Today, CNN reported that home prices reached their lowest point in more than 10 years. According to the National Association of Realtors, the median U.S. home price fell from $219,000 in 2007 to $154,700 as of January 2012. While this fact may be good news for buyers, it certainly is a negative development for sellers. Moreover, it is a negative development for the country as a whole, because it affects homeowners’ spending behavior.
Lower housing prices negatively influence consumer spending behavior, because of the wealth effect. According to this economic principle, by “making people feel less wealthy,…the decline in home values inhibits consumer spending and hampers the nation’s stop-and-start economic recovery.” Since consumer spending is responsible for roughly two-thirds of GDP, a persistent decline in home prices does not bode well for the current anemic economic recovery.
It is possible to model how the 29% median home price decline impacted the median family over the last five years. The chart at the top of this page shows how a homeowner’s equity would decline to less than zero if that homeowner bought a house in 2007 at the median home price of $219,000 with 20% down and a 30-year fixed mortgage rate of 5%. From 2007 to January of 2012, this hypothetical family would have invested a total of ~$59,000 in their home, yet would have negative equity of ~$6k. Not only has their home equity been completely wiped out, but also their debt obligations require them to invest an additional $6k just to break even. In other words, if they sold their home today, they would lose more than their total investment. In this case, a 29% depreciation of their home represents a 109% decline in their equity.
That said, families that had lower mortgage rates and took on less mortgage debt at the onset, would be relatively better off today than those who did not, as the chart above shows. However, everyone is poorer off by the tune of $7 trillion in household wealth according to a recent Fed white paper.
Until this imbalance corrects itself, people will be belt-tightening for some time to come. I know I sure am.