What effect did the housing bust have on them? Household balance sheets among the Facebook generation were the hardest hit: between 2007 and 2009, half of those under the age of 35 lost over 25% of their wealth. A quarter of those under 35 lost over 86% of their wealth. Not surprisingly, they have been badly hit by the foreclosure tsunami; the median head of household in foreclosure being eight years younger than the median not in foreclosure. Younger households typically started off with less wealth than older ones and, following the bust, ended up with much less.I wrote back, and the following exchange might be useful for blog readers here. We don’t come to hard and fast answers, but I think we clarified a lot of channels that do and don't work.
This bodes badly for their future, and the country’s
John:
Your oped was very interesting, but I have to disagree with a basic point. Lower house prices are great news for the majority of young households.
They either don’t own a house or are looking to trade up. Cheap stocks are also great news for them. Even those that lost money in one house will still want to live in houses for a long time, so they can buy a new house for the same low price that they sell their old houses for. Lower prices are only bad news for old people who want to downsize.
Benn:
For those that did buy – a lot – the data I cite say they’re in bad shape. For those that didn’t, you surely have a point, with the major caveat that credit standards are much, much tighter now (I’ve been through a mortgage and a refinancing over the past 2 years, and they were hell). You yourself have commented several times on the great rates that no one seems to have access to.
John:
The ones who bought surely are in bad shape, at least on paper. A young person who bought stocks on margin leveraged 90% in 2006 would also have lost a lot of money! But together with a collapse in wealth, there also has been a big decline in the cost of living – houses are cheaper. They don’t need as much wealth as before.
View it another way. They still have the house. If you bought a house in 2006, and you’re still employed, by and large your wages haven’t shrunk. You can have exactly the standard of living you had planned for in 2006, and it doesn’t matter a whit that the resale value of your house has declined. Really, look at it: same wage, same mortgage payment, same prices for stuff. So what if the house price went down? And even if you want to move - - again, you buy a new house for the same low price you sell your old hose. You can keep the planned standard of living.
OK the ones who are not employed have trouble. Or the ones whose wages are cut. But really, employment is the source of their trouble, not that the value of their house has gone down.
Benn:
If your net wealth, including home value, was $100,000 in 2006 and $10,000 today, you could still “have exactly the standard of living you had planned for in 2006”?
John:
If you can afford to buy the same basket of goods, you have the same standard of living.
Basically, it’s deflation. The deflation is not yet recorded in statistics because they use the rental equivalent measure of housing costs. If your net worth goes from $100,000 to $10,000 but there is a 90% deflation you are exactly as before.
As an extreme, suppose technical improvement makes housing free – we figure out how to grow houses from chia pets in a week. The price of existing houses goes to zero. There are winners and losers here too. But obviously as a society we are much better off.
Benn:
If I lose 90% on a stock am I no worse off because the broader index is also down 90%?
John:
You don’t live in stocks…
So, yes. If you lose 90% on a stock, but the stream of dividends is completely unchanged, then yes, you’re just as well off as before. If before you were planning to live off that stream of dividends, you can still do so. If before you were going to exchange the stock for a different one that gave a similar stream of dividends, you can still do so.
The key difference: Stocks typically fall when there is a big bad shift to the expected stream of dividends. When your house price falls, there is absolutely no effect whatsoever on its value to you as living space.
As with houses, you’re worse off if you were just about to switch from stocks to bonds. And you’re better off if you were young and about to invest in stocks, as now you get to buy the same dividends much cheaper.
(In retrospect I’m being a bit too strong, as usual. The fall in house prices comes with a lot of foreclosures and neighborhoods that are no longer great places to live. A lot of the houses are now in the “wrong places,” so genuinely less valuable. But for the argument here, that’s really about foreclosures costs, and the rise and fall of neighborhoods, i.e. collateral damage from house prices, not the direct effect of house price falls per se. Also, if you don't have the cash to pay off a mortgage and take the loss, moving is tough.)
Benn:
Is the ability to borrow against my appreciated home worth nothing, then?
John:
Now I have to give in a bit. Yes, this is a good point, and I ignored your credit point above.
Remember though that borrowing has to be paid back. So you bought a $100,000 house in 2005 with $10,000 down, and $1,000 per month mortgage. It goes up to $200,000. Great! Now you can refinance and take an extra $90,000 out of the house and go on that round the world cruise you had been hoping for. (Or start a business, or whatever.)
Whoops. Except now you have to pay the loan back. You have to pay $2,000 per month on your bigger mortgage. As long as you want to live in the house – or another one of the same size – you didn’t get any more wealth. “Removing a borrowing constraint” is different from “having more wealth.”
So you are better off, but only if you knew you were going to get a big raise, so that you wanted to borrow a lot of money but the bank wouldn’t let you. That might be true for a lot of people. On the other hand, we are perhaps becoming skeptical that it is such a great idea for young people to pile on a huge amount of debt, so perhaps not such a social tragedy that they can’t do it as easily any more.
But don’t confuse the size of a possible borrowing / collateral constraint with “wealth.”
That’s part of the transfer question. Those who rented did worse when house prices went up, and do better when house prices go down. There’s no question that It’s better to be a renter if you know prices are going down and vice versa. Just as it’s better to be out of the stock market when prices are going down.
Benn:
My point is precisely that the young, as a group, are worse off (irrespective of what they thought they knew about where prices were headed). I think there’s more than a fair debate to be had about the macroeconomic effects of this going forward. But surely what I’ve found on the demographics must be relevant to the question – so at least worth raising. No? . . .
John:
Yes indeed! I think we’ve talked about all sorts of interesting channels by which some groups benefitted, some were made worse off, and we all were made worse off by the end of the housing boom. Less collateral (for better or worse), houses built in the wrong places, half-finished houses, foreclosure externalities, the difficulty of young people starting carrers and so on.
But let’s also steer clear of the things that aren’t true, like the idea that just because the resale value of your house declines, you are automatically a lot poorer, especially if you are young and going to live in the house for a long time.
(A special thanks to Benn for graciously agreeing to let me post our exchange.)
