July 05, 2007

$5 Trillion in Housing Wealth Gone: The Impact of the Housing Bubble Bursting

A sane person surrounded by insanity will at some point, question his or her own mental health. Examining the past decade of housing especially from Southern California, the epicenter of the housing bubble, you begin to question economic fundamentals and simple rules of finance. At this point, we are reaching the overdue housing correction. Housing has created immense wealth in the economy and has propelled us out of a brief recession earlier in the decade. Yet this wealth was created on an illusion of easy credit. It is estimated that the housing bubble has created 5 trillion additional dollars of wealth as compared to a scenario where housing kept pace with inflation. This is important to note because historically, housing has only kept pace with inflation as an investment. When you have certain areas up 80 percent in real terms as the Center for Economic Policy Research has showed, we have speculation and not normal growth.

We will look at the past decade of housing and address the following issues: income, inflation, rental rates, bubble specific regions, and the public policy issue of bursting the bubble.

Income Has Gone Up

In real terms, per capita income has grown 2 percent annually since 1997. This is something positive for our economy. It does show that as a nation, we are growing and thriving. Yet certain industries are now facing the pull back associated with the housing downturn. Consumption and automobile sales are taking massive hits in the last few months. Construction is falling in large numbers. We have only started to see any of this impact in our economy. The $5 trillion in bubble wealth has created an extra $250 billion in consumption that would not be present if it were not for the housing bubble. This works out to be 2 percent of our GDP; in other words, without that wealth we would already be in a recession.

Even though income is up, it does not justify housing prices being up in real terms of 80+ percent. And with income being up, we also have higher cost associated with health care, energy, and household items so the 2 percent increase is really negligible.

Real Estate Has Normally Treaded with Inflation

Decades of data show that real estate normally grows at the rate of inflation. That said, why do we have real increases of 80 percent in certain areas? You may say, 80 percent is large and I doubt this is true. In California, countless homes that cost $175,000 in 1997 are now on the market for $500,000. Pick any of the 88 cities in Los Angeles County and you’ll see that this 80 percent number actually understates the growth. So is it possible for housing to fall 50 percent in a few years? If housing can go up 200 percent in certain areas over 10 years, then yes, a 50 percent drop is plausible. As a caveat, when you are arguing market fundamentals for a bubble, any number is possible but the eventuality is that the bubble will burst and market fundamentals do rear their head again. For example, the long tested rule of housing keeping pace with inflation.

Rents have not Increased Significantly

During the initial stages of the bubble, rental rates did go up in decent numbers. However, in the past few years, real estate has outpaced rental market rates by an unbelievable number. Most investors and economist associate a rental value on the property in terms of deriving the actual value of the home. For example, many investors will divide annual rents - expenses by the price of the home to arrive at a return on the investment. In most cases, it will always be slightly more expensive to purchase a place than renting even after factoring in tax benefits. The premium will always exist because you are purchasing an appreciating asset that is building up equity (normally at the pace of inflation) and will create a real store of value for you.

After a few years of bubble psychology and straightjacket number crunching, many people modified their equations to factor in 20 to 25 percent annual appreciation rates and thus justified the price of homes even though rental rates were significantly lower and in no way supported the market value of the home. The premium of the home was based on the false assumption of abnormal market returns. In simple terms, pure speculation. Now that more inventory is hitting the market and sales are dropping, we will see certain areas declining in rental rates. In certain prime areas, we will see an inverse reaction with rental rates going up while housing prices go down. It will all be specific to each certain market. In the end real home prices will decline.

Only Certain Areas Have Bubbles

Certain areas such as the South and Midwest actually saw no true real increase in prices over the past decade. Then we have areas such as the Southwest, DC, Northeast, and Florida seeing real price increases of 80 percent in certain regions. The bubble is national in the respect that overall statistics are heavily tilted by regional bubbles. Meaning, the numbers are skewed by certain metro regions being overvalued. Population trends do not justify the upward jump in prices because overall, we are seeing many baby boomers retire. If anything, they are getting ready to downsize their home as opposed to expanding for a growing family.

We also have massive construction that really had no bases in population growth. If anything, as a society families are choosing to have fewer children. The need for larger and bigger homes is spurned on by nothing more than bubble speculation. The demand is simply not there. That is why we are seeing a record number of vacancies hitting the market in many regions of the country. Many people bought homes in other states thinking that they would be able to rent them out as investments but forgot to check local market conditions. The population in many of these areas simply did not meet up with the growth in housing. In fact, some areas didn't even have a population to begin with - these are the future ghost neighborhoods of America.

Public Policy: Bursting the Bubble Now is Good

When you watch shows like American Idol or America’s Got Talent, you can see that some contestants honestly believe they are the greatest thing to walk this Earth when in fact, the sound of mating cats is more enticing. Just like these delusional would be superstars, we have many folks accustomed to the decade long bubble in housing. They feel entitled to this $5 trillion of pseudo-wealth created by a bubble fueled by horrible public policy. Public policy by who? The Federal Reserve and the hunger for mortgage backed securities on Wall Street. The quicker the bubble bursts the better it will be for the overall long-term sustainability of the economy. The bubble has already been left unchecked for too long and the repercussions will be felt to the very core of our nation. You cannot use debt to finance your entire economy. Unfortunately, we have too much credit floating around and we are going to face a radical public policy debacle and potentially a government (read public) bailout.

Many baby boomers are counting on the wealth in their homes. In fact, savings rates and retirement nest eggs for many of these folks are massively under funded. And why should they save? If they have the perception that their home is going up $50,000 per year unabated for the next decade, why fund a 401(K) or IRA when you can make much more simply living in your house. This is reflected in the response many people have regarding their retirement. They assume the money will be there. Like a mirage in the desert, the closer they get to retirement the more they will realize much of what they saw was simply an illusion.

Then we have 8 million people a year buying homes at inflated prices. Like Alan Greenspan has mentioned, bubbles are only identifiable after the fact, it is hard to say the exact start date of the bubble. Was it 1997 or 2000? It also varies on which region. Back to the millions of recent buyers, they are purchasing homes at current bubble market rates. When the market corrects, the negative wealth effect will hit these folks very hard and direct. Even those who bought 10 years ago and never planned to sell, will take a psychological blow because their once valued $500,000 home is now only “worth” $375,000. This will have a major impact in our nation’s consumption.

Even with this tremendous housing wealth, owner’s equity isn’t that high. A startling fact if you think about it. The ability to take money out of your home has been a national phenomenon in the last 10 years. Once thought as an untouchable resource, folks have been more than willingly to extract perceived equity and fuel consumption. This only increased the magnitude of the bubble. For one, the money tapped out of the home creates a 2nd lien on the property that needs to be paid back. It isn’t free money. Yet people treat it as a grant that doesn’t need to be paid back. In many cases, these loans are paid over 10 years. Now what do you think the impact on a person taking out $50,000 in their home only to realize their home was never worth that additional $50,000? My guess is they will feel slighted and think that they got suckered into signing up for $50,000 of relatively cheap debt.

This irresponsible lending has created an environment where the only recourse is a hard and steep correction in the housing market. The Fed, housing industry, buyers, and sellers were only all too happy to be accomplices in this bubble. Yet this doesn’t mean that what has occurred is based in any economic reality aside from the fundamentals of asset bubbles. It was all an illusion. Now that we are seeing subprime lenders imploding and mortgages resetting, the true cost of this economic expansion is coming to fruition. The more and more I look into this issue, the more it seems that we will not see a soft-landing in housing.

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dabankerdavee said...

Its funny. Right now the actual "insane" folks, think us "sane" are crazy. I guess I'll have to keep hanging around us "crazy" folks a bit longer, until the insane get a dose of reality and realize that we were "sane" they were nuts!

Great message. Thank you for keeping us in touch with reality.

Mr Vincnt said...

Thanks for continuing to mention the HELOCS from hell. From what I see, many of these are used by older homeowners (baby boomers).

I know several people who used them liberally to finance their lifestyles - new cars, lanscaping, vacations and kids education for example.

Yes, this money must be paid back and the interest rates can be pretty high on these loans.

The american dream for the boomers was suppose to be early retirement. They shot themselves in the foot with this last housing bubble and will probably be working past 65.

Maybe this is a good thing and will save Social Security and Medicare.

socalwatcher said...

This almost like trading on margains. Borrowing to predict future gains. (like taking a HELOC thinking the home value is only going to increase)

One thing I have learned from the pros: If you do not know what you are doing, NEVER trade with margains.

Like a home, all it takes is for the market to fall and a margain call to come in. Then, you are screwed.

Make Mine A Bubble said...


This article is yucky, and sad for the poor animals.


I smell desperation (among other things),

Warren said...

Any guesses what the next bubble will be? Seems like we transitioned from the dot com bubble to the real estate bubble quite quickly. In my opinion, the general public is obsessed with "getting rich quick" to the point where the masses will jump into something without really understanding it or respecting the fundamentals. What happened to working hard, living within your means, and saving/investing for retirement? What about american individualism and thinking for yourself? Many people would rather lease BMW, carry a Loius Vuitton purse, and be up to their eyeballs in debt than have the peace of mind of living within their means. I think BMWs are nice too, but I'll buy one only after I've saved enough for my kids' education. Just seems like people's values and priorities are really out of wack. This makes americans great consumers, but extremely "bubble prone".

Anonymous said...

Warren... It's great that you are doing it right. Nice things are just that, nice things. What you really want is a nice LIFE. A nice life has health and health is directly related to less stress. Financial freedom from excessive debt (there is "good debt" such as low interest educational loans to better yourself and increase your salary and that's ok) leads to peace of mind and a decrease stress in an organism (ie, you.) So, keep up the good work, it'll keep you off Paxil.

Dr. HB, I enjoyed your educational article. You are entertaining and a your grammar is near perfect.

Look, why is it that we don't just see even a few people putting their houses on the market for say, 100K lower than the most recent comp to get them sold? When basically nothing is selling, I'm just so surprised we haven't seen more downward movement quicker than we are seeing it. It is hard for me to swallow such a mass delusion. Do you have any thoughts on timing in the Inland Empire? Things seem to be stuck.

Brian B said...

A few years ago I was looking for a new car and bought a Honda CRV. My friends all have nice cars and were telling me I should buy a BMW using the equity in my house. They made this sound like such a great idea. When I responded, "But I'm still going to have to pay it back" they would respond, "Yeah, but the interest is deductible so it doesn't matter." I was like "Huh?". Needless to say, I decided that this wasn't as great of an idea that they made it out to be and I still have all the equity in my home and my car loan is close to being paid off now.

socalwatcher said...

BrianB, I saw alot of home equity checks when I sold both Honda and Audi's for a while. The is here in the Chicago area. The funny thing is instead of a 3,4,5 year loan...I asked a few how long the HELOC is and some said 10,15,etc years.

So, to get a wonderful tax writeoff you just took a 5 year loan to two or three times that on a CAR? Stupid stupid stupid stupid....

mrslovelly said...

Dr. HB,
I love your blog and I read it everyday. I have to agree with anonymous about your grammar being "near" perfect. ".... families choosing to have less children" should read, "families choosing to have fewer children." If the noun following is plural you use the word fewer, not the word less.

Anonymous said...

I left the comment above about the near perfect grammar. Actually the only error I found was the less/fewer thing. I agree you used it incorrectly. However, there is not a whole lot of content to argue about. Keep up the great work. I check back for cogent thoughts daily, too.

Bob from Brooklyn said...

When they come up with a Nobel Prize for Internet Content, expect a call from Sweden...

You're on a roll, and just to add to your Housing Psychological Shift piece, what do you mean "will see" a two-tier system...precious few understand that the elimination of rent regulations in the last few years (NYC as a prime example) has meant the actual eviction of countless real people, replaced by those at market (read "luxury") rents and mortgages...

The North Coast said...

One little thing:

Incomes have not gone up among most of the population.

According to one article I recently read, median incomes for the nation have dropped 1% since 1999.

Could it be that the "average" has been skewed by the extraordinary compensation of the top one tenth of 1%- the $140MM/year Bonus Boys of Wall Street and other CEOs whose comp is in the hundreds of millions? One superhigh earner averaged in with 100 who make the average could really skew that number.

This economy has been carried by debt, not earnings.

Anonymous said...

As another poster noted, income increases are not what the statistics portray. Actually, since inflation is much higher than the CPA says, actual income has been declining over the last ten years. People, however, did not feel it, because their main "asset" (a house is NOT an asset, it gets consumed over time), was increasing in "value", they spent the "equity" by borrowing against it.

Warren said...

I agree income has not gone up. Perhaps this is part of the reason people are "bubble prone" and looking to accumulate wealth in ways that defy basic economics. My guess is that the housing bubble will be followed by fill-in-the-blank bubble for the common man in 2 to 3 years.

The North Coast said...

"My guess is that the housing bubble will be followed by fill-in-the-blank bubble for the common man in 2 to 3 years."

You have observed that we have a Casino Economy, and I could add that we have had such an economy since the early 80s, when we ceased to be a manufacturing economy.

We have witnessed more bouts of "financial euphoria" since the mid-70s than occurred in the previous 75 years. Speculative rampages have replaced true economic activity, which is the production of real goods and services.

We've gone from the first stage of deterioration, that of "taking in each other's laundry" to buying each other's bad loan paper.

Dr. Bingo said...

I'll confess that I have struggled and struggled with the decision to rent or to buy for the past few months. We live in a wealthy housing market in Colorado, where the impact of the coastal bubbles will probably not be felt that hard, but where the outlying townships and counties are taking it on the nose with subprime defaults and foreclosures. I assume, but cannot say for sure, that that will eventually have an impact on our local housing. To make a long story short, after weeks of torture poring over these blogs and the numbers, we finally decided to rent.

But because of this, I question my sanity. I'm terrified of being locked out of the housing market in our town. It's hard to face the big facts when the little ones just flip their noses at you, as if to say: "You lose."

Sigh. At least we can now max out our 401Ks. Which is an interesting question, and one I think you should cover:

Given the option of paying a larger house payment or maxing out (or just contributing to) your 401K, which is smarter, and why? (I'm sure I know your answer, but it might be another way to make the point you've been hammering.)

Anonymous said...

Ms Lovelly,

Since we're being pedantic. Less vs. fewer is related to countable vs. non countable nouns. This is not quite the same as singular vs. plural.

It is only a slight distinction but it might help people make fewer mistakes. For example, if we had 2 sheep, then sold one to leave only 1 sheep. It would still be fewer sheep than before.

Although, if the sands of time slipped through our fingers, we would have less than before. Some would argure that the Florida Everglades is a single entity in need of conservation. In which case if we lost part of it, we would have less Everglades than before....even though everlade is a proper singluar noun, and Everglades is the plural form.



Anonymous said...

Form Anal Retentive...

"Although, if the sands of time slipped through our fingers, we would have less than before. Some would argure that the Florida Everglades is a single entity in need of conservation. In which case if we lost part of it, we would have less Everglades than before."

What nonsense! nobody would ever say the things you claim. You would, for example, say: "We would have less OF THE Everglades than before."

What's your point? Sloppy language is OK? Let's be good Americans and find something else (the language) to dumb down?

I just don't understand you people.

Anonymous said...

One of the things to also consider is that the government in effect sets the prices of housing...not the market.

In some areas of the country you are capped as to the percentage of a property tax you pay. So instead of increasing the rate the towns simply increase the assesment. So a house that's say 240K in 1994 is 285 in 1997 is 340K in 2000 is 385 in 2001 is 430 in 2007....these are all accurate numbers in my area.

But here's the problem....people do not get anything extra for having that...instead it takes longer to sell and people might assume that something is wrong when a house sells for less than assessement.

We have lower taxes, lower interest rates, higher housing values, higher governmental spending vs. ten years ago. Obviously no one will run in office and say they want to raise taxes and neither party will cut spending...leaving the interest rates to go up and up and up. Congress can't touch the reserve if they do so and international rates are now getting higher than the USA. I'm predicting the fed raises rates a few more times but typically overshoots.

Meanwhile you are correct with the reguards that people assume their houses will go up in value and they'll sell it to move to a cheaper area...well if it does NOT sell then what? I encourage anyone to go to housing sites and look at to what price brackets yield what houses.

Anonymous said...

Perhaps the the next bubble will show itself in the commodities markets, such as the PMs. It will be interesting to see what happens when the herd mentality collectively realizes the value of their fiat dollars is shrinking even faster than their home values. A mass run for the golden hills?

Anonymous said...

when the bail out comes do they have to give all the toys..i.e. atv's boats big ol trucks to the people who didnt re finance

Dr Housing Bubble said...

@ Dabankerdavee,

The mainstream media is now picking up the message that housing is overpriced in certain areas. There are many subprime lenders going down so something was amiss with all this easy credit. You are welcome to hang around the asylum as long as you want.

@mr Vincent and socalwatcher,

Mortgage equity withdrawals have fallen off a cliff in 2007. People can refinance only if the property has increased or if they have any further equity left in their home to tap out. In addition, rates have gone up dramatically for HELOC and home loans over the past 3 years.

@ mmab,

I was reading about a home in Arkansas that was infested with possums and pigs (literally). Some areas were overbuilt but hey, you can double it up as a barn.

@ warren,

We may be at a peak here, or the end of a super cycle according to the Elliot Wave theory. However, there may be a bounce in the foreclosure market and services in these areas. I think oil will be strong in the next decade. It is a limited resource and with China and India booming, they are requiring a lot of oil to expand and putting pressure on the supply.

@anon 10:27,

Appreciate the comment. Timing the inland empire? At a bare minimum I would wait until Q2 of 2008 to put in any offers. If anything, you’ll need to do a market analysis by looking at rental rates and factoring this into a property that will probably have zero appreciation for 3 to 5 years. So in effect, you are buying for tax benefits and equity build up. You should use online rental resources and gather market information and do a comparative analysis. Run some simple calculations and if buying makes more sense, you should buy. Fortunately, there are many good “rent-vs-buy” calculators online free of charge.

@brian b,

Smart move. Good car that you’ll be able to run into the ground. The maintenance on a BMW is extremely high. You can purchase Honda parts anywhere since they are ubiquitous. And again, people have this misconception that home equity is somehow free money. Not true. After all, they are still paying their BMW while you are close to paying off your car.


Thank you for pointing out the error. I have corrected it.

@bob from Brooklyn,

I’m reading this book about the 20 to 30 year old generation having a hard time digesting the fact that the baby boomer generation is putting a lot of pressure on the new working class. The book is a novel and hits on so many points. I’ll actually write a post on it once I’m done reading it.

The overall point is that many of the younger generation feel that they are being saddled with debt even though they themselves try to live financially prudent. After all, I have no doubt that Social Security will not give me a cent when I retire yet a big chunk of my paycheck goes into paying for this. Why not let us keep the money and invest for ourselves or at least have a system that will be intact long-term? However, SS is a ponzi scheme waiting to explode. We are hitting our first wave of boomers retiring and putting the system to the test.

@the north coast,

The average has gone up and of course that is why they use median income instead of average income. Again the wealthier in the US are richer than they have ever been. Measured by the Gini coefficient, which measures income inequality in a nation, we are lagging many 1st world countries. It seems like many dispute the income numbers. I recommend people read the brief article at Wikipedia and follow the references for further details:

Household Income: Wikipedia

Your point about the economy being carried by debt is well taken. Hence the $5 trillion in pseudo-wealth that has kept us afloat since 2001. But the smoke is clearing and as Warren Buffet states:

“Only when the tide goes out do you discover who's been swimming naked”

@dr. bingo,

There is always risk in life. You are doing the smart thing by maxing out your 401k. From recent stats I’ve seen, the overall nest egg for the average American entering retirement is only $50,000. How long can someone live off of $50,000? Many of these people cite Social Security as their haven for support. SS was not intended to be a retirement income but a safety net for the less fortunate.

Back to your point, it is hard to question your sanity when everyone around you is running around with dilated eyes and looking like mad max. But you are doing the right thing. It is very simple to do a market analysis. Simply check local rental rates, use a easy rent-vs-buy calculator online, and assess your tax benefits if you bought. If it makes sense, buy. Don’t listen to the emotional ploys of those in the industry, they only make money when you buy. So of course they will try to convince you to buy. Those that own want to believe housing will always go up because guess who it benefits? Either way, the economics of housing in certain areas is clearly overpriced.


Great comments. The housing market is facing some hard times this summer. Credit being more stringent. Appreciation going negative. Rates resetting to the tune of $1 trillion dollars. This is not the time to buy in many overpriced metro areas.

In regards to the next bubble, I’m not sure we will see one. This is the same mentality that led us from the tech boom/bust to the current real estate boom/bust. Housing has a stronger impact on the overall economy than the technology boom we had in the 90s because everyone is impacted by housing and so much of our wealth is rolled up in home equity. And with the massive boom, folks got accustomed to the inflated prices. I’ve talked about this in the Duesenberry Effect where a $1 increase in wealth does not translate exactly to a $1 decrease in wealth when the economy shifts gears; the reason being people have a hard time scaling back when the economy contracts.

Son of Brock Landers said...

Dr HB, Are you reading Boomsday? That's on my Christmas list once it gets to paperback. While it is a satire, I would not be surprised if some mild forms of protest or financial punishment are directed at the BB generation in 10-20 years.

Dr Housing Bubble said...

@son of brock landers,

Yes, Boomsday by Christopher Buckley. It was recommended by a reader on the site and I must say that even though it is fiction, the author has a strong sense of the current culture in America including the blogger world.

I try to read one book per week. The last few that I've read are:

Evolutionary Psychology: Robin Dunbar

100 People Who are Screwing up America: Bernard Goldberg

Audacity of Hope: Barrack Obama

I try to read books from all vantage points. Although I don't agree with everything I read, it helps to get a perspective from all sides. Boomsday in many ways reminds me of a modern day Catch-22. I'll make a final comment once I complete the book.

Anonymous said...

When Americans return to the time tested policy of buying a home to live in for enjoyment and raising a family the foolish speculative buying will stop. If you can afford to buy a home in any area of the country and plan on living in that home for at least the next 5-10 years than buy it. Home appreciation at the very least will end up keeping pace with inflation, you will have a dependable annual tax write off and the bank you are sleeping in will provide an excellent souce of revenue when it is time to trade down and/or retire. Unfortunately a large per centage of the population is living beyond their means and will end up taking substantial losses due to overextending themselves on many types of credit, interest only mortgages and wild, speculative buying. There will not be a nationwide housing crash, however the east and west coasts along with a few other overvalued metro areas will certainly see corrections of 10-20 percent over the next 18-24 months before inventories decline and the market stabilizes.

Anonymous said...

My situation is something that tells me the market is still far away from a fair price as well in the Northeast:

I live in NY (outside Manhattan) and have a great income. I am looking to upgrade from my current 800 sf co-op but this is what I'm facing:

Manhattan (where I work):
an avg. 2 bedroom condo with a bit more than 1000 sf costs about 1.2MM (of course you can find cheaper, but there are tons for over 2MM). In addition the taxes and mtc. adds another 1500 $ or so.

Even with a 30y mortgage (putting up a boatload of equity just for the 20% downpayment!!) you get to total costs of about 8k/month!!

And everyone is convinced that it'll not go down.. It's insane, you've got to compete with investment bankers making millions, CEOs, professionals, investors and wealthy internationals who want to have a piece of the city. Some of these folks making millions don't know where to stick their money anymore, so they buy up one apt. after the other... that keeps the prices of property in nyc high (at least as long as the market booms and bonuses are paid the way they currently are).

So even if you make good bucks, you can barely afford to live in anything decent. Someone making half of what I make in a place like NC can live in a nice house with a good piece of land.

And keep in mind that the American tax system isn't quite fair either. Living in a high income, high expense city such as NYC has the disadvantage that it brings you to the top tax rate (in addition to that you've got over 3 % city tax and 7 % NY State tax, giving a total top tax rate of 45 %).

Now with the tax man eating that much money away from you, suddenly the salary doesn't look that great anymore when you have to look at the housing prices that we're facing here...

Look at this example:
An assumed 250k gross income would probably leave you with about 150k net income.

Now you'd like to live in a 2 bedroom in the city you work in and have to fork over 96k p.a. for that!

That is 64 % of the net income just for living in a 2 bedroom apt.????

I am wondering how anyone can live here with the median income (which is somewhere around 60k).

Even looking at new places just outside Manhattan but with a short commute, you still see 1MM for a 2 bedroom.

It's insane..

Anonymous said...


You need a home based business, and get a ton of your tax money back...read anything by Robert Kiyosaki. Earned income is the worst type of income to be working for; the gub-ment takes 50%. 401K is next worst; the GM takes 20% at least, and B-quadrant business is THE best, because you pay taxes after you buy the stuff you need to run your business. I have learned a ton about financial mindset in the last month!! Good luck, everyone:)