Top economics blogger Barry Ritholtz wrote in June about a coming second leg down in housing. Even though prices had already fallen by 33%, Barry predicted that the decline should continue:

…. Whether we are looking at US housing stock as a percentage of GDP or Median income vs home prices or even ownership vs renting costs, prices remain elevated. Indeed, we see prices remain above historic mean.

Consider price relative to income. From 1977 to 2010, the median US home price was 4.1 times median household income. But … home prices are still above that mean. Oh, and that mean is artificially elevated due to the 2002-07 boom. Same with home prices relative to rentals, or housing value as percentage of GDP.

Further, we should not assume that prices will merely mean revert back to historic levels. In most markets, a near 3 standard deviation price move is resolved not by reverting to the mean, but by by careening far below it.

We can look at numerous other factors. Employment, inventory, REOs, credit, another wave of foreclosures. etc. But the bottom line remains that prices must revert to a sustainable level, and we simply aren’t there — yet.

Yes, government policies temporarily stopped prices from finding their natural levels. Now that the tax credit has ended, and most mortgage mods are failing, the prior downtrend in price will now resume.

Neither the Bush nor the Obama White House seemed to truly understand this. The assumption has been that if we can modify mortgages or voluntarily refrain from foreclosures, the RRE market will stabilize. Through a combination of mortgage mods and buyers tax credits, the government has managed to — temporarily– create artificial demand and keep more supply off of the markets.

But as we have seen, that fix was at best temporary.

One of the things that Markets are best at is price discovery — the determination of a price for a specific item through basic supply and demand factors. Without the heavy hand of the government intervening, the residential real estate market is about to experience what price discovery is all about . . .

My comment: Barry is neither mincing his words nor hedging his bets, is he? With the benefit of a few months’ hindsight, let’s have look at how actual housing prices and volume turned out in July this year, after Barry’s call for a resumption of the decline: according to Mish’s reporting of the July 2010 numbers, it turns out that volume of new houses sold fell 19%, the volume of resales fell 15%, and prices for new homes fell a median 6%. All came in below expectations, and all the declines were vs. an already depressed 2009. (Note: The New York Times reported an even bigger decline of 26% in July volumes). Housing market stats for August are not out yet, but this well researched analysis of housing stock backlog and proportion of distressed sales posted a few days ago, together with consumer spending and confidence trends and the stubbornly high unemployment three years into a recession after the US government and the Fed have spent all their fiscal and monetary ammunition, simply do not augur well for August’s housing prices or for a near-term housing recovery.

As long as a US housing recovery remains elusive, net new lending will be decreasing, the endogenously determined money supply (including credit) will be shrinking, and the existing debt-deflation dynamics will remain intact. The importance of the money supply to economic well being, and specifically certain dynamic situations in which monetary expansion might be rendered impotent to reverse deflationary outcomes (the “liquidity trap”), are nicely illustrated in an allegory based on real events that is quite approachable for non-Economists: the Capitol Hill Baby Sitting Coop.