Reviving the Real Estate Market

"Decline in Home Prices Accelerates"
—Page One headline, the Wall Street Journal, Feb. 27

Gloom. Doom. Calamity. Home prices are tumbling. We're bombarded by somber reports. But wait—this is actually good news, because lower home prices are the only real solution to the housing collapse. The sooner prices fall the better. The longer the adjustment takes, the longer the housing slump (weak sales, low construction, high numbers of unsold homes) will last.

It's elementary economics. Pretend that houses are apples. We have 1,000 apples, priced at $1 each. They don't sell. We can either keep the price at $1 and watch the apples rot or cut the price until people buy. Housing is no different.

Even many economists—who should know better—describe the present situation as an oversupply of unsold homes. True, there is about 10 months' supply of existing homes, as opposed to four months a few years ago. But the real problem is insufficient demand. There aren't more homes than there are Americans who want homes; that would be a true surplus. There's so much supply because many prospective customers can't buy at today's prices.

By definition, the "housing bubble" meant that home prices got too high. Easy credit, lax lending standards and panic buying raised them to foolish levels. Weak borrowers got loans. People with good credit borrowed too much. Speculators joined the circus.

Look at some numbers from the National Association of Realtors. From 2000 to 2006 median family income rose almost 14 percent, to $57,612. Over the same period the median-price of an existing home increased about 50 percent, to $221,900. By other indicators the increase was even greater.

But home prices could not rise faster than incomes forever. Inevitably the bust arrived. Credit standards have been tightened, and the (false) hope of perpetually rising home prices—along with the possibility of always selling at a profit—has evaporated. For many potential buyers prices have to drop for housing to become affordable.