Did Someone Say Bubble?
A significant real-estate correction would have serious consequences for our economy. Housing has become a more critical proportion of our productive effort than at any other time since 1950, when we were in the postwar housing boom. Home building has accounted for about a quarter of the jobs created since the 2001 recession. In the past five years, housing has also provided about $2.5 trillion in cash for owners refinancing through home equity loans ($751 billion last year, twice the high point reached in the late 1980s). If prices flatten or decline, this flood of new money will become a trickle.
Caution. Another danger looms from the large number of loans with an initial period of three to five years at low rates and no principal payments. Upon "reset," monthly payments on these loans will rise as much as 50 to 100 percent. In the next two years, about $2 trillion in mortgage debt will be reset in this fashion so that millions of Americans will get a financial shock that they can ill absorb. Why? Because 22 percent of borrowers in the past two years have negative equity in their homes, and 40 percent have less than 10 percent equity. A third of those who got adjustable-rate mortgages in 2005 have negative equity, and 52 percent have less than 10 percent equity, meaning that even a slight decline in prices would endanger their entire investment.
The result could be the vicious cycle of declining home prices, less consumer spending, a slower economy, and more foreclosures. This would detonate the easy assumption that everybody can make gobs of money in real estate and that real-estate prices will never fall. This is a good time for caution.