Now that the data are showing that home prices are falling, news reports are again citing statements from the experts who told us that home prices would never fall. According to these experts, house prices declines are no big deal after the extraordinary appreciation of the last decade. The data indicate otherwise. People have been borrowing against their homes at a rate of more than $700 billion a year. This borrowing has helped to sustain consumption in the wake of slow job growth and declining real wages. This borrowing explains the negative savings rate, a first since the beginning of the Great Depression. The problem with declining house prices is that it could quickly put an end to borrowing against home equity. The Fed reported that the ratio of equity to value was at a record low 54.1 percent last quarter. From the fifties through the eighties, this ratio was consistently in the high sixties. Coming after a decade of unprecedented price appreciation, this record low ratio is shocking. It is even more disturbing given that the country's demographics, with the huge baby boom cohort entering retirement, points to a higher than normal equity to value ratio. If house prices drop further, this ratio of equity to value will fall further. More homeowners will hit their borrowing limits. This will both curtail consumption and likely cause many people to lose homes. It would be good if the media talked to experts who were not in the "who could have known" school of economics.
-- Dean Baker
