The Federal Reserve released mountains of data on the financial health of American families and companies on Thursday. The chart, above, from the financial accounts of the U.S. shows that homeowners’ equity in their housing rose to 67.3%, the highest since 1989. Or put another way, leverage — debt-to-value — in the housing market is very low.
Contrast that with the situation in 2005 through 2009, when leverage led to the worst global recession in 80 years as mortgage debt grew faster than home prices, fueling an unsustainable bubble that was destined to pop when prices stopped rising.
Back then, leverage exploded with the proliferation of unwise mortgages (including HELOCs, NINJA loans, balloon payments, and payments that didn’t even cover the interest costs).
Many buyers were pure speculators, counting on house prices to rise forever, allowing them to find a “greater fool” who would bail them out of their ill-advised debt by buying their overpriced home before the music stopped.
Of course, the merry-go-round had to stop at some point. When prices started to fall, many homeowners went quickly underwater on their mortgage, especially if their monthly payment increased after initial teaser rates expired.
This was the essence of the housing bubble that popped before the Great Recession: Owners were forced to sell at a loss because they couldn’t make their monthly payments even as housing values deflated. Forced sales drove prices even lower in a vicious spiral.
Ultimately, national home prices plunged 28% from peak to trough, by far the worst drop since the Great Depression and making a mockery of the conventional wisdom of the time that home prices never decline. (Previously, the worst post-depression decline had been a 3% drop during the savings & loan crisis of 1990.)
High levels of equity
Today, it’s much different. Over the past six years since mortgage debt began to grow again, debt has been increasing only about one-third as fast as home values.
High levels of equity mean that, even if housing prices were to flatten or fall slightly, very few homeowners would be forced to sell at a loss. Most loans now have fixed interest rates, so monthly payments wouldn’t rise. Most homeowners could sit it out in comfort (as long as their incomes held up, that is).
If prices were to flatten or fall slightly, sales would dry up, but prices wouldn’t be driven even lower by forced sales. That would mean that mortgages wouldn’t default, and mortgage lenders wouldn’t fail and bring down the global financial system.
Anyone who thinks home prices are destined to collapse in the next few years needs to show their work. What’s the economic or financial mechanism that would drive homeowners to sell at a loss?