Home seller denial means protracted slump: James Saft

LONDON (Reuters) - Denial ain't just a river in Egypt, it's the state many from California to Florida are in about the dwindling value of their most important asset: their homes.

The old adage is that markets are driven by greed and fear, but in real estate, with its central place in people's psyches, the transition from one to the other includes a period where many refuse to accept the new reality.

The implication is that we are facing a protracted period of weakness in housing and associated economic activity, rather than a quick purge followed by a return to normality.

Like their kids, homeowners love their houses, and like their kids every home is above average in the eyes of its owner.

But unlike with their children, when the market is going up, homeowners are happy to sell, taking the increase as their due, while buyers are eager to get in before prices get dearer still.

However, when the cycle reverses, as we are now seeing in the United States, sellers tend to wait a long time, sometimes until their hands are forced. Buyers, for their part, figure waiting makes good sense if prices are falling.

So, while prices are slow to fall, transactions slow sharply, as we have seen.

Average U.S. house prices rose 3.2 percent in the second quarter from a year ago, according to the Office of Federal Housing Enterprise Oversight, the slowest rate of gain in a decade. The S&P/Case-Shiller index of national home prices showed a fall of 3.2 percent in the period.

Sales of existing homes fell in July to a 5.75 million unit annual rate, as against 6.32 million at July 2006, while the inventory of unsold houses hit the highest figure in more than 15 years.

The subprime fiasco, and the credit crunch rippling outwards from it, will be forcing some homeowners to sell, and some will lose their houses to repossession. But many others will still be thinking in 2006 terms.

That matters quite a bit to jobs in real estate, construction and finance, all of which are facing a rocky period just about now.

A quick reset of price expectations, and everyone from Mortgage Backed Securities traders to real estate agents to carpenters could get back to business. That doesn't look likely.

SKIING TO RECESSION?

Edward Leamer, the director of the UCLA Anderson Forecast, presented a paper at the Jackson Hole conference arguing that housing should play a great role in determining monetary policy.

"We love our homes," he wrote in the paper, titled Housing, Housing Finance, and Monetary Policy and available here

"We don't love our investments in General Motors or IBM, and when the stock market sends us the daily message that share prices have plummeted, we reluctantly accept that unwelcome reality. Homes are different."

He argues that in recessions since World War Two, weakness in housing and consumer durables have played a major role, preceding eight of ten. The only exceptions, according to Leamer, were a downturn in 1953 caused by an abrupt slowdown in defense spending after the Korean Armistice and the dotcom bust in 2000/2001.

A false positive, a recession that residential investment figures seemed to predict but didn't happen occurred in 1951-52 and 1966-67, but both were avoided when spending on the Korean and Vietnam wars provided stimulus to the economy, according to Leamer.

"We have recently been skiing down a steep slope like the ten steep slopes preceding the ten recessions," wrote Leamer, who thinks that U.S. manufacturing will be resilient enough this time to avoid a recession.

I'm not so sure.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund)