Learning to love falling house prices
Optimism has been all but extinguished from the U.S. housing market.
The number of Americans lining up for new home loans is shrinking again, according to Wednesday’s release from the Mortgage Bankers Association, and the best that can be said of homebuilding is that it has stabilized at almost 80 percent below its peak.
With no end in sight to falling prices, perhaps we should look on the bright side. Indeed, there are three good reasons why sliding prices are not such a bad thing.
Falling house prices are usually seen as wealth destruction. But they can also be seen as wealth transfer. The next generation of homebuyers will benefit from our loss. Those young homebuyers who have been able to cling onto their jobs are already reaping the advantage. The American dream of home ownership can now be achieved at bargain basement prices.
Take San Francisco. If you earned the median wage in San Francisco at the peak of the housing market in 2006, you would have needed to devote 75 percent of your income to meet mortgage payments on the average home. Now people will pay just 35 percent of their income, according to Ian Morris, chief U.S. economist at HSBC.
It would no longer be any surprise if prices remained stagnant for a decade – spreading the benefit of cheap housing for at least 13 million new households.
Americans may also reflect that much of their temporary housing wealth was illusory anyway. Since house prices in a given area tend to rise in tandem, the only way to cash out was to borrow against equity, or move to a cheaper area or smaller space, or die.
A second consolation is political. Tumbling prices have exposed the flaws in the American government’s efforts to subsidize housing.
It is now clear that these efforts did more harm than good. More thoughtful U.S. politicians must now question the mortgage interest tax deduction. The benefit of this tax was heavily skewed towards high earners since they paid a stiffer tax rate. Instead of fostering broad home ownership, the deduction encouraged rich Americans to borrow more and build bigger homes.
This is bad financial and even worse environmental policy. At the very least, Congress should now cap this deduction at $500,000.
The third source of solace is macroeconomic. For several years America borrowed money from abroad to make an investment that did nothing to expand its productive capacity or its ability to export. Residential construction in 2005 reached 6.3 percent of US national income — its highest level since 1951.
A more sober level can be gauged from the average since 1980, which is 4.5 percent. Rampant home building went far beyond the actual housing needs of Americans. Over the past five years around 8.9 million housing units were built and just 6.7 million new households were created, according to Harvard economics professor Edward Glaeser. The number of vacation homes jumped from 3.6 million in 2002 up to 4.8 million now.
An ever-growing number of U.S. homes were also vacant, as investors waited for tenants or buyers. Not only did houses become more numerous, they also got bigger. The average square footage of a U.S. family home expanded from 2,200 to 2,500 over the past eight years. “Mistaken beliefs about housing may have crowded out more productive investments,” argues Glaeser.
Since two-thirds of Americans own their homes, falling prices are never likely to inspire street parades. The economic loss has certainly outweighed the gains and the banking system may take years to fully recover. Even so, our loss is a hidden accounting gain for the next swath of homeowners. A more balanced economy and housing policy may now emerge. For more philosophically minded Americans, this is a cloud with a silver lining.