House Values and Affordability: Intro (part 1)

Throughout the bubble economy of 04-08 (approximately) there was a lot of talk about wealth creation through home price appreciation. However, the question always was, where is this money coming from in the first place?  Barring an increase in the money supply itself, there is only a finite amount of currency in circulation at a given time. Increased expenditures on housing must mean decreased expenditures in another area for a given household.  In this case I am referring to increased expenditures in monthly housing payments, rather than total house price, though that is another component as well.

One might point out in argument to the above point that there were also jobs being created, which increased flow of money to individuals, this is true.  However, if one was to go back and analyze the type of jobs created in the last decade, the vast majority were in the service sector, as the US economy has shifted away from manufacturing and into service.  This is all well and good as long as there is someone to service (no innuendo intended). The problem with all of this is that much of the consumption that drove the creation of these service sector jobs was being financed by assets that didn't really exist, i.e. home price appreciation that was unrealized (on paper only). Many were capitalizing on the tax benefits of the mortgage interest deduction and using home equity loans to finance consumer spending. This, arguably, is now acting as a multiplier on the downside of the slope, as people walk away from their houses and leave banks on the hook for not just the purchase price of the house, but also an Escalade and a few jet skis as well.

To veer back on topic, we can all now agree in hindsight that the runup in house prices was unsustainable and will have a lasting effect on the US economy.  Most can also agree that in order to get things back on track we need a return to affordable housing.  In many ways, this return will be unavoidable, as we are now overbuilt in the US of A.  All of those who quoted Will Rogers' memorable "They aren't making any more land" line are now looking a bit foolish as well. Regardless, how do you judge what "affordable" means, in regard to housing?  This, in my opinion is one of the toughest tasks ahead in predicting where we will end up after the economic crisis. Things will obviously sort themselves out as they do, but for many industries and in fact, our own government, forecasting will be necessary to gauge demand for services and markets.

What makes matters even more complicated is that housing demand is not as inelastic as many tend to think.  During severe recesssions several things occur that reduce demand for housing.  Note that I say housing in general, rather than the purchase of a home.  I will get to this later.

-Households become more willing to take on renters (i.e. renting out a room)
-Singles become more willing to find roommates
-Multiple generations will move in together (ex: Jon and his wife lose their jobs and move in with Jon's parents)
-Larger homes that are vacant (McMansions!) become chopped up as duplexes and multiplexes. If you don't believe me, look at many of the houses in older urban areas. They were once larger victorian style homes that were converted at some point. A local example would be in the U-District, San Francisco also has many of these.
-Couples move in together sooner
-Students are more likely to stay close to home for college, more choose to live at home, others boomerang back to their parents house when done

As I am not a professional numbers guesser, I will not attempt to construct an elaborate demand curve for any of these items, but everyone shoudl be aware of these factors when looking at figures from a "professional".

For part 2 I will look at some differing definitions of affordability, and why affordable housing is a good thing.  Stay tuned