Bursting our bubble

If President Obama could ask for one gift from the economy — one statistic that turns unexpectedly rosy — what would it be? If Americans in general could choose one change in their financial situation, what would they choose?

I suppose Obama would choose a decline in the unemployment rate. But a close second for Obama, and quite possibly first on the list of other Americans, would be a rebound in house prices. Although we all recognize now that real estate was a classic bubble, bubbles are wonderful fun. It’s the burst that hurts. In the good old days — before 2007 — following the prices for which houses in your neighborhood were selling and then recalculating your own net worth was a national sport. Even the experts who correctly predicted a price decline or collapse generally delivered that prediction as bad news.

The assumption is that ever-rising house prices are good, and that a decline in house prices is bad. Ordinarily we cheer when the price of an essential (product goes down, and complain when it goes up. Take oil, for example. We like it when the price of gasoline goes down and are unhappy when it goes up. But with homeownership, it’s the other way around.

I wouldn’t attempt to argue that the current mess of the real estate market — the irresponsible lending, the home loans underwater, the brutal foreclosures, the ramification for the economy in general — add up to a good thing. But before we start dreaming of a return to the days when ever-rising real estate prices were considered a constitutional right, let’s think this through a bit. Why do we want home prices to go up?

In very general terms (with plenty of exceptions and variations) the housing market affects three different groups. There are those trying to break in — generally young people searching for their first home. There are those in the middle, who want to trade up from a smaller house to a bigger one. And there are longtime homeowners, “empty nesters” who are approaching or already enjoying retirement and want to downsize or get out of the market completely.


How are each of these groups affected by rising house prices? The first group surely doesn’t benefit. During the big housing bubble, stories about young couples watching helplessly as the American dream of homeownership passed out of their reach were a newspaper staple. As prices come down, more people can afford to buy a house. That’s a good thing, isn’t it?

Then there are the people who want to trade one house for another. Mostly they are hoping to trade up — to a larger house for an expanding family, or a nicer neighborhood. These people are in the same situation as the first-time buyers. Obviously all house prices don’t go up and down in unison. They are affected by neighborhood, by region of the country, and by changing fashions and tastes in home design. But on average the house you want to buy should have gone up or down in price by something like the same percentage as the house you want to sell. And if you’re trading up, that means rising prices should hurt you just as they hurt the first-time home buyer.

The only people who clearly benefit from rising home prices are those who are selling their last house or downsizing. This is the same group that benefitted most from the previous run-up in prices — that is, typically, older people who have lived in the same house for years. Most of these people enjoyed the enormous past run-up in prices. In 1970, the median price of a house was $25,000. In 2006, at the top of the bubble, it was about $240,000. Even adjusted for inflation, that means home prices more than doubled during the period.

These homeowners are mostly not underwater. That is, the value of their houses is more than the remaining balance on their mortgages. In fact, they could still sell their houses at a profit even in the current market.

Whatever figure you may have stored in your head about the “value” of your house (removing this figure to polish and admire it when home prices are rising; leaving it to gather dust in some dresser drawer of your unconscious when they aren’t), a house is worth only what someone will pay for it. That number has two components: one is the value of occupancy — that is, the privilege of living in the house, mowing the lawn, calling the plumber and so on. This should roughly equal what the house would rent for. The other component is the investment value — how much you think the price of the house will go up when you sell it.

Any investment value greater than zero (or zero plus inflation) is suspicious because it depends on the greater-fool theory. There is no physical reason why a house should become more valuable at all. It is not growing like a crop. It is not producing anything that you can turn around and sell, like a factory. It just sits there. It becomes more valuable because people believe that it will become more valuable. Worse, since the general assumption that it will become more valuable is already reflected in the price you paid, you need a buyer who believes that it will become more valuable even faster than the general consensus.

The larger issue in all this is the wisdom of encouraging homeownership — even if you don’t get carried away with it as we did in 2007 to 2009, practically forcing mortgages on people at gunpoint. About two-thirds of Americans do live in homes that they own (along with the bank). There is no way all of them could cash out and collect that number in their heads — how much is their house worth? — even now that it’s 30% or 40% lower than it was before. And it’s hard to see why people should want that number to resume its relentless rise back up and beyond.

Michael Kinsley, a former editorial page editor of The Times, writes a column for Politico.