there is a real shift downward in housing demand, it would have
a dramatic impact across the entire economy," said John Benjamin, a
professor of finance and real estate at American University.
of Americans have become dependent upon rising home values to
support home-equity loans and mortgage refinancings, which can be used
to pay for cars, remodeling projects, clothes and more.
live in a consumption economy that is financed by debt," which in
turn largely rests upon our home foundations, Benjamin said.
labor market, too, depends upon feeding the hunger for housing.
the beginning of the economic recovery in November 2001,
employment in housing and housing-related industries has accounted for
43% of the increase in private-sector payrolls, according to Asha
Bangalore, an economist for Northern Trust Corp.
collapse suddenly. They go through a long series
of self-reinforcing deflationary stages that typically last five to
seven years. Given the extreme and unprecedented nature of the current
housing bubble, I expect a ten- to fifteen-year downturn to follow this
boom. The government will step in with all manner of supports and
bailouts along the way, similar to those that created the bubble in the
first place, so the exact trajectory of the decline is impossible to
predict. Here I estimate how and over what time period the decline may
of Housing Prices to Employment
Chart 1 above shows
prices are strongly correlated to the
unemployment rate. Housing prices fall as unemployment rises, and vice
versa. Given that 43% of all jobs created since 2001 are housing
(bubble)-related, a decline in housing-related payrolls can be expected
to reinforce housing price declines in the bust part of the cycle. The
rate of home equity extraction is a good proxy for the housing market
itself. Home equity extraction tends to rise in line with property
values and declines on the way down; no home owner wants to borrow
against a deflating asset, and no bank wants to secure a loan against
2: Home Equity Extraction - Past and Predicted
extraction as our yardstick to project the bust. Thanks to my friend Paul
at Northern Trust for the original of Chart
2, which shows home equity
extraction from 1950 until 2005. I have modified it to show a possible
trajectory of home equity extraction decline in seven steps, A through
G, from now until 2020. While I'm fairly confident in the length of the
entire process, the length and timing of each step is subject to a wide
range of error.
are here. Whether the rate of home equity extraction
implodes from here (as shown) or decreases more gradually is a matter
of debate, although in past boom-bust cycles, the bust rate of decline
has been significantly more rapid than the boom rate of growth. What is
not debatable is whether the rate of home equity extraction will revert
to the mean rate of about zero, from the current rate of more than $250
billion annually. It will.
In fact, the rate of home equity extraction will tend to overshoot the
mean to reach an extreme negative rate of equity extraction (building
equity) that's twice the rate of positive extraction that occurred
during the boom phase. This relationship occurred in the previous two
cycles, which bottomed in 1982 and 1995, respectively. This implies
negative equity extraction of minus $500 billion per year at the cycle
trough. Chart 2 shows a more optimistic prediction of negative $250
billion occurring between 2015 and 2020. This more prosaic estimate
accounts for government efforts to mitigate the impact and minimize the
overshoot, by offering specialized loans, making direct purchases of
securitized mortgage debt, and so on.
Step B: As housing prices begin to
though more slowly and less frequently. Old habits die slowly. One year
into the decline, housing speculators will have left the market, but
home owners will generally still believe that prices will either resume
their rise or at least flatten out, not continue to decline. Remember
the first year of the stock market bubble decline, when most people
hung in there until they'd lost all of their money? The first lesson of
behavioral finance is that the most common mistake made by market
participants is to hang on too long and fail to cut losses.
While home owners at this stage will borrow less against their houses,
and loans will be more difficult to come by, the average home owner
will still make frequent trips to Home Depot or hire contractors to
make home repairs and improvements, believing they'll "get their money
back" in an increase in the value of their home at least equal to the
cost of fixing it. Some home owners will put their home up for
they purchased early enough in the boom so that they can still realize
a profit, even selling at five to twenty percent below the peak price.
Step C: After prices have declined for
of buyers who purchased near the top of the market will begin to feel
the psychological effects of being underwater on their mortgage. They
will be less inclined to borrow money, or to spend money fixing up
their home, as home improvement value increases will be swallowed up by
general market price declines. There will still be profits to be made
by those who bought very early in the previous boom cycle, but fewer
people will have this option.
As transaction volumes continue to fall, demand for housing-related
employment will decline too. The first signs of labor market distress
will start to show up, as more and more of that 43% of the private
sector who found jobs in the housing industry are no longer needed.
Coincidentally, major employers—such as the U.S. auto
going through major restructuring, adding to pressures on housing
prices in some areas. Some home owners will need to sell at a loss in
order to move to regions of the country where the labor picture is
better, and will do this if they have enough equity and are not paying
cash out of pocket to cover their remaining mortgage obligations. These
sales will further depress home prices.
Step D: Three years into the decline,
learn what owning a home really costs, versus renting when housing
prices are declining and jobs are more scarce. Rent is a fixed cost,
whereas home ownership presents many variable costs, including
increased interest payments on ARMs,
and rising tax, insurance, and energy costs. Also, upkeep for the
average home typically costs five to ten percent of the price of the
home, annually. As prices fall, homeowners will have less access to
home equity loans. Many will not be able to afford repair and
maintenance expenses. Homes in some neighborhoods—and in some
entire neighborhoods—will begin to look neglected, further
Step E: Five years into the downturn,
begin to more seriously affect the market, as indicated in Chart
unemployment rises, homeowners will leave housing bust regions to move
to areas where there are more jobs. Many houses will be sold at a loss,
or even abandoned, as the market price falls below the loan value.
Given the choice between paying cash out of pocket to sell their home
or leaving the keys with the bank, many home owners will make the
Step F: Ten years into the downturn,
will be widely regarded as a terrible, "can't win" investment. McMansions will be subdivided for
Step G: Ten to fifteen years after the
start of the
housing values, prices will bottom out, setting the stage for the next
boom. Time to buy.