednesday on CBSNews.com.

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By now it should be clear that our economic woes have been caused in large part by an unsustainable increase in housing prices, which are now falling back to earth.

Some of the blame must go to politicians like Democratic Rep. Barney Frank, whose prognosticating abilities were evident five years ago when he fought reform of Fannie Mae and Freddie Mac by claiming they do not pose "a problem with a threat to the Treasury." Whoops.

Now these same Washington soothsayers are predicting that today's economic troubles can be ameliorated by propping up real estate prices. Reps. Frank and Nancy Pelosi said last week that it's "essential" to partially guarantee 1.5 million mortgages, and President-elect Barack Obama also wants "direct, immediate assistance for homeowners."

In reality, more government intervention will do more harm than good. The sooner prices are allowed to naturally fall to normal, post-bubble levels, and the sooner that houses become affordable, the sooner the economy can heal itself and start growing instead of contracting.

By way of analogy, imagine a reprise of the Dutch tulip mania of 1637. Say the price of tulip bulbs has grown handsomely in the last few years, and impressive fortunes were made by early speculators.

Bidding wars erupt, with the winners hoping to resell them the bulbs at a handsome profit months or years later. Cable TV hosts proclaim that a golden age of prosperity has dawned. Prized bulbs change hands for $1 million each, and skeptics are reviled as doomsayers.

Eventually this boom leads to a bust, as new buyers become scarce, and the price of tulip bulbs suffers a dizzying fall down to $10 each. Speculators complain to Congress. Politicians pledge to use tax dollars to purchase bulbs for $1,000 or $10,000, invoking phrases like "stability" and "liquidity crisis," or offering taxpayer-backed loan guarantees to speculators.

This would sound silly for tulips, but it's close to what's happening for houses. All this will do is slow -- and not arrest -- the process of prices falling. Not even the president of the United States can veto the laws of supply and demand.

By usual metrics, such as the ratio of prices to incomes, the ratio of rents to mortgages, and the ratio of current prices to expected ones, some areas of the country still look pretty bubbly.

In the decade ending August 2008, according to S&P Case-Shiller data, house prices in New York metropolitan area leaped by 2.2 times, though incomes grew only modestly. The Washington, D.C. area experienced a 2.1-fold jump -- while non-bubbly areas like Cleveland saw an increase of a mere 1.17 times, which is consistent with incomes and inflation.

The median family income in Allentown, Penn. is $46,400, and the median home price is $125,000, meaning houses tend to cost 2.7x the median income. Compare that to San Francisco, where homes consume a whopping 11.6x the median annual salary.

Robert Shiller, who teaches economics at Yale University, has calculated that housing prices have remained remarkably constant from 1890 through 1998, rising only 13 percent when adjusted for inflation -- through world wars, the automobile, and the rise of the two-income family. When the dot-com bubble burst, money flowed into real estate, encouraged by the Federal Reserve cutting interest rates more than prudence allowed.