DID McMansion fever cause the US housing bust? Now that the home crisis finger-pointing season is in full swing, it’s a good time to take a look at how ‘house lust’, as author Daniel McGinn calls it, affected the property market.
Crumbling market: Realtors inspecting a foreclosed house in Leesburg, Virginia, placed back on the market for more than US$1 million last December. Status- seeking has been described as a root cause of the US housing crisis. But it likely went much deeper than that, as a combination of the American Dream and a mass amnesia of economic reality took holdMcGinn, who recently published a book on the topic, points to a convergence of personal economics and good old-fashioned status-seeking as one of the root causes of the crisis. More likely, it went much deeper, as a combination of the American Dream and a mass amnesia of economic reality took hold.
Identifying ‘primary drivers’ for what caused house lust, McGinn cites the revolution in home finance. Many homebuyers, whose only qualification for a mortgage was a human pulse, qualified for large loans. As rates dropped in the last decade, homeowners also operated like ‘mini-CFOs, deciding just how much of their wealth to keep in their houses’, he writes.
Millions figured if home prices were going to keep climbing at double-digit levels, whatever they pulled out of their homes in refinancing or home-equity loans would be replaced by appreciation.
As we know now, that didn’t happen and far too many homeowners ended up with more debt and almost no equity.
Those that took the equity-gain bet with little or no downpayment are looking at a losing hand as home prices and sales continue to fall in most US markets. Even Manhattan apartment sales, which were until recently immune from the slump, dipped 34 per cent in the first quarter - the most in 18 years.
Slide in equity
The massive vacuuming of home equity has been huge in recent years and is a far cry from the way Americans saved after World War II.
Home equity fell to about 48 per cent of total household real-estate holdings in the fourth quarter of 2007, the lowest level since the Federal Reserve began keeping records in 1951.
Americans used to store equity in their homes like a well-stocked larder. In 1952, American homeowners maintained more than 80 per cent of the value of their homes in equity, according to Michael Rizzo, a senior economist at the American Institute for Economic Research, based in Great Barrington, Massachusetts.
Homeowners have ‘taken on larger debt to buy their homes and increasingly spend down their equity via home-equity loans’, Rizzo says.
A generation or two ago, McGinn says, ‘the average family took out a 30-year mortgage, which they intended to pay off one day. There were no home-equity lines of credit, refinancing was unusual and whatever wealth a homeowner built up in the house stayed there until it was sold. No more.’ During the housing boom, homeowners became speculators, making double wagers on the bond market maintaining or providing low rates and properties delivering guaranteed appreciation.
This Las Vegas attitude towards homeownership was aided and abetted by the built-in cultural bias that homeownership was a solid investment, not a gamble. Is the irony lost that the state with the highest foreclosure rate through February was Nevada? Not only was home gambling legal in Nevada, it was permitted in every state as mortgage brokers, banks and Wall Street got in on the action.
Hypnotised by the dual mantras ‘buy as much house as you can afford’ and ‘your home is your retirement plan’, Americans were sold on the home-as-investment mythology.
Home investors also stopped or slowed their investing in non-real-estate assets as the nation’s savings rate turned negative in 2005. Why squirrel away money in stocks or bonds when your house is a veritable cash machine? Since financing was cheap and popular optimism irrational, the participants in the boom felt like they were on a run at the craps table. So they upped the ante by buying bigger houses.
The average new-home size is more than 2,500 square feet, according to the National Association of Homebuilders, a Washington-based trade group.
That compares with 1,600 square feet in 1973. The number of single-family homes with three bathrooms or more has doubled in that period.
Almost 40 per cent of new homes have at least four bedrooms, compared with less than 25 per cent in 1973. Twice as many houses have three bathrooms or more compared with 1987.
Status was a powerful force in the building of ever-larger homes. Those who wanted to make their neighbours envious leveraged up to build three- and four-car garages, master suites and commercial-quality kitchens that would make Wolfgang Puck jealous.
Moving up into fancier digs didn’t get the housing market into its current morass, though.
Homes aren’t investments
Since McGinn focused on the nation’s physical obsession with home amenities, I was disappointed he didn’t explore more of the economic maladies. The long-term reality is that homeownership in non-bubble times is unlikely to beat inflation once you subtract maintenance, taxes and financing costs.
Yale economist Robert Shiller estimates that homes gained an average of 0.4 per cent annually from 1890 to 2004.
With the exception of rental properties, residential real estate produces no earnings or dividends. It doesn’t split like profitable stocks. The cost of ownership always goes up. If this is a love affair gone sour, then a new focus on building equity and the laws of supply and demand will make for a quicker housing rebound. — Bloomberg
John F Wasik, author of ‘The Merchant of Power’, is a Bloomberg News columnist. The opinions expressed are his own
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