Facing the Housing Mess

Shilling's forecast is based on the historic value of homes, adjusted for what he calls the "McMansion effect" of today's larger homes being worth more. Using historical data compiled by Robert Shiller, he says that home prices would have to drop 45% to get back to their historic normal levels.

Existing-home prices peaked in October 2005 and are down about 4% on a national basis through March 2007. But Shilling says the worst is yet to come, because he estimates that it takes about 18 months from when home prices first start to slide for homeowners to recognize that this is not a fleeting blip. Now the "interval of denial" is about over, and homeowners will start realizing that if they want to sell, they'll have to cut prices, says Shilling. But actual recorded sales at lower prices will take a few more months to show up in statistics.

Even worse, Shilling says there is no way this problem can be confined to the housing market. He estimated that overbuilding has resulted in at least 2 million "excess" homes -- a factor that will depress not only homebuilding but related industries as well in the coming years. Already, housing starts have fallen 33% from their peak of 2.265 million in January 2006, to 1.518 million in March. Shilling predicts an additional 25% decline in housing starts and says there is no way that capital spending by businesses can pick up the slack. Ugh!