Of the many asset classes to be victimized by the end of cheap energy, residential real estate is perhaps the most vulnerable. A call option on future wage growth, and, leveraged to our liquid-fuel based transport system, housing in North America is currently making its way back to the stable, but barely appreciating asset it once was. However, having started this journey only recently there is still a long way to go. A long way in price that is, for housing to fall.

The housing crash is currently in the midst of its next leg down. In similar fashion to those who missed the initial crash, the past year has seen a number of observers calling for a bottom. One of my favorite calls came last year from Karl Case in an editorial in the Wall Street Journal. In A Dream House for All, Mr Case made the following argument: because house prices had fallen so much already, housing was now more affordable. But of course that wasn’t true at all. Not then, and not now.

Mr. Case was mistakenly anchoring his viewpoint on price to the purchasing power which existed prior to the crash. Yes, surely, last Summer’s house prices—had they existed early last decade with its flowing credit and growing economy—would have not lasted long on the market. But late Summer 2010 was of course not 2004. Indeed, Mr. Case’s error goes to the heart of the problem: it’s not only the massive debt and negative equity that ails housing. It’s the economic conditions, an inflationary depression, that really controls housing’s fate. Our structural unemployment, our flat to declining wages, and our rising food and energy costs. Each of these keeps knocking down the price level of houses.

Mr. Case’s editorial is now 9 months old. House prices nationally have been falling again and in many cities rather steeply. Some metro regions are on pace to fall by 10% on the year. And so, to the point: housing was not more affordable last summer. Nor, as Mr Case put it, was it a bargain. And, it’s still not more affordable. In addition, housing starts are also carving out new lows as the massive supply of existing and foreclosed homes continues to obliterate the homebuilding business, as was reported just today.

House prices have still not reached the lower levels Americans can now afford. The continued replacement of high wage jobs, with their upwardly volatile partnership profits and bonuses, with lower wage jobs and their poor prospects for advancement, means there is no class of new homebuyers coming along to purchase the high priced homes of existing owners. This is especially true in the $700,000–$1,000,000 price level–a tranche of homes that came to dominate so many metro regions in the US, from Boston to Seattle. Oh sure, homes still transact at those price levels. Indeed, homes still transact at all price levels. But massive inventory languishes at all price levels and only transacts after continual price reductions.

As I have been remarking on Twitter the past few weeks, I believe the FED has a decision to make now about housing. Either they start to buy MBS again, attempting to force mortgage rates down to new all time low levels–or–they simply let housing “go.” Let’s be honest. There is really very little the FED or Congress can do to alter the course of housing. Moreover, Chairman Bernanke in his dolorous news conference several weeks ago also stated rather lucidly that “the FED cannot create more oil.” That too is very much to the point. Oil’s historic repricing, which occurred seven years ago when the new regime above $40 started to unfold, cannot be undone. And trying to run a housing, commuting, and workplace system on 100 dollar oil that was originally built out on 15 dollar oil has run into predictable trouble.

As explained in a previous post, there is not going to be a return to “normal” oil prices and accordingly there will be no return to “normal” wages or “normal” house prices. Many real estate markets in the 1980-2005 period were characterized by their trophy pricing, or Giffen Good pricing if you will. More broadly, beyond a positional asset conferring status, nearly all American houses became call options on future wage growth. In this context the 30 year mortgage made exact sense as the owner, at around the half-way point of the loan’s term, would find his earning’s power reaching escape velocity. And voila! — the monthly mortgage payment would then drop down to a much smaller portion of one’s income allowing the owner to consume even more (and maybe even buy a second home). Such were the pleasures of a growing economy, running on cheap energy.

That era is now over. For those who wish to forecast a recovery–a sustainable recovery–in US housing I would suggest you must also forecast a quick transition to a cheap energy source. One that can be adopted broadly, and which will allow us to run our system in some facsimile to its current iteration. Barring such, the prospects for a surge in new employment–and especially wages–remains low. The peak oil model for housing’s future prospects is now dominant.

-Gregor