How Far Will Housing Prices Fall

I am more confident, however, about predicting long-run prices in the Third America — the growing areas, like Atlanta, Dallas, Houston and Phoenix, where the housing supply is essentially unrestricted because there is abundant land and few building regulations…

But since 2002, prices in Las Vegas and Phoenix have soared. While these cities sat out the price boom of the late 1980s, they experienced a brief, utterly unsustainable explosion in prices between 2003 and 2006. One explanation of this historically unprecedented price boom is that during a brief period of booming demand, perhaps caused by irrational exuberance, builders just couldn’t keep up. According to this view, the price boom was bound to end when supply eventually caught up with demand.

And that is the point of this post. In the unconstrained markets of the United States, that Third America, there is every reason to expect that in the long run prices will be close to construction costs. According to this view, prices in Las Vegas and Phoenix shouldn’t just mildly mean revert and fall by 20 or 30 percent. In these places, prices should fall back to development costs, which is where they were in 2002.

If this reasoning is right, then prices have plenty of room to continue falling. That’s good news for ordinary Americans looking for cheaper housing. It’s bad news, however, for the financial markets — and possibly also for the return the government can expect to receive on the taxpayer-financed purchase of Wall Street’s troubled assets.