Home prices in Southern California have dropped more than 40% since January 2008, making the “American Dream” more affordable than it was in 2000, reported the L.A. Times. But falling home values also give homeowners who are already underwater with negative equities further incentive to default.

first tuesday take: By defaulting on payments, rational homeowners with negative equity mortgage situations exercise the “put option” contracted for in their trust deeds, thereby forcing the lender to buy the property. The lender’s alternative to foreclosure is to voluntarily agree to reduce the loan amount to the fair market value of the property or involuntarily have them crammed down under the hammer of a bankruptcy judge (as is coming). Lenders made a king’s ransom during the boom and now must give part of it back to the homeowners who borrowed.

Keep an eye out for prices to bottom and stabilize in 2012, at around 1999 levels. Sales volume will jump around between now and 2012. After 2012, prices will start to work their way back up from 1999 levels. If we get better results, we’ll take them. But please don’t expect them.

RE: “Southern California home prices fall, affordability returns to normal” from LATimes.com