Of Bubbles and First-Time Buyers

by Alex Stenback on January 25, 2005

Bearsignsm_1 "Millions of Americans became stockholders in the late 1990s, just in time to experience the biggest bear market in a generation. Does the same fate await millions of first-time homeowners?"

That’s the big question posed in this recent article in the Wall Street Journal’s RealEstateJournal.com and though it raises some interesting questions, a couple of portions left us scratching our heads.  For instance, the article calls into question the numerous policy initiatives aimed at encouraging home ownership by reducing or eliminating the need for a down payment:

From The Article:

"But are these
policies wise? Housing prices, adjusted for inflation, are up 36% since
1995, the steepest boom in at least 50 years, according to Dean Baker,
co-director of the Center for Economic and Policy Research in
Washington. "This is a particularly bad time to be promoting
homeownership among young people," Mr. Baker told a media briefing last
week. "A lot will see substantial losses in home value as a result of
that bubble, which will be ending soon."

Mr. Baker’s point (as he glimpses inside his double-secret crystal ball to confirm not only that there is a bubble, but also that it will be ending soon.)
is that many homeowners who purchased homes with little or no down
payment will be faced with financial hardship.  Just what form will
this hardship take?

"An
end to annual double-digit house-price gains could spell real financial
hardship. Mr. Baker says such [lower income] families seldom benefit
from the tax deductibility of mortgage interest, either because they
don’t owe income taxes or they don’t itemize their deductions."

Were
not sure what exactly is meant by this non-sequitur.  Unless we are re-defining
"financial hardship" as "homeowners will no longer be able to rely on
massive gains in home equity to sustain consumption patterns that they
cannot afford," we have no idea what they are getting at here.  Of the
many factors that might be fueling a speculative housing bubble, the
tax-deductibility of interest seems pretty low on the list.

Though Mr. Bakers suggestion that programs designed to help
boost home ownership might be "too risky" and "Ill-timed" is sketchy
reasoning at best, it does illustrate that we can learn a few lessons
from the stock market collapse of the late 1990′s. Chief among them: We
like the fact that people are actually talking about the possibility of a bubble, which didn’t really happen when we were all stock picking geniuses.

Here’s a few other thoughts (armchair economist style) to ponder as we chew on the great bubble debate:

  • Your house is not a stock.  Your home isn’t going
    anywhere, it can’t be de-listed, and nobody from HUD is going to show
    up and say: "Sorry, our records indicate this property is no longer
    valuable enough to be a house.  The bulldozers will be arriving in two
    hours, please gather your personal belongings."
  • For the bubble "doomsday-scenario" to unfold two things must happen.
    A significant decline in home values AND large scale mortgage
    defaults.  What causes defaults?  Lots of things, but mainly, the loss
    of a job or income that cannot be replaced.  Lots of talk about a
    bubble in real estate.  Not so much about skyrocketing unemployment and
    widespread economic depression.  Even if your mortgage ends up being
    larger than your homes value, as long as you can still make the
    payments, things will eventually turn around, even if you have to
    stick-around a little longer than you planned.
  • Define MUST SELL. Only in those rare
    "iron-clad-absolutely-positively-must sell scenarios" can you get stuck
    having to pay to sell your house.  But what are must sell scenarios? If
    you really must move, can you rent the property, even if it doesn’t
    cover the entire payment?  Again, unless you believe we are on the
    verge of widespread economic depression, the list of MUST SELL events
    is actually pretty short.
  • Consider buying a little less home, but do so with little or nothing down.
    Contrary to the implications of the article, buying a home with little
    or nothing down may actually be less "risky" than investing 5, 10, 20%
    or more in a first home.  Consider this scenario:  Homebuyer "A" buys a
    $200,000 home with nothing down.  Buyer "B" purchases a $200,000 home
    and puts down $40,000.  Then, the unthinkable happens. The bottom falls
    out and home values decline by 20%.  Buyer "A" is left with paying back
    a loan worth more than the home, but she’s (hopefully) still got that
    40K working elsewhere, which can be used to help make ends meet if
    things get really bad.  Buyer "B" has discovered a way to make $40,000
    disappear, and own a house that he "can’t afford to sell." Which
    position would you rather be in?

Bubbly Linklube
House Prices and The Fed [Townhall.com}
Liars Poker.  Is there a Housing Bubble? [Behind The Mortgage]
No Bubble Trouble [Kiplingers]

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