Could Falling Home Prices Be Good?

As the majority calls for price supports and taxpayer-funded bailouts to support the falling housing market, some think it's better to let prices fall. They believe that this would finally deflate the bubble that started the trouble in the first place. At least then we would have appropriately priced housing.

As the housing crisis grows, it also gets more surreal. Ed McMahon-often seen on TV delivering million dollar prizes to homeowners on behalf of the Publishers' Clearing House Sweepstakes-is headed toward foreclosure, according to the Wall Street Journal.

Just another statistic among the millions unable to refinance away from cumbersome and troublesome loans, McMahon is not alone. This year, a staggering 25 percent of all home sales have been foreclosures. Some blame lenders; others blame homeowners. Many call for a national strategy to pump up the real estate market and get us back on track to higher home prices.

Minority has major contrarian view

A small minority, however, say that prices need to keep dropping until they reach levels that are more in line with economic reality. They cite numerous revealing statistics:

• Take out a new mortgage or refinance an existing one, and most banks now require that no more than 28 percent of your monthly income be spent servicing the mortgage, property taxes, and homeowner's insurance. Debt counselors agree that a safer ratio is 25 percent.
• By those numbers, the average breadwinner on a $50,000 annual salary earning $4,200 a month can afford to buy a house worth $130,000 or less with a safe and predictable 30-year loan at 6 percent interest. If that sounds like a ridiculously low price for a home, bear in mind that the median price of a home in 2000 was less than $140,000.
• In California in 2006, with real estate prices peaking, the state's median household income was approximately $54,000, but the median price of a single-family home was more than $560,000. Servicing a prudent 6 percent 30-year fixed-rate mortgage for $560,000 costs about $3,500 a month, not counting taxes and insurance.
• Meanwhile, the price of the average California home dropped to $403,870 in April 2008, so home values in the examples above have fallen 30 percent. Homeowners continue to spend about 30 percent of their income to pay for them.

Let them eat the house

An economist told Reuters news agency that the household debt of the average American is equal to almost 140 percent of their after-tax income. We spend nearly 15 percent of our income to service that debt, and less than that to buy food. That can make a budget-and an economy-rather anemic.

Maybe it's better to give the house back to the bank and bank some savings, while allowing prices to settle down to a level that corresponds with budgetary reality. Right now, we seem to be following the kind of flawed financial logic that inspires people to buy lottery tickets or enter a sweepstakes of the popular Ed McMahon variety.