Red,
If this had begun in 1994 before the crazy lending really go out of control, I would say a Bay area kind of scenario with steady prices might have occurred or maybe something similar to the slow grinding declines of the early 90's. Ordinarily it is difficult for prices to fall in a strong job market because there are always new buyers eager to step in and take out those who lost their jobs. But all of that assumes a reasonable level of prices. When new buyers simply cannot afford to buy at market prices without exotic financing, prices fall. Best case scenario at this point is an early 90's type of slow, steady declines for a very long time.
I don't think the FED will lower rates if foreclosures go crazy, and even if they did, I don't think it would help. The sub-prime loans currently going into foreclosure were originated at historically low interest rates, and many of the loan reset time bombs were originated with teaser rates even lower still. IMO, the FED could lower rates to zero and it wouldn't improve the situation because prices are just too high. Also, it won't help the sub-prime borrower much. Sub-prime enjoyed interest rates that were too low for too long because investors failed to recognize the risks they were taking on. Now that the defaults and foreclosures are rising, the interest rates being charged to sub-prime borrowers will also rise to compensate investors for taking on the added risk. The impact of this will be to effectively eliminate sub-prime borrowers from the marketplace. This will have a strong impact on demand.
Remember, demand is not desirability. Irvine is very desirable, and it will continue to be; however, demand it measured by the amount of dollars buyers are ready, willing and able to put toward housing. By this measure, demand will decline, perhaps precipitously, when sub-prime borrowing costs increase. So when you look at the demand side of the equation, I would agree there is pent up desire, but there is no pent up demand; in fact, there will be a drop off in demand as credit continues to tighten.
As I mentioned in the previous post, it is the supply side of the equation that will force prices down. The dramatic rise in foreclosures to come will overwhelm the dwindling demand. This is why prices will not slowly drift down, but will instead crash down very hard. Further, once this sequence of events gets put in motion, it will take out other marginal borrowers who are treading water. As each buyer sees the market approaching and their equity evaporating, there will be a panic to get out before they go underwater. This panic selling will put even more supply on the market and make buyers even more reluctant to buy. Again, this would not be a problem if people had equity, but they don't. Statistics show home equity in the United States at a record low despite the increase in house prices. Everyone went out and got a HELOC and spent their equity. Just look around at all the BMW's and MB's in driveways around Irvine. Do you really think people make that much money? They would like you to think they do, but government statistics say they don't.
The key statistic to watch to see if this scenario is going to unfold is the number of foreclosures. If I am right, the quarterly foreclosure number will exceed the 1996 peak in the second or third quarter of 2007, and it will show no signs of leveling off. It is a simple prediction to verify, and it won't take very long to see if I am correct.
