Emmer column: The dangers of relying on home equity for wealth
Local real estate is bubbly again, even in Leadville, perhaps Colorado’s most colorful town.
Home equity has run rings around all other tools of middle-class wealth building. Yet home values have a thick layer of “fakeness” in them.
The housing market is less organic than canned lunch meat. Officials pumped up home values prior to the financial crisis. When the policy overdosed, prices were pummeled into mass foreclosures. To paraphrase pundit Ruchir Sharma, “If it is not broke, politicians will fix it until it is.”
Three policies provide much of the distortion in home prices. First are two big and mistakenly beloved tax breaks. Mortgage interest is deductible. Also price gains on primary homes are exempt from income taxes. Both artificially shift costs from homeowners to the broader society.
Second, policy-makers crossbred government with business to form Fannie Mae and Freddie Mac. These two organizations buy up most of the mortgages made by banks and mortgage brokers.
Risk does not matter much to the government half of the organizations. The business half wants to make money. So the twin titans splash out mortgage money like a hippo dropped into hot tub.
That seems OK until recession hits. Then the most vulnerable borrowers default and spread the misery to their neighbors, banks, savers and taxpayers.
Planning and zoning shapes the housing market further by adding risk, delay, cost and inflexibility to housing production. That restricts supply and pushes the have-lesses, including the young, away. Think San Francisco, London and Colorado ski country.
Together, this package of policies twists people’s decisions like a Cirque du Soleil act. Resources are sucked into housing from other uses. There is less for energy efficiency, or auto maintenance, or child care. The subsidies reduce the efficiency of society.
One’s success building home equity is also driven by economic mojo, especially in places like our local, one-legged resort economies. Home values depend on jobs, which depend on the vacation spending of people from far away.
Local home prices, local home equity, and therefore local retirements and local kids’ college money dangle from the cosmic picture. The global economy, national debt, recessions and even global warming all can make big differences to peoples’ home equity.
From 1950 to 2008, the U.S. enjoyed the piñata years. Now the whole rich world seems to be weakening financially.
The system might be losing its mojo, like the Catholic Church, IBM or Justin Bieber. It seems outlandish, but if the U.S.’s money mojo slips away, home equity and local household finances will not be far behind.
Analysts at JP Morgan say the median net worth of baby boom households, now aged 53-71, was $150,000 in 2013. Of that, about $85,000 was home equity. More than half. Home equity is the trunk of most families’ financial tree.
Rising home prices are important, of course, but it is debt that turbocharges home equity. How? For a home financed with 20 percent down and 80 percent borrowed money, a 5 percent increase in home value is levered into a 25 percent first-year jump in homeowners’ equity.
That magic is the same for a $200,000 condo and an $8 million second home. Hedge funds sweat bullets for a chance at such glorious returns. Beware, however; this rose has thorns. Falling home prices destroy five times more equity, as well.
If the rich world’s financial mojo keeps melting, more sparkling profits will morph into leveraged losses,
Even if public policy gets housing right and the West’s economy generates good growth again, under the best plausible forecasts for growth in home equity, it will be far from enough to fill most people’s retirement savings shortfall.
Betting on home equity for too much of retirement, or using it to add frosting to the ol’ lifestyle looks like a losing strategy. All debt involves an element of Russian roulette. It is probably best to avoid excess.
The Greatest Generation accumulated less wealth and less home equity than the boomers, partly because they borrowed less. Now the boomers may have overdone the debt thing.
Gen Xers have come to know real estate as the drunken driver of the economy. The financial crisis has set them back. JP Morgan speculates that the average Gen Xers may never recover to the average boomers’ level net worth.
Home equity is not rock-solid. Many forces can change its value.
Mortgages turbocharge home equity, home equity turbocharges individual wealth. However, too much debt is a weapon of mass destruction.
Even with its power, home equity is too little to cover most people’s retirement.
If public finances continue to weaken, so will home equity, so will household net worth.
Vince Emmer is a financial analyst in Gypsum. He runs Citizens Due Diligence after hours. Reach him at
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We can’t always put it on government to completely solve a problem, especially one with so many challenges and so much nuance such as homelessness.