US homes may lose as much as half their value in some US cities as the housing bust deepens, according to Yale University professor Robert Shiller. Meanwhile, Martin Feldstein of Harvard University says that experience suggests that the dramatic decline in residential construction provides an early warning of a coming recession. The likelihood of a recession is increased by what is happening in credit markets and in mortgage borrowing. Feldstein says that most of these forces are inadequately captured by the formal macroeconomic models used by the Federal Reserve and other macro forecasters.
“The examples we have of past cycles indicate that major declines in real home prices ”” even 50 percent declines in some places ”” are entirely possible going forward from today or from the not too distant future,” Shiller said in a paper presented last Friday at the Federal Reserve Economic Symposium in Jackson Hole, Wyoming.
Falling real-estate values may undermine consumer spending by spurring households to save more and by preventing them from tapping home equity.
Because price gains were larger and more widespread this time compared with past speculative booms, the risk of “substantial” price declines is greater, wrote Shiller, who is also the chief economist and co-founder of MacroMarkets LLC. Shiller is also the author of Irrational Exuberance, in which he forecast the end of the tech boom in 2000.
First, kudos to ‘FinFacts’ — it’s coverage is far better than what has been seen here in the States, right down to including the full text of Feldstein’s remarks.
The most important thing to watch is Americans’ [i]response[/i] to unfolding events. Feldstein quite correctly fingers one emerging dilemma:
[blockquote][i]The household savings rate has begun to rise [for the first time in decades], from 0.4% in 2006 to 0.8% in the first two quarters of 2007.It will be challenging to raise the household savings rate without triggering a deep economic downturn.[/i][/blockquote]
He seems, however, to have missed the second. Mortgage finance has been the principal pathway through which the Fed has goosed the money supply. New debt increases the money supply, but what if they throw a liquidity party and nobody comes?
People increasingly don’t want to take on any more debt, or (often) they [i]can’t[/i] take on any more debt. Therein lie the seeds of what is called a “liquidity trap.” People refuse to borrow, no matter how low the interest rate drops. Ask the Japanese.
Dealing with debt — either by repayment or default — is deflationary, because in the same way creating debt increases the “money” supply (because both the cash and it’s offsetting note are counted as monetary assets), [i]retiring[/i] debt contracts the money supply because the note simply goes away.
Once people a) stop borrowing, b) increase their savings rate, and c) begin retiring their existing debt … [i]DE[/i]flation is inevitable because as the money supply contracts — nobody will borrow the liquidity the Fed attempts to create — and monetary velocity declines (because nobody wishes to borrow those savings from their local bank) … CASH becomes king.
It’s happened many times before, and it’s not the end of the world, but for people who’ve spent their entire lives in an inflationary period the risk is that they’ll not recognise that the “rules of the game” they thought they knew will have flipped 180 degrees.
“The wise see danger ahead and prepare for it. Fools continue on, unawares, and pay the consequences.” Proverbs 22:3
This may be a “scary” scenario for those who borrowed too much & then lose their jobs, but it would be really helpful for first-time buyers of modest means.
And unlike investing in shares of peachfuzz-dot-com [fictional, although these days there really could be something with this name], the value of a house will never decline to zero. Everybody has to live somewhere.
Plenty of houses have declined to zero in the past–think of deserted villages in England, ghost towns in Colorado, burned out row houses in Harlem, and bulldozed subdivisions in Texas. People can’t live in places where there’s no living to be made.
And if one has paid say $500K for a house one can’t sell for $300K then it is worth a good deal more than zero, and the owner will just walk away.
#2 – the problem could be though that there are more places to live than there are people (or at least people willing to buy). the Miami condo bust is a glaring example of that.
This doesn’t surprise me. My father builds houses in the South, where there has been a boom for over a decade, mainly due to Yankees selling their homes up north for $400000+ and moving South. For the money they were getting for homes in NY/Boston/etc. they could build a mansion in the South. His work has been rather slow the last few months because the housing bust up North has trickled down South.
#3 Austin: I suppose if a nuclear explosion vaporized my house, you could say its value had declined to zero. But paying the mortgage would be the least of my worries. However, we’re not talking about that here.
My point was that, although declines in prices hurt sellers, they help buyers, who are not likely to find the situation [i] scary [/i] .
And if you know of any villages in England with a value of zero, please let me know. I’ll buy them.