Tuesday, June 24, 2008

Your House Is Worth Less? Good

The last time we had this feeling of financial vertigo was when the Internet bubble popped seven years ago. But this is much worse: the value of our homes is collapsing. For generations, rising home prices have been central to our general sense of well-being.

So why is the real estate collapse a good thing? First, because the collapse of any financial bubble can be interpreted as a morality play: greed gets its comeuppance. Subprime mortgages play the role that used to be played by junk bonds. They represent easy money--too easy, in retrospect. Borrowed money, if it gets out of hand, puts economic history on speed: everything rises faster, then collapses harder. Foolish lenders become the enablers of foolish borrowers. In the 1990s, people came to believe that stock prices would rise forever. They learned differently. And now we are learning differently about real estate as well. Whenever the price people will pay today depends on the belief that other people will pay even more tomorrow, you've got a bubble. It takes only a slight letdown in those expectations to send the whole delightful, self-feeding process into reverse.

The end of the housing bubble is good for practical reasons as well. Real estate--land and buildings--is fundamentally different from most other things people invest in. Unlike a factory (or a company full of factories), a house does not produce anything. Sure, it's a place to live, and that has value. But that value--as measured by what the property would rent for--hasn't been going up anything like the 20% or 30% or 40% a year that some houses have appreciated recently. If the price of, say, onions goes up 40%, more onions will soon flood the market. The extra money people pay will go to the production of onions. This happens in the housing market only to a tiny extent. Most houses that change hands each year were built long ago. When they are sold for a higher price, the money goes into the pockets of the previous owners.

We all count this money when we tot up our net worth. If you don't want to sell your house, you can borrow against its rising value. Nowhere is the real estate insanity of recent years more vividly on display than in the market for second mortgages. Lenders hawk them like patent medicines in the 19th century, as a cure for all your ills.

And even if you don't take out a second mortgage, you can still fantasize about what the house is worth. Fantasies of real estate prices have long been a staple of middle-class conversation. These days you can go to the Web and get a specific number.

All these rising house values added trillions to our sense of national wealth, but it is an illusion. If everybody, or even a fraction of everybody, tried to cash in on this rising value, prices would collapse, and the value would disappear. (By contrast, there aren't millions of onion owners counting on the value of their onions to keep going up year after year.) Economists predicted for years that something like this would happen as the boomer generation aged. Nobody believed them.

Since most families own their homes, the country is happier when real estate prices are going up. But it is healthier when prices are going down. Look at it this way: in the housing market, people fall into three categories. Some, mostly young folks, are trying to buy their first home. Some, at various stages of midlife, own a home but will trade up someday, or at least think about it. And some, mostly older, are trying to sell and downsize. Who is served by soaring house prices? Not the first group: rising prices make it hard for those people to get into the game. Not the second group: what it will have to pay for a bigger house is probably increasing faster than what it can get for the current one.

The only clear beneficiaries of rising house prices are those, generally older, who want to sell their home and buy a smaller one or none at all. These people, on average, have benefited the most from the spectacular rise of real estate prices over their entire adult lives. If they have to forgo part of that windfall, it is no tragedy.

If they borrowed against a value for their house that turns out to be fictitious and spent the money on ephemeral things like vacations, as the commercials urge them to do, that was foolish--in some cases, maybe even tragically foolish. People want the government to do something, and presidential candidates are beavering away at plans. But any plan that would prevent home prices from declining would be foolishness squared. Genuine tragedy deserves sympathy and help, even if it is the result of your own foolishness. But when we do not even guarantee basic health care, it would be nuts to think about making protection against real estate losses part of the social safety net.

[Via Time]

No comments: