Housing is a special form of wealth…If its price falls after a bubble, the cost of consumption is falling at the same time as the amount of wealth. In fact, the country has become richer, because all the same real assets exist, but their replacement cost has fallen.
Also, since houses are mortgaged, the wealth loss is shared by household and banks, while the consumption cost gain is entirely to households. The real wealth of households will thus have risen, and consumption should increase (I am thinking that banks are owned by richer people, who save more). Am I right on this?
Here is the link. Here is my previous post on this topic. So is Eric right not to worry?
Ouch! Eric is wrong because he ignores credit effects and government guarantees. First, the only way the banks will lose wealth on housing prices is if actual bankruptcies result. This will naturally make mortgages more expensive, which will not only offset the fall in the price of a new house but also affect consumption-fueling credit cards. The payments, not the sticker price, are what matters to consumers.
Second, the “richer people” who save more are the ones who will be able to buy second homes or rental property at newly-cheap prices. The less rich people whose wealth is entirely in home equity or whose total wealth is negative will be the ones at highest risk of bankruptcy, with less ability to tap home equity for consumption, and with the greatest additional costs for other forms of credit.
Third, if things get bad enough and some “rich” banks or the overleveraged Fannie Mae get into trouble, guess what? Taxpayers will be on the hook.
Property tax will cause a howl too. I think comunities will pretend the bubble hasn’t burst as long as they can on that one issue alone.
In a rising interest rate environment even foreclosures may not hurt lenders that much. Many recent mortgages are at low rates. I’m not talking about the interest-only or very low teaser ARM’s. Even conventional rates have been quite low. A foreclosure eliminates this low-rate debt from the mortgage-holder’s portfolio.
Even a loss on a foreclosure and resale might be largely made up by being able to lend the proceeds at today’s higher rates. For example, if you foreclose on a $100K mortgage at 5%, and realize only $90,000, you are ahead if you can lend the $90K out at 6%.
Essentially you are calling in long-term low-rate loans early, at a discount, and re-lending the money at a higher rate.
Gotta go with DK on this one Tyler
Foreclosure of mortages, like all collections, is a negative sum game. In the worst case, a lendor would spend $0.99 to collect $1.00 of debt, which is a net loss of $0.99.
There are two groups: those with houses and those without. So if prices fall, it will increase consumption for those without houses and decrease consumption of those with houses through the wealth effect. The problem is that interest rate rises will tend to coincide a housing price drop and cause a liquidity squeeze for most people, especially those with adjustable rate mortgages. The bursting of the bubble is caused by the climbing interest rate so you can’t really analyze the housing market as though interest rates are held constant.
I doubt there will be many foreclosures. People in general are unaware of the really difficult position of a homeowner in negative equity. One cannot sell (not without making up the deficit, but if one had that sort of money he wouldn’t have taken this sort of mortgage). One can’t refinance with a competing bank. The alternatives are (1) make the payments agreed to, (2) be foreclosed, (3) accept whatever deal the mortgage holder offers.
What I expect is mortgage holders will offer to “renegotiate” mortgages where the homeowner has fallen behind on the increased payments. They will probably say to their victims, “We don’t want you to lose your home.” The new payment will be lower than the agreed-to payment, and therefore more affordable; the difference between it and the agreed-to payment will be added to principal, as will a sum represented as the cost of “renegotiation.”
No loss to the bank.
This is my way of thinking, In fact I have money just waiting to invest in some property, but I want to wait until the “bust” so i can buy at lower prices. I have one rental already, and its earning me income, and growing my wealth at the same time.
this would be a lot more convincing if there was even one single example of a bursting real estate bubble which had not left the country where it happened visibly worse off. I mean seriously guys; theory is all well and good, but there are facts of the matter here.
There are other mechanisms besides foreclosure and renegotiation of loans. A company I worked for in the early 90s had bought its headquarters building in Los Angeles. About 1992, when the market for commercial property in LA was very soft, they discovered that their lender had placed their mortgage up for sale on the secondary market at a half-million dollar discount (on a $4 million mortgage). They arranged to buy the mortgage, financed through a different lender, thus sticking their original lender with much of the loss from the decline in property values. (The original lender, in exchange, reduced its risk of a default which would have cost them even more.)
There’s a saying “If you owe the bank a thousand dollars, you’re in trouble, if you owe the bank a million dollars, the bank is in trouble.” In Santa Clara County, it takes 2500 average homeowners to have an exposure of $1 billion. With that much at stake, the banks will find ways to deflate the bubble slowly, so long as the rest of the economy cooperates.
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