Will Home Prices Fall Again?

The question I'm hearing most often at the moment is, "Do you think home prices will fall again?" My answer is, not unless the job market takes another dive. Take a look at the chart below, which shows the Case Shiller home price index and the unemployment rate for the Bay Area.

The current recession is unusual because it was brought on by falling home prices. Financial institutions and households both were highly leveraged at the peak of the housing market. As a result, their balance sheets suffered serious damage when home prices fell. Economic demand naturally fell, leading to the current recession. (As you can see from the chart, home prices began falling rapidly before unemployment started climbing. That's consistent with the idea that falling home prices caused the recession.)

That's not the normal pattern. Normally, job losses lead to falling home prices, as in the last recession. When the job market stabilizes, home prices tend to stabilize as well. That's what happened in the last recession and it appears to be happening again. The job market stabilized around June of 2009 and since then, Bay Area home prices have increased by roughly 15%.

I wouldn't bet on continued price increases, but as long as the unemployment rate holds steady, my guess is that home prices won't fall appreciably from here.

Note: I didn't have time to make this case as strongly as I'd like. I'll have more to say about it soon.