Rrising foreclosures will NOT halt the price slide. You are forgetting about buyer psychology. When the NASDAQ lost half its value, did people suddenly rush in to buy up the cheaper shares? Of course not. After the frenzy dissipated, they realized that earnings mattered. Likewise, by next year, people will realize that fundamentals matter, that mortgages made with exotic loans are not sustainable, and that houses should be worth a reasonable multiple of that city’s wages and its underlying rental income stream.
Above, several people proposed that dropping prices will increase demand, saving the housing market. They are basically saying that prices and demand are inversely related: as prices drop, demand picks up.
The fact is, it doesn’t work that way in an asset bubble. What we find is the opposite: as prices rise, demand increases as people are in a frenzy state to get in before prices rise further. When the bubble pops, demand falls, causing prices to drop, making demand fall further, in a vicious cycle. Buyer fear leads to fence sitting, as they are afraid to buy today in fear that prices could be lower tomorrow.
Prices will keep falling until they return to their fundamental value, and then people will start getting interested in buying homes again.
My guess is that the first group of buyers will be landlords, who wil pick up lower priced properties because the time is right to be cash flow positive on rentals. This will make the median drop further, as the low end sales will make up more of the solds. Once home prices are a multiple of 3x a person’s income, they will become interested to buy a house, since it will be affordable. So the necessary condition for psychology to turn is low prices that are back to fundamental values.
Another factor is lending and credit availability. Rising foreclosures and the new FDIC lending guidelines will tighten underwriting rules. Soon enough, borrowers will be qualified on the fully indexed rate, not the teaser rate. They’ll need to prove their income and make down payments. Bank defaults and foreclosures will lead to less money available for mortgages, so only the most creditworthy will qualify. This will reduce the number of possible buyers.
In summary, prices can only turn around once they are down to fundamentals and people can truly afford a mortgage based on traditional underwriting standards. Don’t look for any false bottoms or sucker’s rallies. Houses are not like stocks.