Monday, August 25, 2008

The Great Disappearing Equity

Many people think that the figure quoted on a home's value either stays the same or goes up. Unfortunately, as we know both of these assumptions can be wrong. House values can go a third direction - down. The problem is compounded when people began counting on an ever increasing house prices to pay for retirement, college for the kids, or having a non-otherwise affordable lifestyle. With the downward flow of home values people, the equity is also disappearing.

Part of the decline of home values is the ever shrinking pool of potential buyers. During the Great Housing Bubble low interest rates and exotic new mortgages that did not require any down payments produced an ever expanding pool of potential home buyers. But the exotic mortgages were not supported by the fundamentals. And interest rates would never stay at record lows forever. This article from Reuters, Home buyers hold fate of U.S. economy, illustrate how bad the potential problems could be. Lets take a look -

Many economists say that home prices have another 10 percent to fall to bring them into balance with rents and incomes. A fall of that magnitude would elicit a huge sigh of relief from Wall Street and Washington.

If banks tighten lending standards further, denying loans to borrowers with good credit histories, affordability won't be enough to keep people buying homes. And a sharper housing bust would leave deep scars in consumer sentiment, which would likely lead to a deep recession.

If borrowing costs eased to 5.5 percent, the Case-Shiller index may have only another 7 percent to fall, Credit Suisse said, but if rates rise to 7.5 percent, house prices may tumble another 24 percent. A 24 percent decline would wipe out the entire home equity for millions of homeowners, many of whom were counting on their homes to finance their retirement or pay for their childrens' college education. Without that nest egg, spending would suffer, triggering a consumer-led recession that some economists predict would be the worst since the early 1980s.

"If there's a consensus, it's probably that prices will fall another 10 percent between now and next summer, which would be 25 percent down from peak to trough," said [Mark] Zandi of Moody's

There are definitely parts of the country that are experiencing a significant recession. There are also places, even locally, that really never had any of the boom benefits but are feeling the aftereffects of the crashing prices.

The potential devastation for those who budgeted their lives based on the value of their home are going to feel an enormous impact either way. The real question now is how bad the impact of falling prices will be - a tidal wave or a tsunami?

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