POP! goes the housing bubble
America is heading for an abrupt and rather unpleasant crash into a financial brick wall; in fact, it is already feeling the crunch. The housing bubble has been pricked and everyone is running for cover from the hissing sound. The latest figures, published on Aug. 23, show that for the month of July house prices climbed at their slowest rate in more than 11 years. Locales that have seen high population growth and attracted wealthy residents and retirees, such as California, Florida, Nevada and Hawaii, have experienced the most frenzied growth in house prices, and therefore have the most to lose from a bust. But why is this of any concern to anyone other than those who invest in real estate? If a homeowner is not considering selling his house in the near future, why should he be concerned about falling house prices?
The trouble appears when one takes macroeconomic stock of the situation. Although the real wages of American workers have hardly moved since 2000, American consumers have gone on a spending spree. What allowed them to do so were their rapidly rising asset prices; homeowners borrowed heavily on their property, betting that the value of their houses would be sufficiently high enough the next year to offset the borrowing. Rising house prices also encouraged consumers to save less and count on capital gains if they were to get into a tight financial spot.
A tight financial spot is exactly where many of these homeowners now find themselves, but the homes that many thought would be their saviors are now the culprits. Rising house prices and subsequent spending cushioned the blow from the 2000 recession; in fact, American spending kept the world economy fairly buoyant after the economic downturn. According to The Economist, “The boom has lifted the economy in three ways: it has boosted residential construction; it has made people feel wealthier and so encouraged them to spend more; and it has allowed homeowners to use their property as a gigantic cash machine, taking out money by borrowing against their capital gains. Merrill Lynch estimates that the three together accounted for more than half of America’s total GDP growth last year….The housing boom has also been responsible for one-third of all jobs created since 2001.” At a time when American households were spending record amounts, the rest of the developed world, especially Europe, was stashing away record amounts of their income in savings. Spending here in America helped avoid a deeper recession.
But now that spree is at an end. No longer able to continue borrowing on capital gains, consumers will be forced to save more of their income and spend less. America will feel the crunch as domestic demand drops off in proportion to how far house prices fall. Saddled with debts they can’t repay and confronted by all-too-empty savings accounts, many homeowners will have to default on their loans.
Being the world’s largest economy, the United States causes quite the ripple with any change in its economic situation. As aforementioned, spending in America padded the world economy when the rest of the world’s consumers were saving. This helped fuel the fantastic GDP growth of China and India, which in turn boosted oil and raw material prices. It also spared the international economy from a harsher recession. Indices such as consumer confidence and domestic demand in Germany, a typically sluggish European economy, are on the rise, perhaps indicating that other developed nations will take over some spending as American consumer confidence drops. This leads optimists to believe that the downhill side of the boom will perhaps not be as harsh as is imagined. Since 1997 the average house price in America has doubled, whereas prices in Britain climbed almost 180 percent. In fact, the economies of Britain and Australia, another bubble-to-bust case, did so well after prices peaked that their respective central banks raised interest rates afterwards. The Fed might likely do the same if the inflationary pressures that have caused recent rate hikes remain strong.
America’s economic imbalances do need correction. Consumers need to spend less of their income and save more; the long-term health of the economy depends on it. If house prices slow dramatically, the Fed might be pressured to slash interest rates to support spending; this is what happened earlier this decade when share prices plummeted. To do so now would be a mistake. An economic jolt brought about by a decline in house prices is exactly what the economy needs to regain an even keel of spending and savings.
The American consumer will feel a bit of a sting from the slowdown. Much like the initial shot of a vaccine hurts a bit, the economy will take a short term hit. But this is much preferable to a long-term terminal illness that poisons the system and is much harder to cure. A housing shock is a necessary evil that homeowners should reconcile themselves to and start preparing for immediately.
About this writer:
John Jose is a first-year finance and international studies double major. He can be reached at [email protected].
