The Impact of the Housing Crisis on Main Street

There was an article in yesterday’s NY Times discussing the broader economic impact of the decline in housing values and how the real life impact felt by the average American may be far greater than the impact felt by declining stock prices. I have to agree with that assessment as the average person isn’t depending on their non-retirement stock investments to fuel additional investments, supplement their income, drive day to day spending decisions, etc. Instead, most people feel their biggest investment is their home and housing values help define the average person’s sense of financial stability, perceptions of wealth, etc. Furthermore, the “house as an ATM” phenomenon inflated the financial lifestyles of many Americans, allowing them to live “higher” than they would’ve been able to normally.

From the NY Times:

Every time economists and Wall Street executives think they have acknowledged the full extent of the losses from the meltdown in real estate mortgages, more bad news turns up.

[...]

Merrill Lynch said yesterday that it would take a charge for mortgage-related securities on its books that is $3 billion more than the $5 billion it expected just two weeks ago. And a report from the National Association of Realtors showed that sales of existing homes in September fell twice as much as economists had expected, to their lowest level in nearly 10 years.

[…]

At this juncture, economists say the troubles in the mortgage market could, all told, cost financial firms and investors up to $400 billion.

That is far more than the roughly $240 billion cost, adjusted for inflation, of the savings and loan crisis of the early 1990s, according to estimates of the combined financial toll of that crisis on both the federal government and private sector. The loss in total real estate wealth is expected to range from $2 trillion to $4 trillion, depending on how far home prices fall, according to several economists.

Experts caution that these estimates are preliminary and the total costs could get bigger still. They also note that the loss of real estate wealth could prove more damaging for the general public than falling stock values because more American families own homes than own stock.

In recent years, the rise in real estate values has helped propel consumer spending, as homeowners refinanced mortgages and took out home equity loans.

“There weren’t a lot of people living off their capital gains from stocks,” said Jane Caron, chief economic strategist at Dwight Asset Management. “There were a lot people using their home as a piggy bank.”

Housing enabled a lot of Americans to “feel wealthy” and to spend like it as well, whether they just tapped into their home equity or made speculative real estate investments. Now that prices are falling, not only will their psychological sense of financial well being decline, but many Americans will be left with debts and financial deficits that it will take them years to overcome. When assessing the impact of the housing downturn on Main Street, we have to only consider the economic impact, but the psychological impact as well, as both could depress housing prices for years to come.

Another thing to consider, are the scores of baby boomers who abandoned the stock market to speculate on real estate after seeing the values of their 401ks declines during the tech crash, in hopes of using real estate to fund their retirements. Prior to the real estate boom (and even during) we had a generation of Americans who were woefully ill-prepared for retirement, and it’s likely that the housing downturn/mortgage crisis set them back in even further. Social Security, Medicare and other public services could face more strain in coming years as a result of the current housing/credit/mortgage mess.

Whilst the “investor class” will recall Black Monday, the Asian Currency Crisis and the Tech Crash as their waterloos, Main Street will remember the housing downturn.

Sources:

NY Times: “Reports Suggest Broader Losses from Mortgages” -- VIKAS BAJAJ and EDMUND L. ANDREWS, October 25, 2007

Disclosure: the Author doesn’t own a position in Merrill Lynch or any of the companies mentioned in the reference article.