Is There An Equivalent To Godwin's Law For Comparison's To The Great Depression?
If so, I’m going to break it.
The last time we saw the kinds of sustained home-price declines on a national basis that we’re seeing these days was back in the 1930s. Per the Case-Shiller national index (there are 3 indices, one covering 10 major metropolitan areas, one covering those 10 plus an additional 10, and one attempting to cover the nation as a whole), as of the end of March we were down 16% of peak, and house prices were back to mid-2004 levels on average. Four years of no appreciation is not unprecedented; that’s what we saw from 1989 to 1993, for example, as a consequence of the S&L crisis and the downsizing of southern California’s defense industries. But nobody currently working in the financial markets was working (assuming they were even alive) the last time we saw multiple year-on-year outright declines in national housing prices. There are those who are more pessimistic about the likely national economic consequences, and those who are more optimistic, but the most important fact to remember about the likely consequence on business confidence specifically is that these opinions are based on very little data – because, as stated, nobody currently operating in the markets was around the last time this happened. We’re in uncharted territory, which means confidence should be exceptionally low.
I am, instinctively, a relatively cautious person. I don’t have the natural enthusiasm of the perma-bull or the taste for apocalypticism of the perma-bear. But I have gotten extremely negative about the likely consequences of our current housing market mess. Consumers were encouraged to eat the housing market appreciation from 2001 pretty much up to the peak of the market at the beginning of 2006. And since the peak, there’s been a double-digit decline in housing values (the national data is only through the end of March, so we’re probably at a significantly worse level by now). Let’s imagine you were a relatively conservative person, father of two, earning $60,000 per year, who bought a house at the end of 1995 for $200,000. You put down 20% – $40,000 – and borrowed the $160,000 remainder. If you saw average appreciation, you saw that house go from $200,000 to about $480,000. So you took advantage of this appreciation to offset a variety of other setbacks – your losses on the Nasdaq from 2000 to 2002, the rise in the cost of education, etc. – and, also, to augment your lifestyle (which would otherwise be trending backwards due to the steady march upward in prices and relatively stagnant wages) by buying a second car, renovating your kitchen, replacing the roof, taking a nice vacation every year – these things add up, and are hard to afford on $60,000 per year for a family of four. Since buying the house, you took out $240,000 in equity – $20,000 per year, though obviously spread unevenly – leaving you with $80,000 of equity, or 17% of the value of the house. And in the last two years, that equity has been wiped out completely. And you were the prudent one! You didn’t borrow to buy second and third homes to flip; you kept an equity stake in the house roughly comparable in percentage terms to your original downpayment (and double in absolute terms); you didn’t leverage yourself as much as the mortgage broker was willing to leverage you. And you are wiped out, with negative equity in your house and your mortgage payments about to reset upward.
For most homeowners, their home is their primary savings vehicle. This hypothetical “prudent” person thought he had doubled his money on his equity after taking money out. He thought he was doing OK. Given how much he was taking out, he probably wasn’t saving materially elsewhere – he’s put a bit into his 401(k) and a 529 for his kids, but the market hasn’t gone much of anywhere in the past few years either, so that doesn’t amount to much – so basically that $40,000 of additional equity he built up over 12 years is it. And it’s all gone. He’s saved nothing, it turns out, over 12 years – in fact, he’s lost more than that, because he’s out the original $40,000. He’s got 12 years of savings to catch up on – can you imagine what that’s going to do to his spending habits? And remember: his spending habits are what primarily undergirds the global economy.
Obviously, not every homeowner is in this situation. Some are much better off – particularly wealthier people who didn’t need to supplement their incomes by taking money out of their houses. But some are worse off – they bought later, put less down, speculated on second properties, etc. My imaginary homeowner was imagined to be average. If the average looks anything like that (and it probably doesn’t quite – my imaginary homeowner took an awful lot out cumulatively over 12 years, but I did that to make a point), I can’t see how we’re going to avoid some very serious economic pain.
And I’m really not sure what, if anything, the government can do about it. We don’t want to reflate the bubble even if we could. There are things the government can do to try to mitigate the impact on neighborhoods of massive foreclosures, and there are things the government can do to try to stabilize the lenders who are suffering so much stress – but neither of these things change the reality that a huge amount of what was perceived by homeowners to be real wealth, real savings, has been wiped out, and they need to rebuild their balance sheets. There are real costs and risks associated with the proposed interventions to solve the liquidity crisis afflicting the markets, but even if these all work out splendidly we could still have a pretty ugly recession. And whether or not the government can do anything meaningful to prevent such a turn, it will have political consequences.
Here’s an aspect of this whole mess I’ve never really seen commented on: as the price of your house increases, so does the property tax burden you owe on that house. But though your net worth is rising along with the price of the house, that’s not cash-on-hand, liquid assets— like the kind you need to pay your taxes. I mean if your home has appreciated by $50,000 or more in a few short years, a wholly common thing in the lead up to the current crisis, you’d be paying thousands more a year in taxes, but with no additional liquid capital to pay that tax burden. Seems like a big deal to me.
— Freddie · Jul 28, 03:23 PM · #
Freddie: allow me to introduce you to Proposition 13.
— Noah Millman · Jul 28, 03:35 PM · #
It’s hard to see, exactly, what government should or could be doing on this, given that even this “prudent” person (and I’m guessing by the scare quotes you mean to indicate he wasn’t all that prudent) was in fact living beyond his means, at least on a monthly cash-flow basis. Whether this story is typical or not will determine, I would guess, how bad things get. If it’s enough for his family to put aside the vacations for a couple of years, keep driving that older car, etc., then I suspect that we’ll have some rough patches but things will basically hang together and – like Southern California five or six years after the disasters of the early 1990s – things will bounce back and he’ll have his equity back. If, on the other hand, he’s representative of a much broader swath of homeowners who can’t meet their basic financial obligations, then we’ll see some real financial blood in the markets and demands for even more aggressive government rescues. You might say what happens depends on where the Sam’s Club folks are at and what they demand…
— Michael Simpson · Jul 28, 04:00 PM · #
“Since buying the house, you took out $240,000 in equity – $20,000 per year, though obviously spread unevenly – leaving you with $80,000 of equity, or 17% of the value of the house. And in the last two years, that equity has been wiped out completely. And you were the prudent one!”
I’m going to have to disagree. This hypothetical guy’s situation is understandable, but to my mind he was very far from prudent. Taking out home equity loans to finance vacations seems to me like the height of stupidity.
— Stuart Buck · Jul 28, 04:04 PM · #
Stuart: I think stupidity is more common, and goes to much greater heights, than you may be aware of.
— Noah Millman · Jul 28, 04:30 PM · #
If your income hasn’t increased substantially, how can you possibly afford the payments on the extra 240k that you’ve borrowed—it’s more than the original mortgage?
That’s in no way prudent. That someone can envision it as such says a lot about how distant a virtue prudence actually is these days.
— TW Andrews · Jul 28, 05:12 PM · #
TW: depending on the terms of the original mortgage, it’s not implausible that, with the “right” structure and timing, the homeowner could double the size of the mortgage without increasing the monthly payment. Go from a 30-year fixed rate to a 2-year interest-only ARM and, again, depending on the timing, you might even lower your payments. For a little while, anyway.
I agree, this kind og behavior was wildly imprudent. But people with no credit histories were taking out these kinds of exotic mortgages with no money down, and doing so on multiple properties. That was the extreme end. My hypothetical guy might plausibly have thought himself prudent by comparing himself to true lunatics. Kind of like the guy who bought only “blue-chip” internet stocks in late 1999 . . . and so lost only 95% instead of 100% of his money. Everything is relative.
— Noah Millman · Jul 28, 06:03 PM · #
as the price of your house increases, so does the property tax burden you owe on that house.
Is that generally true? In our town, there’s a more or less defined amount of revenue they expect from property taxes (which inches up every year), and if a revaluation has sent assessments up overall, they adjust the mil rate down (and vice versa). All that really matters for us is the change in the assessed value relative to other houses in the town.
— kenB · Jul 28, 06:57 PM · #