Home Prices

Here’s today’s figures on home prices via the New York Times:Home Prices Plunge in October

The long term decline in house prices can be expected to continue. Do not believe the analysts. They are the ones who completely missed the dangers of the housing bubble and its impact on society. Home prices as a ratio to incomes are still too high, and with wages under pressure from the recession there is now an additional downward impetus for home prices independent of the bursting of the recent inflationary bubble.

Americans fell prey to a massive fallacy: that a home is an investment rather than a place to live. During the inflationary years of the middle of the last century the middle class saw the value of their homes rise constantly and, often, rapidly. This fostered a feeling of wealth. As an unfortunate side effect it also fostered a feeling that a home was a savings mechanism so other non real estate mechanisms were of diminished use. This trend was reinforced when home prices surged and began to produce a ‘return on investment’ way beyond that of other potential savings assets. Finally many middle class families shunned the stock market because of its apparent volatility when compared with what appeared to be reliable and steady gains in home prices.

Eventually this bias towards home-as-investment gathered a momentum of its own. Home prices as a ratio of earnings rose way beyond historical norms. The housing market became a lucrative market for lenders who wanted to facilitate home ownership. The Republican Party adopted the social engineering mantra of home ownership as part of its overall ‘ownership society’. Home owners were privileged in the tax code via the mortgage tax deduction which hid at least some of the inflationary impact from home owners – the government effectively subsidized home purchasing in what has become a huge welfare program for the middle class.

Finally the administration continually ignored asset price inflation as part of the calculus for its anti-inflation policies. So even while the Federal Reserve Board spoke of its anti-inflationary stance it turned a blind eye to the rampant real estate price inflation going on right under its nose.

All of this was bound to end in tragedy.

So it has. When the elastic band finally was stretched too far it snapped back with a vengeance.

Not only did the stupidity over real estate leave us with an impoverished banking system, but it has left a whole host of middle class families with too little saving for retirement. Because the real estate bubble led to a false feeling of wealth it also led to over-consumption. It is the undoing of that over-consumption and a the return to an economy of thrift that is the most severe danger we now face.

Dealing with bank losses is an enormous and essential task, but at least it has a limit. Dealing with a middle class that now has to switch to thrift, and the dire cut in consumption that may be associated with such thrift is a potentially far more devastating policy issue.

About two thirds of the American economy is based upon consumer spending. Any prolonged decline in spending as consumers shift their priorities towards saving instead of spending could lead us into a spiral downwards of reduced production, reduced employment and thence to a need for further saving. That is a policy nightmare.

The only cure for such a potential spiral down is a massive injection of cash to bolster confidence and put a floor under the decline in consumption. Simultaneously efforts to encourage responsible spending habits, rather than panicked habits, are also needed.

Thank goodness that Obama has a first rate economic team. He, and we, are going to need them.

And remember: a house is a home, it is not an investment!!