Over the past couple of months, the market’s volatile reaction to the mortgage backed securities meltdown and the Bear Sterns collapse has been nothing short of alarming. The house of cards isn’t just falling – it’s losing value.
U.S. housing prices sank 11 percent this month, the largest monthly dip in over 20 years. And there’s no silver lining. Despite cheaper homes, ownership is still beyond the financial capacity of the average income earner. A recent study by Joseph Stiglitz showed housing prices out pacing median income growth by 4 to 5 percent annually over the past decade. Housing prices still need to come down by 20 to 25 percent before the market stabilizes. We see this market alignment already happening in places like Florida Las Vegas, Nevada.
To curb the homeowners’ equity loss, the Fed must bail out the crumbling MBS market and create a rescue package similar to during great depression. In the short run, tax payers are going to take a hit, but a long-term asset deflation is a much more painful alternative. With the soaring deficits we can expect to see either higher inflation or cutbacks in public and private services.
Without a hasty move from the Fed, expect a painful market realignment process. But either way, it’s clear that with the spreading market uncertainty and freezing buyout markets, the worst is yet to come.