Why Houses Now Are Like Stocks in 2002

An astute comment comes today from wcw, whose blog seems to have sadly gone dormant:

Bubbles are hard to squash. The Case-Shiller 10-city composite remains 70% higher than ten years ago as of December. Equities, on the other hand, are down -30% over the recent ten-year period -- and that's with dividends reinvested. You are better off, I posit, with $500k in stocks right now than owning a home instead of renting. The equity bubble, in other words, has finally popped. The housing bubble, not so much, just as the equity bubble hadn't actually popped yet in 2002.

Analogies are dangerous things, but this is a good one: houses now are like equities in 2002. Prices are down substantially from their highs, and a few of the most bubblicious assets (dot-com stocks, Miami condos) have imploded spectacularly, but the faith of the general public in the asset class as a whole has not been shaken.

What's more, nominal house prices are being supported by artificially low interest rates and massive government intervention: the housing market is truly too big to fail, and if the bubble is going to burst, it's going to have to do so very slowly, over many years, through the combination of modest nominal price declines alongside a good dose of inflation.

The house-price decline that we've seen to date feels particularly bad because so many Americans bought or refinanced their houses during the boom years, leaving a thin sliver of equity which has long since evaporated. If you put your life savings into buying a house, then a 20% price decline can wipe those savings out entirely; if you put your life savings into an S&P 500 index fund, then a 50% price decline still leaves you with half your money.

But a look at how far house prices rose over the past decade or so is all it takes to see how much downside still remains. Price-to-rent ratios are still far too high, especially since rents in many places are falling as quickly as prices. And in New York City, for one, prices have a very long way to fall:

A review of preliminary figures for the first quarter, through last week, put the average condo closing price at $1.82 million, with a median price of $1.195 million. The average price was about 14 percent above that of the second half of 2008, and only 4 percent below the peak average price in the first quarter of 2008, when many apartments were closing at very expensive new developments like 15 Central Park West.

These kind of pockets-of-bubble don't exist in the stock market any longer: it's been well and truly squashed. Certainly, the stock market can continue lower -- and it's even possible that house prices will rally, much as stocks did between 2002 and 2007. But looking out over the long term, the long-equities, short-housing arbitrage still seems to be a smart trade to put on right now.