Wealth: Homes Top Stocks

by Alex Stenback on June 15, 2005

Homes_vs_stocks Graphic Courtesy of Wall Street Journal Online

The Real Estate Journal Online joins the legions of bubble watchers and weighs-in on what might happen if the real estate market goes bust.

Aside form covering the usual bubble ground, the article draws an interesting parallel between real estate, stocks, and the ‘wealth effect.’  According to the chart above, US homes are worth upwards of 145% of GDP, whereas stocks currently check in at just 83% of GDP.  As a result, the effect of a true housing bust (however unlikely) on our economy would likely be much greater than a collapse in equity (stock) prices.

"…[C]iting IMF research that from 1984 to 2000 in the U.S. and similar economies, a dollar reduction in stock wealth cuts household spending by four cents, but a dollar lost in housing wealth reduces it by seven cents. Mr. Rogoff says the effect may have since grown because home buyers are more leveraged.

The IMF found after studying housing cycles world-wide that "private consumption fell sharply and immediately in the case of housing price busts while the decline was smaller and more gradual after equity price busts."

In other words, while price contractions in real estate are less severe (a 5-6% decline in real estate values is considered large) than those in stock values (see NASDAQ getting an 80% haircut) the effects of such a decline (on household spending, demand, and thus our economy) happen quicker, and may be nearly twice as bad, as a similar decline in stock prices.
ยท What Happens If Real Estate Goes Bust? [realestatejournal.com]

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