The latest Case Schiller index (for December 2008) which tracks US house prices has recently been published and shows a picture of continuing house price declines. Although the picture at first glance would appear gloomy there are some signs of a flattening in the rate of decline.

 

 

 

 

 

On a month to month, seasonally adjusted basis prices fell by 1.88% in December (the latest month available). However this falls needs to be taken in context with the strong seasonal nature of the US house prices as the graph below demonstrates.

 

 

 

 

Regional differences

 

As usual the Case Schiller 20 city index does mask some strong regional discrepancies, not just in terms of rate of decline but also from the point at which they started declining.  Cities such as Seattle, Portland, Dallas and Charlotte, experienced a house price peak much later in the cycle, hence if you measure the price change from the start of the ‘national decline’, performance in these areas overall is still reasonable compared to the national average. However if you measure from the point when prices peaked in each city/region, prices are now falling in the previous ‘stable’ areas at comparable rates to areas such as Phoenix and Los Angeles. For example, prices in Seattle are down circa 9% since June 2006 but over 18% from the city peak in July 2007.  Prices in Charlotte peaked in June 2008 and are now down 9.0% in the six months since.  Undoubtedly the current recession is having an impact across the US in areas that were otherwise relatively stable.   

 

 

Why US house prices matter to the global economy

 

As we have covered before, there is little actual direct linkage between house prices in the US and the UK (although the point of stability may be the same). However, with over $6 trillion of US mortgage debt out in the markets in various forms, until US prices stop falling the prospects of a global recovery are greatly reduced. Falling property prices means increased losses for holders of mortgage backed securities (MBS), a mark down in MBS prices and a reluctance by banks to lend new money when the risks remain high and there is no clear exit route (given that securitisation markets remain effectively closed). As well as the direct impact on the banks and asset holders themselves, falling prices have a major impact on consumer spending patterns. The good news is that President Obama clearly understands the importance of trying to stabilise the US housing market

 

Is there any good news?   

 

Well surprisingly yes. Whilst falling house prices are not good for the economy, the quicker prices adjust the quicker the bottom will be reached and an line can be drawn under losses. Rather like having a tooth pulled, a short sharp adjustment is better than a long drawn out affair. Our stated position has always been and remains that Q3/Q4 this year will mark the turning point for the housing market for four significant reasons:-

 

 

 

1.    Prices in the UK will be off nationally, peak to trough, by circa 30%.  In the US they will be off by circa 35%. These price falls are the consensus peak-to-trough falls agreed by most industry analysts. In a UK context, lower prices combined with low interest rates will bring buyers back into the market and there is tentative evidence of this happening already.   

2.    Mortgage rates on both sides of the Atlantic are at historically low levels. Whilst the full extent of the rate cuts are not yet being passed on, rates in real terms are very affordable. For example many two year fixes are now under 4.0%.

3.    The governments on both sides of the Atlantic are putting in place a number of measures to kick start lending both to businesses and homeowners. In the UK, as well as the Northern Rock recommencing lending, a condition of the government assistance to the both RBS and Lloyds is that they significantly increase their lending. Unlike other initiatives we understand from senior sources at both banks the pressure to increase lending is intense and should not be under-estimated.    

4.    Many believe that there could be investor demand re-emerging for bland, simple securitised structures which will increase lending and positively impact house price dynamics.

 

We believe that asset price, borrowing rates and supply of funding, will converge in Q3/Q4 to bring about stability. There may be a period of ‘bouncing around the bottom’ where trends are hard to define, but the period of continual house price falls will be over.

 

The end is not yet over, but it is in sight…