Wednesday, September 10, 2008

The Housing Boom made us Poorer

Most of the gains during the great housing boom were just an illusion that has now since vanished. There were a handful of lucky ones that sold off their homes and did not reinvest - thereby cashing out at the peak. Most of us did the opposite - either pulled out our equity or purchased at the peak. Now that bubble affect is gone but the debt remains. Many are worse off than before boom. The ones getting foreclosed, the ones in too much debt, the ones that had planned to retire using their property as an investment. This AP article titled Many felt harsh side of home price rise interviews Alicia Munnel from the Center for Retirement Research at Boston College to discuss some after affects of the bubble. Lets take a look -

The evidence suggests that the housing boom caused people to increase their borrowing, to extract equity from their homes and to raise their level of spending. The Federal Reserve Flow of Funds report shows total household debt ... soaring to 120 percent of income in 2007 (from 80 percent in the 1990s). Most of this debt is home mortgage debt.

For people approaching retirement, aged 50-62, we found that their net worth was 14 percent lower than it would have been without the housing boom.
And it's all happening at a bad time because financial markets are also not performing well, and the powerful tool of staying in the labor force longer is also not easy to use when the economy's weak.

We found no big decline in either mortgage debt or other debt. Essentially what they did is they saw the values of their house going up and they wanted to consume more because they felt richer. The easiest way they did it in the short term was to put it on their credit cards. And then they covered their credit-card payments with debt. So I think the credit-card debt was stimulated by the increase in house prices.

Housing booms help households because they can take money out, consume some of it and their balance sheet is still stronger. But when you have a housing boom that's followed by a bust — a housing bubble — people borrow against gains in their house that never materialize.

In retrospect, when you look at the run-up in house prices, perhaps we all should have said to ourselves that this is not reasonable given the historical pattern — that house prices can't go up by 20 percent a year for a long time, and perhaps we should not cash in on it.
The enormous housing gains are now gone. Many people owe more than they can hope to pay. Those who saw their house being a ticket to the golden years now have to ticket to grim years.

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