By Chris | December 5, 2007
I tutor a Principles of Macroeconomics class and today I helped some students prepare for a final exam question on the causes of the subprime housing meltdown. We discussed how the packaging and sale of securities on Wall Street provided the wrong incentives for banks granting loans. The tendency of appraisers to overvalue homes was considered. Low interest rates and irresponsible (occasionally fraudulent) borrowers were also mentioned as culprits.
Growing up in the 90’s my mom was constantly looking for a new house. We went to a lot of open houses. It got to the point where she knew most of the Realtors in my hometown of 50,000 on a first name basis. And while, she never found anything with the charm and location of our brown house with black walnut trees, perusing houses with my mom gave me a pretty good pulse on the housing market. And prices always went up, at a surprising rate. Initially, I thought a growing population was the driver of price increases. Land, as a finite resource, will become more expensive as more people are alive to demand it. But, population growth alone can’t explain real estate prices. The U.S. population grows at approximately 1 percent per year. Moreover, land is usually a small percentage (maybe 25% at most) of the cost of a new house. In California, and elsewhere, restrictions on land use have likely contributed to higher housing prices. But, the root of growth in national housing prices lies elsewhere.
While median income has grown slowly over the last decade and a half, consumers tastes and preferences have changed dramatically. One need look only to the most recent subdivision to see that today’s median home dwarfs those built in the 1960’s and 1970’s. I found the argument made by this article very compelling:
People have become so enthralled with status that they seem to have forgotten the reason why we live under a roof and between four walls–shelter.At one point, that’s all a home really was. Nowadays, things are a bit different. Owning a home has not only become the equivalent of owning a piece of the American dream, it has become a way to measure success.
An overwhelming number of people embraced this concept during the most recent housing boom. Home prices began to swell beyond reasonable levels as more and more people bought into the market.
It wasn’t long before it became impossible for most people to buy median-priced homes on median incomes. By 2005, people were spending 60 percent more on average in the largest metro areas to buy rather than rent.
Median income doesn’t capture the entire picture. Higher incomes in the top percentiles have been growing at a faster rate than median income and some of that income is being plunked into real estate. Nevertheless, in a country so image conscience that average annual savings is often negative, is it really surprising that lots of homeowners have bit off more than they can chew when purchasing their home?