Monday, January 24, 2011

Vernon Smith: Disequilibrium in the Housing Market - Newsweek

The headline of this piece refers to the housing-market disequilibrium that caused our economic troubles and not to its consequence, which is the persistence of a 9 to 10 percent unemployment rate.

Our disequilibrium course is reflected in the ratio of the median house price to median family income, steady around 4 in the 1990s, recovering to its previous high of 4.15 in 2001, and then surging to the unprecedented high of 5.2 in 2005. Economically, we borrowed massively from future income-based growth in housing demand, financing it by credit creation: from 1997 to 2010, the total market value of housing rose by $4.09 trillion, while mortgage debt rose by $4.52 trillion, a dismal sector performance. Some 23 percent of homeowners owe more than their home is worth on the market, and their demand for goods is restrained by the need to pay down debt. This is the essence of a balance-sheet recession, and is what underlies the so-called Keynesian liquidity trap.

Most postwar recessions also had origins in housing but were much less severe. All past sustained recoveries have been accompanied by a recovery in housing, hence the uncertain sustainability of the current recovery.

The flip side of homeowner negative equity is bank negative equity—to wit, insolvency. The Fed took care of that by relieving the banks of some $1.2 trillion in shaky assets in late 2008, rescuing the system from the consequences of its own decisions, not good policy but deemed by the Fed to be far better than the alternatives. When you are left with no good options, the important lesson for the future is to avoid getting into that bind in the first place and to start rethinking what you have been up to.

The banks were saved but home owners are still loosing on their investment

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