Wednesday, September 12, 2007

How much poorer do falling home prices make consumers?

One of the big questions about the deflating housing bubble, apart from how large it will be, is how much impact will it have on the broader economy. By clearly, different people have different conceptions of what the "broader economy" means. The always-glum Nouriel Roubini has this to say:
It is a insolvency problem as you have now millions of US households that are near insolvent and will default on their mortgages; dozens of sub-prime mortgage lenders who have already gone bankrupt; dozen of home building companies that are under distress; many financial institutions in the US and abroad - such as hedge funds and other highly leveraged institutions – that have already gone belly up...
I would not consider hedge funds, mortgage lenders, home building companies, durable goods manufacturers, etc. part of the "broader economy" -- they are all part of the housing economy as their business is fundamentally tied to houses -- either directly or through their financing. If you believe that housing prices became too high (ie. that there was a bubble) -- and some people don't -- then prices have to fall. If prices have to fall, then any party that's counting on rising prices will be caught on the wrong foot.

Moreover, I'm not sure that higher housing prices make an economy richer overall. Everyone needs somewhere to live, and if your house price goes up, and so does the price of any home you might ever want to move to, then how is anyone richer? You're still swapping a house for a house? If you own multiple houses, then yes, you are wealthier as prices rise, but if you own no houses, you are poorer. I'm guessing that overall, multiple home owners and renters come out a wash for the economy as a whole.

Certainly, it's hard to make an argument that expensive real estate makes everyone richer when you look at how much disposable income it uses up. If people give up playing the home lottery, move to cheaper rentals, and then put that extra cash into savings, or buying other stuff, that seems like an efficient allocation of resources from an overvalued asset (real estate) into better assets, or consumption.

UPDATE: I did not notice the details in the article that spoke about renters. It found that both housing prices and rents have risen by similar amounts. That has not been my personal experience in Boston or California, but the degree to which the ratio of rents and prices has stayed constant is the degree to which the increase in housing prices has been driven by fundamentals.


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