The Housing Crash Payoff: More Affordable Housing, More Disposable Income   (August 11, 2008)

Rather than wringing our hands in horror at the crash of housing prices, we should be cheering wildly and hoping they drop another 50%. Why?

Because the percentage of income we've been paying for housing has been way too high. As Americans have had to spend an ever higher percentage of their incomes for overvalued housing (renters and owners alike), then they've had less to spend or save.

Put another way: how many hours did you have to work to pay your rent or mortgage in 1960? Or: how many loaves of bread could your monthly rent or mortgage buy in 1960? Consider this chart:

The percentage of income devoted to rent rose 42% from 1960 to 2000. While I was unable to locate equivalent statistics for mortgages, the following chart reveals the rising ownership rates enabled by widely available low interest, low-down payment Veterans and FHA loans in the 1950s and 1960s, and what happened to ownership as high interest rates, stagflation and higher housing prices took hold in the late 70s and 80s: it dropped for the first time since the Great Depression:

As interest rates dropped and the economy strengthened in the mid to late-1990s, home ownership rose and continued rising as the Great Housing Bubble inflated under the pernicious effects of exotic mortgages, liar-loans and super-easy money fueled by Wall Street's mortgage-backed securities and derivative "innovations."

In the great housing boom of the 50s and 60s, prices were relatively stable, fixed-rate mortgages were the norm and interest rates remained low, enabling households to devote a modest share of their income to housing.

But the 1999-2006 Bubble was different: households were paying far higher a percentage of their income for mortgages than previous generations. Here is a telling chart courtesy of Lee Williams and the excellent California Housing Forecast website: Percent of Income Spent on Housing

In order to get in on the Housing Bubble, many households were paying a cripplingly high percentage of their income fot their overpriced "piece of the American Dream." Looking at this chart, it's no wonder foreclosures are soaring: any dip in income would leave these recent buyers unable to make the mortgage payment.

Some will point to NIMBYism (not in my backyard) and environmental restrictions as the reasons behind the high cost of housing in 1995-2006; while those are valid issues, I always point out that housing was still affordable in the "high-price" S.F. Bay Area in 1995, even though all those restrictions and costs were already present.

What changed was lending standards were thrown out and "innovations" like no-down, interest-only, no-document "liar loans" enabled anyone with a pulse and the willingness to fabricate/stretch the truth to buy a dwelling. And Wall Street bundled and sold whatever risky loans were originated as fast as shysters could write them: hundreds of billions of dollars worth of mortgage-backed securities and mortgage-based derivatives were sold by investment banks which reaped billions in profits.

And here's what all that easy money did to housing prices: they more than tripled in California:

Meanwhile, other costs such as property, sales and Social Security taxes were soaking up ever larger percentages of household income. In 1960, the FICA tax (Social Security) was under 2%. Now it is over 7% for employee and employer alike. Property and sales taxes have zoomed, too--as percentages of income, which means that "inflation" is not a cause or excuse.

Either household income stagnated or household costs for housing and taxes rose; and it seems both are true. In addition, "junk fees" for services which were once free have proliferated like out-of-control viruses: county and state parks now charge for parking, parking meter tickets now cost $60 or more--the list of fees and charges which did not exist or which were quite modest (adjusted for inflation) is essentially endless.

Squeezed by higher costs and taxes, higher housing costs and stagnant wages/incomes, households compensated by borrowing vast sums off their homes in the bubble. This is illustrated by this chart which shows that household real estate assets rose at a slower pace during the Housing Bubble than they did during the much more modest housing price inflation of the late 1970s.

Why? Because Americans were borrowing against their rising equity at a furious pace.

The crash in financial assets as the 2000-2002 dot-com stock market bubble crashed is plainly visible, as is the plummet in real estate assets as the housing bubble popped 2006-2008.

The game is up on that "income supplement" source. Now as jobs are lost and rising energy and commodity costs squeeze household incomes, it is high time for housing to fall back to its previous percentage share of household income: not 50%, not 40%, but under 20%.

I can already hear the arguments about why that's impossible: houses are larger, apartments are better appointed, and so on. But as I have illustrated here many times, the market value of any debt-based asset (i.e. real estate in all its permutations) is directly correlated to the cost and availability of borrowed money. If money becomes dear and difficult to borrow, the value of all assets which depend on cheap, easy money will drop, regardless of how many square feet of granite countertops grace the kitchen.

In an economy with 15-20 million surplus/vacant dwellings, replacement cost has virtually no impact on marked-to-market prices.

The continuing meltdown of housing couldn't come at a better time for U.S. households. As people wake up to the need to pay down debt and start saving some of their income, one easy way to free up income is to spend less of it on housing.

Eventually this reduction in bubble-inflated values will positively impact the rental housing market in most areas, as the new owners (those buying REOs and foreclosed properties) will have a lower costs structure for ownership (lower property taxes, etc.) and therefore they will be able to rent housing at much lower rates and still make a profit.

Although it is sacrilege of the highest order to even whisper this in our debt-based Empire of Lies and Debt, the ideal housing market might well be "cash only." That would drop the valuations of housing and the costs of owning and renting considerably.

The upside: as housing prices and costs plummet, households will have more money to pay down debt and save for future needs.

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