When we look at the housing bubble and resulting correction, it’s understandable why so many people want to see a turnaround in prices.  Most of the time, they want to believe the best case scenario; that is the human nature in all of us.   But a lot of the time human nature coupled with ignorance will get us in trouble if we ignore the facts. Let me just be right up front and say the following:

The housing bubble was historic in nature.  Housing isn’t coming back soon and “back” wasn’t real, for a long time if ever.   Let me explain.

The problem with the question of “when is housing coming back?” assumes that the market values reached in 2006-7 were real and simply, they weren’t.  Understand that house prices created in this housing bubble were anomalies,  make believe, once in a lifetime rises and it is very likely we will never see those levels even off in the distant future 10 years from now.  So, when you are trying to place a true value on your house,  you can not look at the highs from a few years ago.   Those prices were created with mortgage products that don’t exist anymore.

There is no real delicate way to put this.  We are at a serious crossroads that needs to be comprehended if it is to be dealt with.  Investment Banks leveraged real estate far beyond anything that has any historical perspective.

In so many ways, we are so naive at how real estate prices work.  We never stop and think that the only thing that supports them, real income is declining with the unemployment picture as bad as it is.  People come on television proclaiming to understand real estate, with references like “housing stabilized last quarter”.  Yet, they are only looking at some cyclical metric that is the result of foreclosures being offloaded  for pennies on the dollar.   Many are dangerous to listen to as they drag out charts insisting we are near a bottom because prices are x % from the top.  They don’t understand all the factors that are in motion when it comes to housing.

Every market is in a constant state of flux trying to adjust and adapt to the things around it.  Housing is currently trying to adapt to what is only similar to that of a nuclear bomb being dropped in the middle of a large city.  Given that analogy you have to understand that real estate is the largest market or asset class; it affects everyone.  This partially explains why it seems so bad.  The tech bust that cracked in 2000 was bad but not nearly as severe.  Even the most aggressive stock margin accounts held at least 35% – 50% equity at the peak, whereas 100% mortgages or 0% equity were the name of the game at the top of the housing market.

The other important fact that needs to be understood about this real estate cycle is that because of the securitization of mortgages (Mortgage Backed Securities) banks didn’t care about the quality of the person borrowing the mortgage.  Sure, they would underwrite the mortgage but only to package it and sell it into the market place.  No one really understood what they were buying and it turns out that a great majority of the mortgages were simply fraudulent with no chance of ever performing when the music stopped (2007).  This is why you hear of so many mortgages being underwater.  Here are the cities with the most underwater mortgages:

* Tampa-St. Petersburg-Clearwater, Florida: 48.2%

* Bredenton-Sarasota-Vencie, Florida: 48.2%

* Lakeland-Winter Haven, Florida: 49.2%

* Bakersfield, California: 50.4%

* Riverside-San Bernardino-Ontario, California: 58.5%

* Cape Coral-Fort Meyers, Florida: 60.5%

* Valleyo-Fairfield, California: 61.1%

* Orlando, Florida: 62.3%

* Reno-Sparks, Nevada: 62.4%

* Port St. Lucie-Fort Pierce, Florida: 62.5%

* Phoenix-Mesa-Scottsdale, Arizona: 63.5%

* Stockton, California: 66.9%

* Modesto, California: 70.4%

* Merced, California: 74.2%

* Las Vegas-Paradise, Nevada: 81.1%

This trend has picked up as many more people are simply walking from their mortgages.

We will see real estate prices under pressure for a while.  Looking out, this decline should last into 2012 where we could see a cyclical bounce for 2-3 years and then back to the secular move down.

Typically real estate can rally with inflation or government stimulus. However, because there is so much bad debt (underwater mortgages) being thrown into the system at one time and because we can surely expect higher taxes to make up for the lack of revenue generated from real estate, housing will not be able to sustain any rally.

Many will take this article as negative and I understand that.  It’s not something you want to look at if you’re holding an underwater mortgage.  However, the good news is that because of the dynamics the housing bubble has popped and will correct to levels (not believable now) where mortgages (ultimately) will not be so burdensome.

Here is Parts 2 and 3 to this 3 Piece Series

Understanding the Real Estate Correction Part 2

Understanding the Real Estate Correction Part 3

Related posts:

1. Understanding This Housing Bubble Correction Part 2
2. Understanding This Housing Bubble Part 3, Final (How To Prepare)
3. Underwater Mortgages, The Next Bubble
4. Mortgage Reset Chart, A Look at Housing
5. The State of Housing