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The Drop in Home Equity

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Timothy Taylor has written one of his bests posts. He writes,

Through much of the 1990s, the ratio of owner's equity to GDP fell, but in the early 1990s, that was partly a result of depressed regional real estate markets in certain states in the aftermath of the collapse of many savings and loan institutions in the late 1980s and early 1990s (which made the numerator of the ratio decline), and also a result of fast economic growth from the mid-1990s on (which made the denominator of the ratio rise). Again, the bottom line is that the spike in the total value of housing that ended around 2006 is well outside the post-World War II historical experience. And the drop since 2006 takes this ratio from by far its highest value since 1950 to by far its lowest value since 1950.

My emphasis. Read the whole thing.

To me, the central villain of the story is the rise in mortgage credit. It helped create the boom and bust in housing values. Even worse, it produced a decline in the ratio of housing equity to housing values. Even taking the house price boom-bust as given, Taylor's equity/GDP ratio would be 50 percent higher now if lenders had not become more lenient with homebuyer leverage.

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COMMENTS (7 to date)
Tom E. Snyder writes:

How much of the fall in homeowner equity was a result of home equity loans, the interest on which was tax deductible?

Tom West writes:

I know mortgage interest is deductible in the US, but are house-backed lines of credit also deductible?

Steve Roth writes:

"To me, the central villain of the story is the rise in mortgage credit."

While we certainly saw a pretty wild spike in household debt in the '00s following its long post-war climb (much of that spike resulting from issuance of new mortgage debt), the far more profound long-term change has been the rise of financial-industry debt -- from less than 10% of GDP in the 50s/60s to more than 120% at the peak.

Meanwhile the relatively benign post-war trend in government debt compared to private debt leads one to wonder: from which of these (if either) does the "burden on future generations" arise?

Jeff writes:

Tom West,

I think the answer is yes, up to the value of the house. So if you had a house worth 250k and a 200k mortgage on that house, you could take out up to a 50k home equity loan and still write off all the interest.

I think that's the way it works; I'm not 100% certain, though.

perfectlyGoodInk writes:
the central villain of the story is the rise in mortgage credit.

Well, I agree, but I think the rise in mortgage credit was due to the money coming into mortgages from investors in MBS and CDOs due to the originate-to-distribute model, and these investors mispriced the value of these derivatives due to asymmetrical information (they are much further removed from the borrowers than the lender and thus have a harder time gauging default risk) and just plain-and-simple herding behavior.

Mian and Sufi (2009) found a close correlation between credit expansion and securitization. Purnanandam (2009) noticed that the secondary market dried up in 2007 and found that the default rate faced by banks who made more of their loans after 2007 was much higher than those who made more before 2007. Keys et al. (2010) noticed that borrowers with a FICO score just above 620 actually performed worse than those just below 620, noting that the only observable difference was that 620 was the cutoff for securitization. And Dell'Ariccia et al (2008) found that denials were much lower in areas where loans were able to be resold more quickly.

There was also too much money available due to overly loose monetary policy, of course.

allen writes:

"To me, the central villain of the story is the rise in mortgage credit."

Yeah, but that's hardly the end of the trail.

The rise in mortgage credit was precipitated by the forced lowering of lending standards at FNMA and FHLMC. Since they were thus a great place to dump loans there were sure to go sour, once it became clear that loan originators could use them that way while hanging onto their fees, it was "Katy bar the door".

Once lending standards went down it kicked off an "Oklahoma land rush" mentality among lenders, then among borrowers and finally among all those who benefited from rising home prices. Everyone was strongly rewarded to get while the getting was good with the bill for the party deferred to sometime in the future.

Well, the bill arrived and not surprisingly it was a tad more then we expected. The big question is whether the bill's been paid yet or whether we've got more in the way of descent in home prices to look forward too.

jonathan lopez writes:

"New comparative tables from the 2010 Census underline both the importance of homeownership to building wealth and the havoc wrecked by the recession on that wealth. The Census Bureau released detailed data on the type and value of assets owned by U.S. households in 2005, 2009, and 2010. We are presenting a summary of the 2005 and 2010 figures based on actual numbers not adjusted to 2010 dollars. All numbers represent U.S. medians."

"The net worth of U.S. households was $93,200 in 2005, but had dropped to $66,740 by 2010, a decrease of $26,460 or 28 percent. Of this decline, $20,000 or 75.6 percent could be attributed to loss of equity, from a median of $100,000 to $80,000 over the five year period. Thus household net worth, outside of home equity, declined from $18,150 to $15,000."

I've also read that those most exposed to negative equity are borrowers who obtained high value mortgages that were commonplace before the credit crunch, as they are most at risk from declines in property price.

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