by Calculated Risk on 10/06/2007 05:56:00 PM

From BusinessWeek: Housing: That Sinking Feeling (hat tip seminole83). This article asks if the recent significant price cuts by home builders will shorten the duration of the slump. Here are a few excerpts:

For the first time, big builders are offering massive, often six-figure, price cuts in overbuilt developments nationwide, giving the industry a kind of shock treatment designed to move inventory off the books fast. It remains to be seen whether these radical measures will revive the market or deepen the slump, but it's certainly having an impact on the local communities.
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The real question is whether the drastic price-cutting will short-circuit the usual long, painful downturn builders seem destined to undergo in this economically sensitive business. ... If by doing so the builders can force the market to accept the reality that housing values have fallen--and accept it fast--there's at least the possibility of emerging from the current bust sooner than in earlier down cycles.
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When builders cut their prices in one fell swoop, rather than letting them drift slowly downward, they in essence force sellers of existing homes to do the same. At the very least, that can be a severe psychological blow that in earlier slumps was absorbed over a period of time rather than all at once. For some homeowners, it's a catastrophic financial blow as well. With new, clearly established market prices, troubled homeowners who paid peak prices will have a harder time refinancing. ... As painful as such situations are, however, the excesses must be wrung out of the market before the sector or the broader economy can recover.
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Homeowners are almost always slower than builders to bite the bullet and cut their asking prices. That's why prices on sales for existing homes haven't dropped as precipitously as prices for new homes. ... The resale market will eventually have to realign--meaning homeowners will have to cut their prices--before the slump can end.
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The current housing downturn and the damage it's inflicting on the overall economy are far from over. With a slew of risky, adjustable-rate mortgages still to reset next year, foreclosure rates could climb even higher. ... "Builders definitely responded more quickly this time, and that's a good thing," says Banc of America Securities analyst Daniel Oppenheim. "But the inventory overhang is so great, it's going to take a long time to work through this. They still have a ways to go before there's a recovery."

Reducing prices is a necessary first step towards a recovery, but the builders are in a trap of their own making: so many builders bought into the "land bank" fallacy during the boom, and those builders now find themselves having to keep building too many homes - and sell them at a loss - just to liquidate land to make their debt payments. This means the builders are still starting far too many homes to make a dent in the current huge inventory overhang.

And the new price realities will put even more existing homeowners upside down in their homes, either trapping them in their homes for years or forcing more distressed property on the market. This will undoubtedly keep pressure on home prices, probably for years.