The U.S. housing market gained 86% in real inflation-corrected value from 1998 to the peak in early 2006. In my view, this degree of asset value inflation was unwarranted, and driven by excessive investor enthusiasm for housing as an investment. Since the peak, it has lost 6.5% of its real value.
Note from Figure 1 that neither the rise of home prices to 2006 nor the fall thereafter can be attributed to changes in the rental market for homes or to changes in building costs. That is part of the reason why I believe that the home price changes are basically speculative, and, I believe, driven by market psychology.
The futures market for single family homes at the Chicago Mercantile Exchange that I and my colleagues at MacroMarkets LLC helped establish last year has been in backwardation, that is, it has been implying further declines in home prices. If one corrects for inflation, it can be interpreted as predicting another 7% to 13% decline in real value by August 2008, depending on city beyond the 6.5% we have already experienced. Since the asset values in the housing market are so large (approximately $23 trillion) this amounts to a real loss of home value on the order of trillions of dollars by August 2008.
I am worried that the collapse of home prices might turn out to be the most severe since the Great Depression. It is difficult to predict the depth, duration and all of the consequences of such a decline operating in a much more complex modern economy.
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