Thursday, December 12, 2013
We have just completed a week of celebrating our nation's political independence, recalling and paying tribute to those whose intellectual insight, political courage and personal sacrifices have allowed us to become the world's longest lasting constitutional democracy. It seems fitting, therefore, to reflect a bit on the struggles we face in insuring that our political freedom is accompanied by economic freedom. That task depends primarily on working our way out of the hole of debt we've accumulated.
And nowhere is that more clearly reflected than in the iconic symbol of "the American dream," our homes. In 2006, the total market value of residential real estate owned by U.S. households totaled approximately $22.7 trillion. By the fourth quarter of 2011, that value had fallen to just over $16 trillion, a drop of nearly 30 percent. Measuring that same real estate by replacement cost instead of market price shows a very different picture. In 2006, the replacement cost of all the residential real estate we owned amounted to about $14.2 trillion. In the fourth quarter of 2011, it stood at $14.1 trillion, a drop of only one-half of one percent. In 2006, we valued (were willing to pay) 60 percent more for a house than what it cost to build. By the end of 2011, that premium for the American dream had dropped to 13 percent.
This change in value would be one thing if we had owned our homes outright -- prices go up, prices go down -- we still have a place to live. But our homes, of course, weren't entirely our own. In 2006, at the peak of housing prices, we owed approximately $9.9 trillion on our real estate. In 2007, even as prices fell over 8 percent, our debt rose to over $10.5 trillion. This debt amounted to over 73 percent of replacement value and more than 100 percent of our annual disposable income.
Clearly, we were leveraging our incomes to extreme levels to get to that dream. In 2007, debt service on real estate amounted to over 14 percent of disposable income, the highest ever recorded by the Federal Reserve. Adding rent payments, auto-lease payments, home-insurance and property-tax payments brought the financial-obligations ratio to nearly 19 percent of total disposable income, another record, according to Federal Reserve data.
Clearly these trends wrought havoc on household budgets and their overall sense of economic wellbeing. While the value of residential real estate fell by 29 percent from its 2006 peak, homeowner equity fell by over 52 percent. Debt on residential real estate as a percent of its value jumped from 40 percent in 2005 to 61 percent in 2011.
OK, OK, enough of this litany of bad news. What's the point?
The point is that we as a country face a long-term process of de-leveraging. Just as we pumped up the economy as a whole by paying banks, insurers, financial wizards and the whole range of construction trades that produced both the homes we wanted and the means to buy them, so now we must adjust to the fact that we couldn't afford those dreams. In the first quarter of 2012, household debt on residential real estate had dropped from its peak of 61 percent of market value to 59 percent, a small drop, but a move in the right direction.
At the same time, household debt on residential real estate as a percent of disposable income fell to 83 percent, and the Fed's financial-obligations-ratio fell to 16 percent of disposable income, its lowest level since 1994.
While such adjustments have been painful and go a long way toward explaining the depth of the last recession, they point the way to an economic freedom from debt that will enable us to renew our country's long history of increasing prosperity for all those seeking opportunity.
Charles Lawton is senior economist for Planning Decisions, a public-policy research firm. He can be reached at: