Added October 8, 2010
The attitude of the Federal Reserve (America's central bank) is to just keep interest rates low to try to encourage demand for real estate. Ben Bernanke, the Fed chairman, has talked about that himself. But the Federal Reserve is a pretty conventional-thinking institution itself in certain ways.
The problem is that the real estate market ran out of buyers at the margin a few years ago. This was inevitable for two different reasons. One is that the only way the Fed has been able to keep the economy going in recent times is by blowing one bubble after another - first a stock market bubble (in the late 1990's), then a real estate bubble in the 2000's - and bubbles all eventually collapse. The stock market bubble did and the real estate bubble has also done so in the meantime. The second reason is that when we came out of the recession of the early 2000's, George W. Bush made a pledge to get everyone into their own home. I knew that if the system followed through on that, the real estate market would take a big hit - and that is what has happened. The system did follow through on it - and when they ran out of regularly-qualified buyers, they went sub-prime. Then, after a year or two, they even ran out of those - and then the market crashed (completely inevitably).
There was an attempt in recent times to revive the market again using government incentives, but I knew that would work only as long as the government incentives were in place (and they were very costly, so they could not be made permanent). And, more specifically, according to the information I have (I am not in the real estate business), most of the people who took advantage of the government incentives during the recent push used the tax incentive for first-time home buyers, not the one for people who were trading up. That tells me that most of the people who were coming out of the woodwork were young people who were not even in the market yet when the real estate market was booming a few years ago, but had graduated from college in the meantime and have jobs (even if the job market for college graduates is dismal and not nearly every college graduate is finding a job, some do, and they were probably the ones buying houses). So they simply bought while the tax incentive was still in place (they are not stupid - they are smart enough to get through college, and they have a good, high-paying job in the meantime, so they can afford a house) - and that is why the real estate market crashed again (in terms of demand) as soon as the tax incentives expired (no surprise to me - I predicted that would happen). Now, effectively, the real estate market has truly been sucked dry of buyers (at the margin) - and so it cannot possibly fully recover again (especially in an environment of a weak economy, which will limit highly-skilled immigration, the other potential source of people who might buy a house). And that is why the thinking of the Federal Reserve is so fundamentally flawed - because just keeping the conditions for buying favorable is not good enough, one has to have enough demand for the product, too, and it just simply does not exist anymore to anywhere near a sufficient extent (and I think that will be true for a long time to come).
The American economy can't recover fully unless the real estate market recovers - and the real estate market can't fully recover (see discussion above). So we will not have a full economic recovery - which is why we will have another big downturn.
A note added in the spring of 2011 - the real estate market did crash, in terms of demand, immediately in the wake of the expiration of the government tax incentive. But by a few months ago, demand had returned to above the level that existed last spring during the tax incentive. So people are now asking why home prices are not going up, in fact, why are they still going down? The answer is simple - because demand would have to go up to the level of the previous boom times of the mid-2000's, given the current level of excess inventories of housing, before prices could actually start going up again. I did not foresee that demand would come up as much as it has in recent months - but my prediction is actually about prices, not demand, and I knew that there was no way demand could get high enough again to actually start causing prices to go up again. So prices are still falling - even in the spring. In past economic recoveries, the effects of immigration have helped to stabilize the housing market, eventually enough so that house prices could start rising again. This time, the economy is far too weak for immigration to play much of a role.
The simple reality is that because there was a big real estate boom (in the mid-2000's) and, by definition, everyone only needs one place to live, we would have to go back to the conditions of the boom in terms of demand to have prices go back up again. As noted above, the market went deep into the sub-prime borrowers before it collapsed. Millions of homeowners have since been foreclosed upon and had their credit ratings trashed in the process, which means they will not be able to buy a home for years. And the economy is so weak, as I have known for a long time it would be at this point in the big picture, that there is no way immigration is even going to come close to making up the difference. So there is simply no way home prices are going to come back up significantly, and certainly not enough to eliminate the credit crunch, which happened in the first place because too many homes went down too much in price in an environment of too many mortgages being defaulted on. The defaults, by the way, continue.
A note added in May 2011 -
Word is now that house prices are falling at their fastest rate since the Lehman collapse in 2008, in other words, house price declines are accelerating in the spring, and the percentage of homeowners in negative-equity positions has gone to 28%, a new crisis high.
This does not surprise me at all, I expected it - I was just not sure when it would start, but it is now underway, and just about when I expected it to be, I figured it would become apparent, or even obvious, sometime in April-June (and certainly by the end of the summer). My last comment above hinted at it - defaults continue. And, by the way, I think most people who are bottom-fishing in the real estate market these days are going to come to regret it. As I noted above, I have been expecting another economic downturn, rather than a full economic recovery - and I knew all along that the next economic downturn would be accompanied by another major real estate downturn or even be driven by one. I think the beginning of that next real estate downturn is now underway (it was postponed by a year because of the real estate tax credit).
Most homeowners did not notice the anemic housing market last spring because of the federal housing tax credit - which kept the market going until April 30. But when the housing tax credit ended, demand immediately went way down. There will not be another tax credit this year - because the previous one was already too expensive (the Congressmen themselves said so at the time). I think that last spring, by the time most people would have noticed by about mid-May that demand for housing was way down again, they were mostly focused on summer in the meantime and had not noticed that demand had, in fact, gone way down again right after the tax credit expired, contrary to the expectations of the law makers who had specifically stated in late 2009, when the previous temporary tax credit expired, that they were extending it into the spring of 2010, despite the cost, because they felt it imperative to "support the real estate market until the normal seasonal demand kicks in in the spring." I knew that the normal seasonal demand would not kick in again - because the real estate market had run out of buyers, overall - and that is exactly what happened, demand went way down as soon as the tax credit expired. I think that this time, in 2011, since there is no talk of a tax credit, people will be more focused on the real-market conditions in the real estate market and so they will notice more what is really going on in terms of the real, non-government-supported, conditions.
About a real estate recovery
Added October 8, 2010