Loss of home equity is the crux of crisis
Little noticed in the day's headlines is this little tidbit: Existing home sales fell another 3% last month. The average house today is worth about what it was in early 2004. Commentator Dean Baker says attention must be paid.
Dean Baker, co-director of the Center for Economic and Policy Research. (Center for Economic and Policy Research)
More on The Economy, Housing - Real Estate, Commentaries, America's Financial Crisis
TEXT OF COMMENTARY
Kai Ryssdal: OK, so Citigroup is saved. The president-elect is alluding to a super-sized stimulus package. Unnoticed in today's headlines, though, is this little tidbit: The housing market still stinks. Existing home sales fell another 3 percent last month. The average house today is worth just about what it was early in 2004. Commentator Dean Baker says attention must be paid.
Dean Baker: When our political leaders come up with proposals for fixing the economy, they better remember how we got into this mess. The core problem is the loss of housing wealth, not access to credit.
Homeowners have lost more than $5 trillion in real housing wealth in the last two years and are likely to lose another $3 trillion. That's almost $110,000 in equity for every homeowner in the country. That loss of wealth led directly to the plunge in consumption which is pushing us into a deep recession.
The current fixation on consumer credit misses the point.
Yes, people are having trouble getting loans for cars and other big ticket items. They are also finding it more difficult to get credit cards or student loans.
But the primary problem is not the liquidity of the financial system. It's that the loss of housing equity has made tens of millions of families less creditworthy.
People with equity in their homes don't typically default on debts. If they face economic hardship, they will borrow against their equity in order to pay off a car loan or credit card balance.
People without home equity generally don't have any other resources to fall back on, and therefore are serious default risks. All the homeowners who have seen their equity vanish, due to falling house prices, are now in this less creditworthy category.
So, it is no surprise that banks and other financial companies are now less anxious to make consumer loans.
Of course, even if banks did make the loans available, many families still wouldn't buy. People who lost their life savings in the housing crash are more interested in rebuilding their wealth than buying a new car.
Consumer spending alone will not bring us out of recession. In fact, our problem was that we had too much consumer spending--driven by ephemeral housing bubble wealth. Recovery will have to be driven by other sources, like government spending and an improved trade balance.
Until then, the obsession over consumer credit is only a distraction from the economy's real problems.
Ryssdal: Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C.
Comments
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From Phoenix, AZ, 02/09/2009
I didn't realize how right Dean Baker was until last week.
My husband took a job in the LA area 6 yrs ago. We were shocked at the housing prices so waited until we found something that was less than 2X our income. We also put 20% down and are current on our payments.
We are now transferring back to Phoenix. We were shocked to find out the property we bought is no longer worth what is left on the loan. This is not a sub-prime mortgage problem. It is a responsible homeowner's nightmare. Do you walk away, add to the problem and ruin your credit? Do you rent it at a loss from out of state and hope you still have a job in a year? We have a few months to try to figure it out, but we're not sleeping well these days either.
From hudson, NH, 11/25/2008
I think Dean is wrong too. Falling housing price is NOT the problem. The problem is housing price that is too high and not supported by fundamentals. I am surprise, so many of the so-call "experts" don't know what is going on.
We don't have a crisis now. We have a crisis 2-3 years ago, when housing price ran rampant. At this moment, the housing price is just reverting to the norm (3X income). This is a good thing.
Also, we do not have a credit crisis. There are vast of amount of credit out there. The problem is a lack of credit worthy borrowers. The bank has the money to lend, and they want to lend, but they couldn't find anyone worthy to lend to. That is the problem and it explain why the FED has pump so much money into the system and nothing happen.
We are fixing the wrong problem. It is the JOB, stupid. If people are employ and confident that they will remain employ, they will spend, and the banks will lend.
With the blind leading the blind, we are doomed.
11/25/2008
I was confused as to the point of Dean Baker's piece. While it is true that consumer spending has been buoyed by at least two factors - the wealth effect from persons feeling richer from ballooning house prices and equity and the ability to monetize that "wealth" by very loose credit standards - what exactly are we supposed to do now? Was Mr. Baker implying that we need to re-inflate the housing bubble to get the consumer spending again? That solution is akin to offering a heroin addict one more fix to lessen his/her withdrawal effects.
While consumer spending has collapsed as housing and equity markets wealth has evaporated, this appears to be great time to end the addiction to Reaganomics and financialization of the US economy.
Income disparity and lack of income growth has led the middle class to run faster just to stay in place. They have chased the American dream with credit and housing debt. This is a lousy way to set our economy on a firm footing.
It appears obvious to me that focusing on the foundations the baby boomers parents enjoyed - infrastructure investments, education (they build junior colleges, state colleges, the UC system in California) and labor unions (an effective method of battling executive pay by sharing it with the workers that created it) will be a sounder footing. Consumers can endure a little delayed gratification while we remove the wreckage of Reaganomics and rebuild our shattered economy.
From Renton, WA, 11/25/2008
I pretty much tuned out after Dean Baker declared that "Homeowners have lost more than $5 trillion in real housing wealth in the last two years".
To paraphrase Douglas Adams, this must be an obscure usage of the term, "real housing wealth", with which I am not familiar. This was bogus wealth that was created by an excessive amount of cheap money, with the assistance of chicanery by mortgage lenders, chasing houses. As we see, this was unsustainable. The "problem" is that the bubble has burst and house prices are pulling back to something like their true value, perhaps with some temporary overshoot. The only way that housing values can be pumped up to their previous illusory levels, other than waiting for inevitable population increase, is to pump a massive amount of money into the system. Waitaminnit!Wasn't pumping a lot of money into the system how we got here?
11/25/2008
The second problem, was handing out credit to people who couldn't afford it. Ironically, what the bailout is doing now.
People lied, were told to lie, as long as the money went out, paychecks came in. We went thru this scandal before years ago, when luxury cars weren't selling, so they were loaned out to people without the income, knowing the cars would eventually be repossessed--but at least, they were off dealer lots for a while.
Remember the S&L? Trading dead horses for dead cows? Nothing has changed, b/c no one wanted to learn.
And its a bad sign for a country, when this is the best investment.
11/25/2008
The first problem, was teaching people that a house is an investment. Its not, b/c you can't sell it when its high--you literally lose your house.
Unless you buy a new house, and when will you do that? When the market is high. What's the investor rule? Buy when low, sell when high. Not, sell when high, buy when high.
From Chicago, IL, 11/24/2008
YES - you've hit the nail on the head. SO given that declining housing equity (and excess inventory) is at the root, as a temporary measure, wouldn't be better for the governement to buy up excess housing inventory rather than give loans to banks?
The governement has done this when we have a surplus of other commodities like cheese and butter.
What would the government do with the excess inventory? hold on to it and sell it over a long time period; perhaps some of it that is of lower value/quality should be salvaged.
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