Plastic Toy Homes

For most Americans, our homes constitute the majority of our net worth. Unfortunately, we tend to have relatively short memories when it comes to investments, assets and the inevitable ups and downs that define market cycles. The housing market is no different.

So, it’s not hard to imagine, particularly for those who purchased homes the past 15 years, the general mindset is real estate values ALWAYS go up. What homeowner wouldn’t be comforted knowing the home they purchased for $250,000 just 4 years ago now had a market value of $400,000? Contact a property appraiser to get a property appraisal and you may be pleased what they tell you. Consider all the money that was sitting there as equity, just waiting to be spent by consumers. Two-thirds of the U.S. economy is driven by consumer spending. Getting consumers to release their equity was more than enough to provide the impetus for outstanding economic growth – and it did.

More Recent History

With well over $10 trillion dollars in equity nationwide before the meltdown, banks and mortgage companies were more than happy to help homeowners access it. From 1991 to 2000, home equity accounted for just 0.6% of overall consumer spending. By 2005, the figure was nearly 3%, a five-fold increase in consumers using equity in their homes to finance purchases, and the economy was flying high as a result.  But, as we have since been reminded, housing markets have cycles too. With help from their friendly mortgage banker, homeowners pushed the absolute limits of their financial envelopes. And that brings us to predatory lending practices. Essentially, this consisted of lenders tripping over each other to provide borrowers with adjustable rate mortgages.

Impact

As noted earlier, consumer spending is critical to economic growth. So, when the equity dried up, and the foreclosure rates hit all-time highs, a domino effect occurred. And not just those directly related to construction. Small businesses, easily the largest employer segment in the U.S., were hit hard when consumers stopped spending and banks stopped lending. Without customers, businesses don’t need as many employees, and without work, people turn to government assistance. This comes in the form of unemployment insurance and other aid, like food stamps, putting even more pressure on an already bloated national debt.  Suddenly, all those ridiculous loans on the books were viewed for what they were, wishful thinking. Don’t forget the insurance companies and other large institutional investors who were scooping up these packaged loans in the secondary marketplace. This further exacerbated an already massive problem. Since we can’t have our largest financial institutions going belly-up, we bailed them out with trillions in government funds, further eroding what little consumer confidence was left.  We live in a global economy, so it is not surprising the problems we’ve gone through were subsequently shared by other countries, and world markets took a beating. Greece and Spain are prime examples of the ripple effect the meltdown had on economies across the globe.

Conclusion

As we slowly make our way out of the hole we’ve dug for ourselves, there are a couple of things that will need to change for us to enjoy a long-term, sustainable economic recovery. First is the slow return of consumer confidence; confidence in our financial systems, and confidence in the way management runs our companies. For many, this will mean a return to normalcy in our housing markets.  The other necessity is harder to quantify, but every bit as critical. And that is the need for us to learn from these past 4 years and to remember every action has a reaction, and if we continue to push our personal financial envelopes as we have, we may not like the push we get back.