Why your (newly) expensive house hurts our economy

Michael Kinsley writes about the housing boom, and provides a plain-spoken analysis for how it is likely to end (sometime). He ends with an explanation of the difference in increases in price for labor, capital and housing.

Perusing the real estate ads like pornography and imagining what our houses are worth is the great American pastime. But a real estate crash, if it came, would have some advantages. The 19th-century American Henry George explained how rising real estate values harm the economy by operating as a tax on both labor and capital. Money for labor makes people work harder. Money for capital makes people save more. Both make the country richer. Money for land just makes the owner richer. There are all sorts of complications and qualifications, but the basic point is a good one.

People do foolish things under the impression that they are getting richer because their houses are worth more. They save less, they spend more. Egged on by television commercials, they "consolidate their debts" (i.e., buy a new boat) with a second mortgage. And who really gains from soaring house prices? First-time buyers don't. Nor does anyone who plans ever to trade up. The only beneficiaries are those who are selling their last house, after a lifetime of appreciation. The bigger the house, the bigger the windfall. This is yet another thank-you from
America to the so-called Greatest Generation. I'm not sure it's necessary.

I'd add to elements to this, first housing prices are rising at a time when affordable housing is out of reach for many Americans, a consequence of the federal contribution to housing dropping from $79 B to $29B in real dollars over the last 25-plus years. Second, a major boost to the housing market over the last 2-3 years has been interest-only loans and adjustable rate mortgages (ARMs). Both are dangerous lending devices, the interest-only loans eviscerate any gain for the homeowner through equity; the ARM is a time-bomb in light of the historically low level of interest rates and the weakness in the dollar (both of which indicate that the index on which the ARM's rate is based will shoot up). Alan Greenspan has been a big proponent of ARMs. Not sure if he's being paid by Ameriquest or Countrywide (two notorious predatory lenders) , but if he was, perhaps they'd let him know that many lenders base approval for an ARM on a borrower's ability to make the initial payment, disregarding his or her ability to afford the later, higher payments caused by rising interest rates.

Our housing bubble has been caused by multiple forces, many good. But in the end we have an over-priced market financed heavily by consumer debt. Worse, we have many borrowers who have traded unsecured debt for less equity in their home, which could shortly see a significant drop in its value - and thus put them in upside down mortgages (debt > secured property value). Thus when they try to get out of their much higher payments, they won't be able to find a lender willing to give them enough money to pay off their debt.

There will soon be hell to pay, it's just a matter of from whose hide the payments come.