CR of Angry Bear has a good commentary and round-up of scholarly, blogospheric, and journalistic articles about the putative bubble in housing today. He’s written before about what happens when the bubble (if there is a bubble) bursts:
When the housing boom ends, what is the possible impact on the US economy? This is a broad brush look at three major potential problems:
1) Increased Unemployment.
2) Loss of mortgage equity withdrawal on consumer spending.
3) Financial distress.
He explores each of these at some length so by all means examine his reasoning.
KipEsquire of A Stitch in Haste suggested that a slowdown (or collapse) in housing could have serious implications:
Most stock investors, and almost all individual investors, do not buy stock on margin. They are 100% long (short selling, a leveraged strategy, is obviously not a concern in a falling market). And even those who do buy on margin must put 50% of the purchase price down, up front. Furthermore, margin positions are “marked to market” daily, such that any shortfall must immediately be covered.
The result is that in order for a falling stock market to “hurt,” prices must fall substantially — which is of course exactly what happened in 2000. But the margin crash of 1929 did not (and could not) happen in 2000 because people weren’t leveraged — they were investing their own money, not the bank’s.
The housing market is the exact reciprocal of this framework. The fundamental reason people are concerned about a (potential) housing bubble is not because anyone thinks home prices will fall 25% or 50% across the country. The problem is that prices don’t have to fall anywhere near that much for a serious impact to be triggered.
If you own a share of stock outright (i.e., not on margin), then it can fall 100% and still no banker will come a-knocking at your door. But if you have zero (or negative) equity in your home (or a second or third property that you had planned to “flip”) and prices fall just 5%, then you are in trouble. Big trouble. (And if you have an adjustable-rate mortgage that may soon result in higher monthly payments as interest rates rise, then the trouble only becomes wider and deeper.)
As I’ve suggested to Mark Thoma I don’t think that any of these ideas take into account some important factors about real estate. State and local governments are typically highly dependent on real estate taxes. I don’t know what it’s like where you are but around here we haven’t seen the amount of belt-tightening by state and local governments that I would have expected giving the slowing of tax revenues since the collapse of the Internet bubble. I think the reason is real estate taxes.
Property tax revenues are based in part on assessed valuation of the property so, as the valuation has risen, so have tax revenues without any other actions on the part of the local governments (there’s a decent primer on Illinois property tax calculation here). Projections of tax revenue presumably consider presumed increases in assessed valuations.
So, what if the assessed valuations fail to increase or, worse yet, actually decrease? And, as Mark Thoma pointed out to me, when there’s an economic downturn the need for government services frequently rises. There’ll be a substantial revenue shortfall. How to make up that shortfall?
The obvious answer is cutting government payrolls but since a lot of those government employees are fire fighters, law enforcement personnel, and teachers there won’t be a lot of enthusiasm for that. Income tax increases have been very difficult here in Illinois (and I don’t believe that home rule provisions allow the institution of a local income tax here). Here in Chicago the sales tax is already 9% so that doesn’t look like a likely alternative. I suspect they’ll raise the property tax rates.
That’s precisely what happened during the Great Depression of the 1930’s when local government was a lot small and less well-organized than it is now. Many, many people lost their homes not when the bank foreclosed but when they were unable to pay their taxes.
