Saturday, 15 January 2011
US Household wealth: where did it go?
Where did all that housing wealth go?
In the last four years, US home equity - the difference between the market value of homes and the outstanding stock of mortgage debt - has fallen by half. In terms of wealth destruction, there have been few parallels outside of war. The nominal value of housing wealth today is now at the same level it was back in the late 1990s. In terms of wealth accumulation, it is as if the US housing bubble had never happened.
This chart tells the deeper story than just simple post-bubble wealth destruction. During the bubble years, US homeowners remortgaged and extracted billions of dollars that was spent to sustain personal consumption. Lurking beneath the crazy house price appreciation of the last decade was a lethal accumulation of household indebtedness. Households might have thought they were becoming richer. In reality, they were promising away their future incomes.
Here lies the treacherous asymmetry between home valuations and mortgage loans. House prices are ephemeral, flighty and fundamentally subjective. Debt, on the other hand, is merciless and exact. It must be paid.
Crashing household wealth also goes a long way towards explaining the ferocity of the recent US recession. There is a rough and ready empirical rule relating household consumption to wealth. Most economists agree that if wealth increases by one dollar, personal consumption increases by three or four cents.
If household wealth isn't fluctuating by much, then this wealth effect is quite muted. If, on the other hand, household wealth crashes by 50 percent, then GDP is going to take an almighty hit. So when house prices are racing upwards, the economy booms as everyone thinks they're getting richer. But when they crash, a recession is inevitable.
There is nothing new in any of this. Economists have understood the relationship between economic fluctuations and household wealth since the 1950s. The really interesting question is why would policymakers, in particular the Fed and the Bank of England, allow house prices to continue to rise, knowing the risks inherent when they inevitably crash? They can not plead ignorance.
Stopping a housing bubble isn't difficult. It can be done in one of two ways; raise interest rates or impose lending restrictions on banks, preventing them from writing mortgages to fuel the bubble. All that is needed is the will to do so. However, bubbles are great while they last, and the pain they create is marked down for payment somewhere in the distant future.
If this restatement about the dangers of asset bubbles seems a little too retrospective, take a look at food or oil prices today, which are now beginning to rise sharply. Also, examine recent developments in certain property markets in continental Europe, for example, Paris or Vienna. We still live in a world of asset price bubbles. Interest rates are too low, and we're bouncing from one crisis to another. We never seem to learn, or rather they would prefer to accrue the short run benefits of asset appreciation, and leave the consequences to the future.