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Blog by Kevin Wong

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Why U.S. Housing is Still In A Vicious Downward Spiral

U.S. housing prices will continue to fall well into next year, continuing to put pressure on an American economy that is struggling to sustain its recovery.

That is the view from Paul Dales, senior U.S. economist with Capital Economics.

“Most analysts expect prices to stop falling by the second half of this year — we believe they’re wrong,” Mr. Dales said Monday at the Capital Economic’s annual conference in Toronto.

Mr. Dales said that the excess of foreclosed homes set to be sold this year and next will likely push down prices by 5% by the end of 2011.

“If we are wrong, it is because we’re being too optimistic rather than pessimistic.”

Mr. Dales said further downside could stem from a vicious circle that has the potential to develop in the U.S. housing market this year. Such a scenario would involve falling prices coinciding with rising defaults, ongoing foreclosed sales and subsequently, even further price drops.

If that happens, said Mr. Dales, housing prices could fall by up to 20% from current levels.

But it is not all doom and gloom for U.S. housing. Mr. Dales points out that housing prices are currently as undervalued as they were overvalued during their peak several years ago.

“Against incomes, at no point in the last 35 years has housing looked so undervalued,” he said.

On top of that, U.S. housing has become incredibly affordable. Interest on principal mortgage payments on a median priced home purchased with a 20% down payment was US$670 a month, or just 13% of the median annual income last year. That is nearly half of the US$1200, or 25% of household income, seen at the peak.

But even given the low value and affordability of U.S. homes, Mr. Dales said four obstacles still prevent prices from increasing in the short-term. Those include high unemployment, low credit scores and tighter credit conditions, widespread negative equity and a diminishing desire to own homes in wake of the housing collapse.

Negative equity in particular was a concern, given that about a quarter of all U.S. homeowners had mortgages that were worth more than their homes — leaving 11 million households in the U.S. underwater.

That leaves a large pool of potential foreclosed homes hanging over the market, something Mr. Dales points out could continue to add fuel to distressed home sales, which are keeping prices depressed.

“Forty per cent of all existing sales were distressed sales [last year], and this is particularly devastating for prices, as the bank is willing to offload the properties at any cost,” he said.

As for when there might be a light at the end of the tunnel, Mr. Dales looks to a 5-10 year time frame to when U.S. home prices could move back toward fair value.

“In answer to my original question, whether there is any light at the end of the U.S. housing market — there is, but unfortunately the moment, it still looks rather dim.”