5 reasons why falling home prices will be good for the economy – Higher homes values does not mean higher home equity, financial sector profits back up to 30 percent of all corporate profits, the mortgage debt equation.
A recent report shows that 11 million homeowners with a mortgage are underwater with a deep red line item on their household budget. Add into the mix those with less than 5 percent equity and we realize that 28 percent of all “homeowners” are either in a negative equity position or teetering close to it. States like California have negative equity rates of 33 percent thanks to the growth of highly questionable mortgage products. Yet California looks like a saint when compared to Nevada with an underwater rate of 68 percent! If we want to examine the core premise of the debate surrounding the bailouts, it is that higher home values by default are good for the economy. I would argue that having high home values as a mission is misguided if that is the only goal we are seeking (and that is basically what we have been doing for the last few years). In fact, the majority of Americans would benefit from lower home prices. A market with higher home values is only beneficial if incomes and the economy move along in synchronization. Popping the last few balloons of the housing bubble is a good thing for most. Let us examine five reasons why falling home prices will be a good thing for the economy moving forward.
Reason #1 – As real estate values inflated actual owners’ equity plummeted
The above chart is of paramount importance in understanding the housing bubble. For fifty solid years, homeowners had at least 50 percent equity in their homes nationwide. It is fascinating that during the biggest jump in housing values that actual equity collapsed. What happened? Low to nothing down toxic mortgages funneled by Wall Street and the invention of the home equity ATM. If we slice the above chart into a smaller timeframe and only look at the last decade, we see this insidious trend:
This chart pinpoints the last decade of growth for our economy. To sum up what happened, as the middle class struggled to gain any advantage in actual wages the home became the one-stop shop for consumer spending. Why save $500 a month when you can yank out that much money from your home equity and keep spending going? Of course the problem with this is that it is unsupportable and now the taxpayer is footing the bill. But as we will show later, the burden of the recession has fallen disproportionately on the shoulders of the working and middle class while banks have shielded themselves from the worst parts of the recession.
Why the recent increase in homeowners’ equity? This is good news right? Not exactly. The recent bump that you see is due to people losing their homes through foreclosure. For example, say a subprime borrower bought a home in an area with low incomes for $400,000. The home is now valued at $200,000. If the borrower is current, this is a drag of $200,000 on the equity chart. After foreclosure, a figure of zero actually helps the bigger mortgage pie. So expect this figure to increase in the short-term as foreclosures remain elevated.
Reason#2 – Real estate should not be the primary driver of the economy
Financial sector profits are back to near record levels:
Source: Gluskin Sheff
It is interesting to note that back in the 1950s when Americans had their highest levels of owners’ equity, the financial sector was less than 10 percent of all total corporate profits. Today, it is back up reaching nearly 30 percent. Real estate and the financial sector is now a drag on the overall economy. Finance and capital allocation should be on creating and producing real value in the real economy. Today with no actual changes to Wall Street, we have days with flash crashes that erase trillions of dollars in wealth for most but actually make billions for a select handful of banks. The profit is now in speculating on the biggest casino on Earth. For the last decade, real estate was the hub of this speculation. Today, it is a matter of chasing the latest algorithm and trying to beat other hedge funds to the latest calculation that can rob wealth from the real economy.
If you look at the above chart, we seemed to do well with bread and butter 30 year fixed rate mortgages. For the large part of 50 years we required people to put down 20 percent to purchase a home. That seemed to work and actually provided the biggest net worth boost to individual households and ushered in the largest middle class the world has ever seen. The latest gimmicks and mortgages seem to be only helping one tiny sector of the economy.
Any time you allow easy access to debt, expect to see massive inflation in prices. We have seen this with the auto industry, college tuition, and with of course housing. When you give people the ability to borrow whatever they like, many will do it. Some will argue that this is a question of personal responsibility. I agree. But the propaganda that banks won’t tell you is that they are gambling with taxpayer money. If banks wanted to lend someone $20,000 a year with no income so they can go to a paper mill institution, so be it if the money comes from their capital pool. But the money is largely taxpayer backed. They are funneling taxpayer backed loans into this market so care not if the loan defaults. The magicians of our time are the banks.
Reason #3 – The brunt of the recession has been shouldered by households
The above chart highlights the inequality in the bailouts. The biggest line item for household net worth is residential real estate values. Households in the U.S. have lost over $6 trillion in real estate values since the bubble popped. Interestingly enough, mortgage debt has only fallen by $372 billion. Banks are able to suspend reality and avoid using mark to market accounting so they can continue to gamble on Wall Street. Most typical American families have to contend with actual market values. The massive amount of toxic mortgages still out there is astounding yet banks continue to pretend that things are fine. What this does is stunts the actual clearing ability of the market. Japanese banks did this for decades and how did that turn out?
Home values are going down because Americans are now dealing with more normal market factors. We are now looking at incomes (at least at a more modest level) and as it turns out, the economy is not healthy. We are now looking at debt through a microscope and as it turns out, many households are maxed out. So lower home values are good for those looking to buy. The only way home values can remain high is if the government and Wall Street keep pretending that bubble values actually had some fundamental reason to be so high. Ironically agencies like the FHA which have a core mission to help fund affordable housing are actually the main tool in the market today keeping home prices inflated. I mean how can this agency say they stand for affordable housing when they are backing loans up to $729,250 in value?
Reason #4 – Not everyone benefits from a housing bubble
The brutal reality is that falling home values will actually help many out in the current market:
If you combine those who are renters and those who have zero mortgage debt, these two groups would make up the majority of households in the U.S. Renters will definitely benefit because they can purchase homes at a lower price without going into incredible amounts of debt. Instead of blowing a large part of their income on the mortgage, they can use freed up disposable income to actually spend in the real economy. Who wins when someone is funneling 50, 60, or even 70 percent of their income into a home?
Those who have paid off their house win either way. If home prices fall, they will get less for their home but at the same time, other home prices will fall so they can purchase a home at an adjusted level. Many of these people are not looking to move so either way it is a moot point. The only people that are obsessed with home values are those who are now real estate speculators.
28 percent of households with a mortgage are either underwater or near negative equity. It is hard to call this group homeowners. For many, the only way out is for home values to surge. Yet many jumped in with low down payment mortgages so they have a big incentive to walk away. With a glut of rental housing, many would win simply by walking away, fixing their credit, and buying a home in a few years if they are able to meet stricter lending requirements (we can hope this plays out for the sake of our economy). If you think about it, the only big loser here is the banks holding the mortgages. Now you understand why the entire focus of the bailouts has been on banks. Strip the layers of the onion back and follow the stinking money.
Reason #5 – Negative equity is a drag on the economy
Source: Calculated Risk
Many of those with negative equity are already walking away from their homes. They made a bet and lost. The only way banks can combat this behavior is ignoring missed housing payments and allowing people to stay in the homes while they keep mortgage debt on their balance sheets at inflated levels. But the longer this game of pretend goes on, the worse it is for the economy. Right now the vast majority, renters, those with paid off homes, and homeowners with equity who pay on time are watching this game between negative equity homeowners and Wall Street play out. Why should the majority be brought down because of the bad bets from these two groups? Realize the losses and move on. Otherwise, more and more taxpayer money from the other groups will be shifted to this area. That is not good.
In the last few weeks after I tossed out an estimate of nationwide home values falling by 25 percent, a handful of articles made the rounds predicting a similar figure. This was not some doom prediction for housing but will actually help the overall economy realize the losses and move on. In therapy, you have to accept a mistake to move on. At times, this realization will be painful but in the end it is better for you. Right now Wall Street is in complete denial and trying to pretend all is well. Their profits are up but all that is happening is a wealth transfer from taxpayers to this unproductive group. Lower real estate values will be better for the economy moving forward until wages catch up. If wages don’t catch up why should we insist on keeping prices inflated? Who really wins with higher home prices?