A deeper hole

The New York Times has a good "trend" piece about housing tonight, pointing out that the situation continues to deteriorate in front of us. Two examples: "Merrill Lynch said yesterday that it would take a charge for mortgage-related securities on its books that is $3 billion more than the $5 billion it expected just two weeks ago. And a report from the National Association of Realtors showed that sales of existing homes in September fell twice as much as economists had expected, to their lowest level in nearly 10 years."

The Times goes on to theorize that $2 trillion or more of wealth destroyed in a housing slump will likely have a greater economic impact than the same amount of wealth destroyed in a stock market decline -- because more people are exposed to housing. (The idea that half of Americans own stock is misleading; a small number of Americans own a huge percentage of the stock market. Housing wealth is much more evenly, and widely, distributed).

Your thoughts? Comments? E-mail story tips to lalandblog@yahoo.com.
Hat tip: Amir

Comments

[John]

Here's the problem.

$2 trillion of wealth destroyed in the RE market has a ripple effect that the stock market doesn't, because individual investors can't buy stocks, bonds or mutual funds with no money down, unless they're stupid enough to use cash advances from their credit cards.

On the other hand, not only can you buy real estate with no money down, you could take out HELOC'S / REFINANCINGS based on the inflated value of the home you hadn't actually really begun paying for, and then use that money to buy even more stuff.

But once your house loses a significant portion of its value, you lose not only the ability to pay for the house, but the ability to pay the loans on all that other stuff you bought, and given that our economy is based on consumer credit, there are some REALLY NOT GOOD ramifications for our economy.

I mean, I was getting excited about the opportunity to potentially own a home in Los Angeles after the bubble popped, but now I'm wondering if I should buy a tent and a rifle and some acreage in Idaho to wait out potential societal collapse.

[Toby]

Here's an "out of the box" thought.

The declining values in homes help the economy by freeing up houndreds and some, thousands of dollars in property taxes for each homeowner.

And this type of tax cuts are particularly good for the poor and the elderly and is pretty much fairly distributed across all affected markets.

Now granted, a majority of the declines will be spread over many years for a lot of homeowners (each state has their own way on handling property tax).

But the average owner will see some sort of decline in property tax in their next filing. Or at least they will have plenty to protest the assessment.

For the long term homeowner, this is tax relief.

[Martin]

The domino effect of a drop in real estate values exceeding $2 trillion only rehashes a subject and debate that has been raised on this blog since its inception.

Some have clapped their hands with glee over declining prices. One actually wrote "burn, baby, burn." These are the folks that never seem mindful of the domino effect this will all have on our general economy.

Others, of course, express annoyance over such limited reasoning. There is barely a day that goes by on this blog when an intelligent individual does not forewarn others that a steep drop will mean much more than less equity for current homeowners. They rationally point that this will all create major losses in virtually every economic sector. They are 100% accurate.

I believe the time has come to call this current cycle The Greater Real Estate Panic of 2007.

We can analyze this market and its short and long term impact on our general economy for another year. It will make no difference. The panic has begun. And, I, for one, feel a sense of sadness for everyone who has or will lose their home or their jobs.

[John T Watts]

We bought a horse ranch in Texas and moved there in June 2005. Foolishly, we read the crystal ball incorrectly and kept our home in Merced California as a rental. The value has dropped about $100,000.00 since we left and we are kicking ourselves for not selling it when we moved. So now we will just hold onto it and keep renting it out and hope the value will rise again one day. In a way we have lost $100,000.00 but in another way, nothing has changed. Lots of people have lost value in their property, but for many it just makes no real difference. It either continues to be a home or a rental. The forces of supply and demand that affect vacancy rates and rental rates tend to work somewhat differently than the value of homes.

[Brian]

John, one advantage to converting a house to a rental is that if you do lose money, you can take a tax write-off. There are no tax write-offs for owner occupied houses that lose money (because there is no tax on the capital gain either). I had to do that in 1997 when I couldn't sell my home. Eventually the market recovered and I sold it for what I paid for it.

[xtine]

I understand most people don't "own stocks". But don't many of us have stocks because of our 401(k)s and IRAs?

I think the population's stake in the stock market is undervalued. If you drill down, I bet you'd find more people own stocks through these channels than own homes.

[investorguy]

Martin: Bravo. I made those very points a few times and was shouted down by the "burn, baby, burn" crowd. Maybe your wisdom will fare better.

Toby: Only in areas where assessors are willing to reassess (and not in areas where taxes are based on what you paid for the house). No municipality is going to lower assessments voluntarily and damage services that they support.

[LT investor]

if you really want to understand what's going on, you really have to go back to 2001, after the dotcom bubble burst and 9/11 happened. greenspan et al were very concerned about the impact of a deflationary spiral taking hold. this is why they cut rates to the bone and 'helicopter ben' bernanke was talking about dropping dollars from the sky in an attempt to ignite inflation and stimulate economic activity.

if you've followed greenspan closely over the years, you'd know that he was always appreciative of the wealth effect on consumer spending due to rising home values. in fact, i believe he has since stated that was one reason why he was sanguine about the rise in home prices that accompanied the early rate cuts. he WANTED consumers to feel wealther (and to spend more) in response to the economic shock of the TMT bubble & 9/11.

the problem for us now is that greenspan's little ploy worked all too well. by 2004 home prices were raging out of control and moving well above what most long-term models would suggest was an equlibirum price. in 04/05/06 roughly 20m homes changed hands at what were obviously peak prices. those homes were financed with $4T in mortgage debt that the lenders expect to be repaid.

the problem is being compounded by the fact that roughly 6m of these 20m homeowners were either (a) speculators or (b) lower income / less savvy borrowers who relied on exotic loans to be able to afford a house at the top.

now the wealth effect is going to start working in reverse. home prices will probably decline back to 2000-2003 levels in absolute terms. anyone who bought after (roughly 25-30m households) then will lose a lot of the equity tied up in their homes. they will feel very poor for years to come. as long as they keep their job, they will service their debt but dramatically cut back their spending. in the meantime, new borrowers will find it tough to enter the market because the global financial system will be under strain from the orgy of debt it's created in recent years (not just subprime mortgage, but leveraged loans, corporate loans, prime brokerage lending, etc). so the cost of borrowing money will rise as the system allocates credit to those entities around the world most willing to pay for it.

the process will go on until the excess is cleaned out of the system. debt will be paid down, bad loans will be charged-off and asset prices will return to fundamental values. how long that takes is anyone's guess. it took japan 15 years, but then their bubble was much worse than ours and they were unwilling to use bankruptcy to restructure the financial system. NASDAQ found its bottom in 3 years. i think the right time frame for the recovery is somewhere between these two extremes.

the big unknown question is what this does for general consumer sentiment. when sentiment plunged in the late 20's, it triggered the depression. no one thinks it can happen again, but the conditions that led up to the crash & great depression look scarily similar to what we have today: a compressed period of rapid technological change that created opportunities and de-stabilized industries, relatively loose central banking policies, increasing trade & globalization which led to tighter integration of the global economy, widespread risk-seeking behavior on the part of consumers, and a worldwide property boom financed with leverage.

[aldo818]

That's an interesting theory from the NY Times. Although, it doesn't seem likely considering that the overall US economy is pretty strong.

Nonetheless, it does point out that a drop in housing values could effect other parts of the economy.

[Toby]

Some have clapped their hands with glee over declining prices. One actually wrote "burn, baby, burn." These are the folks that never seem mindful of the domino effect this will all have on our general economy.

Posted by: Martin

I heard the exact same thing about the Internet bubble. Oh so many people work in the Dot Com industry...so much wealth will disappear...spending with stop cause people were spending money cause they had so much wealth in stock...

AHHH It's 1929 all over again.

When the simple truth is, the precentage of people who will be directly affected (foreclosures) is incredibly small (Probably less than 1% of the total population, maybe 2%). And the number of jobs loses will be, precentage wise" equally as small.

Yes, house prices will decline, taking with it built up equity for many homeowners.

Oh darn, instead of cashing out the house at 50 and then buying a small island off the coast of Hawaii, they're going to have to stick to their original plan they had back in 2001 or 1998 or whenever their house price shoot up.

Toby: Only in areas where assessors are willing to reassess (and not in areas where taxes are based on what you paid for the house). No municipality is going to lower assessments voluntarily and damage services that they support.

Posted by: investorguy

Again each State has they're own property tax mojo.

But even politicians are crying about the lose in tax revenue home prices declines will bring.

And I know how in your mind there's NO upside to home price declines (cause one can't short a home), but for the average American AND the general economy at large, a sharp decline in property taxes will free up large amounts of money to be circulated in the economy.

And basic Economics 101: The less money a person pays in taxes, the more money they have to spend on the economy. And the more moeny in an economy, the better the economy works.

So yes, the average American will see more moeny in the pockets due to price declines that they saw when there home prices increased. In fact, the Average American actually lost money if they just sat on their houses and didn't sell it and then rented afterwards.

You see, the price increase was just paper, but the tax increases were REAL.

Do you understand that?

[MK]

"You see, the price increase was just paper, but the tax increases were REAL."

Property taxes are what, 1.5% - 2.0% of a total home value? So by your reasoning, a household that sees a $100k drop in value is going to rush out and spend the $2k they will be saving on property taxes? Please. I would not call that "large amounts of money to be circulated in the economy." And that is assuming 100% of households will rush out to spend this newfound "savings" which is unlikely. That's also assuming that every household would lose significant value. Homes outside of the bubble markets stand to lose less in total dollars. The average savings on the change in property taxes will be insignificant and is not going to be the economic savior you're hoping for.

[investorguy]

Toby: you obviously have no clue how states and municipalities fund services like education and roads and police and fire. Just how do you recommend that they make up the difference in tax revenue if your idea of willy-nilly reassessments occurs? Get that clue, then come back and apologize.