June 12, 2008
Dean Baker
The American Prospect Online, June 12, 2008
See article on original website
This week in economic news: The average homeowner owes more and more, why renters are the ones accumulating wealth, and why we shouldn’t want a strong dollar.
Disappearing Home Equity
The Federal Reserve Board released new data last week that showed that the ratio of homeowners’ equity to the value of their home (in other words, the share of the home that the homeowner owns rather than the bank) fell to 46.2 percent in the first quarter of 2007, the lowest level ever. This ratio had never been below 50 percent until last year, and it was typically around 67 percent through the 50s, 60s, 70s, and 80s.
With much of the huge baby boom cohort near retirement, we might expect that the ratio of equity to value would be higher than its historic average, not lower. Of course, the average number conceals a great deal. Roughly one-third of homeowners own their house outright (they have paid off their mortgage). If the paid off houses cost as much as the average home (they actually cost somewhat less), then for the two-thirds of homeowners with mortgages, the average ratio of equity to value would be close to 20 percent.
But wait, it gets worse. The Fed’s data is based on the Office of Federal Housing Enterprise Oversight’s House Price Index. This index shows a substantially slower rate of house price decline than the more broadly constructed Case-Shiller index.
If we used the Case-Shiller index to measure the change in house prices since 2006, then the ratio of equity to value at the end of the first quarter would be close to 42 percent and the average ratio of equity to value for those with mortgages outstanding would be less than 14 percent. And of course prices are still falling.
This is really bad news for the tens of millions of baby boomers who were counting on the equity in their home to be a major source of support in their retirement. Of course the flip side is that all those folks who are still on the warpath to cut Social Security and Medicare are likely to get chased out of town. Tens of millions of hardworking people will now have desperate need of these programs to sustain a decent standard of living in retirement. These voters will look less kindly than ever on the politicians who try to take these benefits away.
Renting: The Route to Wealth Accumulation
As we like to say here that the Meltdown Lowdown, homeownership is often an effective way to get good secure housing and to accumulate savings. However, homeownership is not everywhere and always the best option. In particular, it is not a real smart idea to buy a home at a bubble-inflated price. As a result, some of the folks who decided to rent rather than buy in the last couple of years came out way ahead.
For example, suppose someone was considering buying a home priced right at the middle of the Washington, DC market in June of 2006. Back then this home would have cost just under $515,000. In March this home would have sold for about $400,000. This means our renter could have bought this house in March and have $115,000 more in wealth than the person who bought the home back in 2006. How’s that for accumulating wealth?
We can tell even more dramatic stories in other cities. The cheapest third of all homes in Los Angeles saw an average price decline of 28.2 percent between June of 2006 and March of 2008. This corresponded to a price drop for a home at the cutoff for this group (that is, a house cheaper than 66.6 percent of other houses) from $595,000 in June of 2006 to $418,000 in March. That means the payoff for renting these 21 months is an additional $177,000 in wealth. In San Diego the same calculation leads to $200,000 in additional wealth, and in San Francisco it’s almost $300,000.
But, this is not the whole story. Prices are still falling rapidly, which means that the renters are accumulating more wealth by the day. And don’t forget that the homeowners had to pay much more in mortgage payments and other ownership costs than the renters did as they waited.
Who Wants a Strong Dollar?
George W. Bush is getting macho again, this time talking tough on the dollar. While this is probably less harmful than invading another country, it would be useful if he explained why we should care if the dollar is strong at all.
The strong dollar is the cause of the $700 billion trade deficit. The trade deficit has consistently been far larger than the budget deficit, in fact often two or three times as large. Large trade deficits are just as unsustainable as large budget deficits. If the country persistently runs large trade deficits then it will have to pay more interest each year on the debt owed to foreigners, just as large budget deficits increase the amount of interest the government must pay each year on the national debt. The main difference is that the trade deficit is much bigger than the budget deficit. In other words, the dollar must fall, the only question is when and how.
It is also important to note that a strong dollar puts workers who are directly subject to international competition, like manufacturing workers, at a competitive disadvantage. By comparison, a strong dollar helps workers who are largely protected from international competition, like doctors and lawyers, since they can buy much of what they need at lower prices, even as their own pay in unaffected.
So a strong dollar is an unsustainable policy that benefits highly-paid workers at the expense of less highly-paid workers. Let’s ask again, who wants a strong dollar?
May Jobs Report: Boast Time
Since ML was on vacation last week, I had to contribute my tidbits about the May jobs report in advance. I told you that the report would show a loss of 80,000 jobs. Adding in revisions for prior months the actual number was 61,000. That puts me well ahead of the consensus expectation of a loss of 20,000.
I only saw the unemployment rate rising to 5.2 percent, when it actually jumped to 5.5 percent. But some of this was quirkiness, unemployment numbers often jump around randomly by 0.1 or 0.2 percentage points in a month. It is therefore likely that the unemployment rate will edge down in June. I also anticipated the demographic story that left the other analysts baffled, predicting that the increase in unemployment would be concentrated among teens and young workers. The moral of the story is that you can read the NYT the day after the report, or you can read ML the week before and get the real scoop.
This week’s cheap tip — the core inflation number will come in higher than expected at 0.3 percent to 0.4 percent. Higher hotel and medical care prices will be major factors.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues. You can find it at the American Prospect’s web site.
