Search News

### Company Matches

Who's afraid of the housing crash?
If you've been trying in vain to unload your house in Boston for anywhere near your original asking price, you might not want to read this. In The Economists' Voice, Berkeley economics professor Aaron Edlin argues that the housing crash might be good for some people. (Free login required. Worth the effort.) "Bring it on!" he says.

Counterintuitively, it's not just renters who win when real estate values fall, Edlin argues. Tumbling home values can also benefit many current homeowners. Which ones? Those hoping to move to a high-priced city, or families who need to move up to get more space. When housing prices fall, the expensive stuff may very well fall more, in dollar terms. Here's the math:
Consider for example a family that owns
a \$500,000 house in the Midwest who comes
to San Francisco and buys a \$1,000,000 house
(probably something much smaller than the
family’s current home, by the way). The family
must cough up an extra \$500,000.

Suppose that housing prices rise by 50% in
both locales. Now, the small San Francisco house
costs \$1,500,000 and the Midwestern house
costs \$750,000. It costs an extra \$750,000 to
make the move after the general appreciation.
What happened is that the difference in price of
\$500,000 grew by 50% to \$750,000....

If prices now fall by 33% in both locales, the
prices will become \$1,000,000 and \$500,000
again. The difference in price will fall by 33% to
\$500,000
You can do a similar calculation for a family trying to bridge the difference between their \$750,000 house and the bigger \$1.5 million house next door. A 33% drop in local real estate prices would cut the gap to \$500,000. Edlin offers the crucial caveat that the price drop could temporarily wipe out the family's equity, but adds that if they can manage the down payment on the big house, they'll ultimately have a lower monthly mortgage payment.

Update: This news story underscores a couple of points we've been talking about on this blog. First, that the boom in real estate has also had a cost--if you're young and in the market for a house, it's just another form of inflation. Second, that real estate prices are changing the definition of "middle class" in many areas.

In the New York metropolitan area, a \$500,000 median-priced home required a \$171,000 annual salary. The median-priced home in San Francisco, the most expensive U.S. market, was \$759,000, requiring income of \$260,000.... On the opposite end of the spectrum, Mansfield, Ohio, homes cost a median \$85,000, requiring \$29,118 in income.

Posted by Pat Regnier 5:43 PM 15 Comments  | Add a Comment

The only real people who get hurt in the downturn are
- real estate flippers
- people who overextended themselves with ARMS and IO loans they really couldnt afford

why should anyone feel sorry for them?

the people to benefit are:
- fiscal responsible people who save their money and didnt want to expose their family with ARM IO suicide.
Posted By saverRE,new york, ny : 9:35 AM

Common sense for newly married couples in a small coop/condo or starter home is that it is better for the market to decline if they plan on trading up to a dream home. However, when a thirty something 200k starter home hits 600K and they start shopping around for the mansions that were priced at 500K ten years earlier they quickly realized that their 500k homes have also tripled to \$1.5 million. Ten years ago the price difference was \$300k starter to mansion and now it is \$900 starter to mansion. But no one realizes this to they go house shopping or try to sell. Out on Long Island I have seen many four sale signs go up and down on starter homes when they realize they have to leave the state of New York to make it from start to mansion on that 400k jum in price. I guess it is human nature to jump up and down as your house keeps going up in value. But in realty it is only hurting the people who want to trade-up.
Posted By Oceanside, NY : 10:00 AM

This logic is flawed. You're under the assumption that home values increase the same % across the board.
Posted By Ray Houston, TX : 10:37 AM

I love theories. They're so useless. Some person who has a byline gets to tell us all how good a bad thing is. I'm guessing Mr Edlin has no personal exposure in this housing market. If he did, I'm sure his theory would be different. When Dad no ends up on Medicaid, I'll show him Mr Edlin's article so he can feel good about it too.
Posted By J. Anderson, Nutley, NJ : 10:38 AM

The problem is that 80 million baby boomers don't want to upgrade to a more expensive house. They want to cash out equity in their current home for retirement. Try telling the aging in America that falling house values is a good thing.
Posted By Mike, Park Ridge, IL : 10:48 AM

I for one, never understood the "benefit" of soaring home values. How can one rationalize that ever-increasing values are good for society as a whole? It creates a society of haves and have-nots, where first-time buyers are all priced out unless resorting to "exotic" (read - toxic, suicide) loans.

Current homeowners may feel rich on paper but homeowners can only trade with other homeowners for so long. Ultimately you need first time buyers to make the cycle work.

What if automobiles suddenly starting increasing in price at 20% per year? Would everybody view that as a good thing? Absolutely not. Asset bubbles are not good for society as a whole.
Posted By John Delany, Arlington VA : 11:37 AM

what a stupid analogy!!
Posted By Anonymous : 11:53 AM

These recent Berkeley articles great, but they were late to the game. Meanwhile, average Joe's were showing us what really was happening within various bubble blogs. One of the best for raw data is thebubblebuster.com. I like this guys site because he removes inflation from home prices so you can determine 'real' gains.
Posted By John Davis, Sacramento, CA : 12:51 PM

The analogy is not stupid at all.But we should not blame people for their greed, when the primary cause for inflation is the iresponsible monetary policy (read : printing more money).
Posted By ANO,KY : 1:03 PM

I think it is a great analogy. many people feel that if prices are rising then it must be a great investment. History has shown us that it is not always true.
Posted By George R, Mineola, NY : 1:05 PM

I recently finished grad school and started looking around to buy a decent house. When the stories about the bust started trickling in it felt that maybe I should rent for a while longer but if I look at house prices in Austin they are still going up 5-10% yearly. Not crazy but well above inflation. So now I am confused. Should I buy or should I wait?
Posted By Prabuddha , Austin Texas : 5:17 PM

Too elementary of an argument. Separate areas are not going correct equally nor increase equally, and the correction factor used is excessive.
Posted By Eric Heinrich Boston MA : 5:47 PM

The Housing Market shot out of control for several reasons.

1. Investment Speculators.

2. Builders Greed!

3. Realtors Greed!

4. Home Owners Greed!

Last but not least...

5. The American Public willing to buy the Overpriced Home!

Until the consumer is willing to tell these other individuals to stick it, these individuals will just keep taking advantage of the consumer. New Homes Starts are down, Foreclosures are up and exiting homes are sitting on the market longer. It's costing the compaines and home-owners money, and in some cases, Big Money.

The Public can wait this out if they are willing to. At some point in time the Building Contractors have to reduce inventories. The best way for this to happen is for consumers to reject the Perks and Free Up-grades, and Barter for a Better Price. After all, depending on the New Home, prices are marked up any where from 15 - 45%.

Thats alot of room to negotiate for those of us that are willing to wait and then make an offer.
Posted By Steve Louisville, Kentucky : 6:05 PM

Why is it that 20-somethings still/always think that they should instantly be able to buy a 2500 sq ft home in a nice neighborhood after working for 1 or 2 years? The Process has always been (and probably will continue to be), rent for awhile, live frugally, delay marriage, and save a down payment BEFORE buying your first house. Any move-ups later-on (like maybe 10 to 15 years later) requires a similar process, but now only includes primarily a frugal life style and committed savings efforts.

The limits of your dreams are determined by where you live - house prices are generally cheaper in the Midwest vs the coasts - and whether or not there are 2 moderate or higher incomes in the family.
Posted By Joel, Portland Oregon : 8:03 PM

For established families, the bubble wasn't that big a deal. When I look at housing price increases over the last 20 years, they grew at just over inflation, which is fine. However, they ALL happened in a 5 year span.

Also, the percentage drops are normally higher up market than down, so a drop helps families moving up... IF THEY HAVE equity.

We stretched and bought an expensive ranch house in our mid-20s because we had no choice. With a crazy market, but low interest rates, if the market cratered, at least we were protected by a fixed rate mortgage we could afford... if the market had crashed and rates went up, we wouldn't risk equity, but we'd have had higher monthly payments.

If people bought a starter-home, and prices crashed, it might have been cheaper to upgrade, but if you lost your down payment and had equity wiped out in a crash, then even though the houses are cheaper now, you can't afford them.

Most people trade up using the equity in their old home as the down-payment, but in a crash, that's gone and you can't trade up. The only way out then was a cash down-payment, and find a way to rent the old house out to wait for the market to correct.

Doubling down in a crash may be a prudent financial move in theory, but is absolutely CRAZY risk for a young family trying to get housing and not get wiped out.
Posted By Alex, Hollywood FL : 11:07 AM