Saturday, December 8, 2007

Real Estate, Disposable Income, Debt, and Home Equity

The following charts are all created from Table B.100 in the Flow of Funds Accounts of the United States. I have divided all data in the following charts by personal disposable income (to give some idea what our ability to pay for things would be).

This chart shows the tangible real estate household assets. Be warned that I've set the left scale's starting point at 100% (vs. 0%) so that more detail can be seen. In order to get the black line back down to the long-term exponential trend line either real estate asset prices must come down (presumably through deflation) and/or personal disposable incomes must go up (presumably through inflation). Heaven help us all if they both come down (recession?). That wouldn't necessarily help improve this picture much, unless real estate prices came down much faster than disposable incomes.

Further, there is no guarantee that the exponential growth is even sustainable. Japan found that out the hard way when their population stopped growing.

Please note the change in behavior in the chart once we fell off the gold standard in the early 1970s.

This stacked chart shows where the value of our homes lie. As a current homeowner, I'm of the belief that structures are depreciating assets. They should therefore not keep up with inflation unless you are willing to continually pump money into them (repaint the house, replace the carpets, roof, windows, and so on). It would make sense that the land itself is continually worth more though, assuming the population continues to grow.

The thing that most strikes me about the chart is that as the land became more expensive, we opted to put more expensive houses on it. In other words, we somehow rationalized that we could have our cake and eat it too. It is the same thing we heckle our government about. When given the choice between more expensive land and more expensive structures, we opted for both! It doesn't stop there though. If you've got a nice chunk of land and a nice house on top of it, might just as well park a few nice cars in the driveway, right? In relation to the price of homes these days, luxury cars are cheap apparently.

How did we pull that little trick off? Inquiring minds want to know!

The best way to look at this stacked chart might be to start at the bottom. First is the mortgage debt. That alone should make people cringe. I've added on consumer credit (which may or may not be appropriate depending on how you want to look at it). The remaining amount I'm calling the equity in the house. As can be seen in the chart, we have really embraced debt.

Here's something else that should make people cringe. Not all homeowners have embraced debt. There's a good chunk of the population that has their house paid off. That means the potential pain seen above is potentially concentrated.

Here's another thing that should make people cringe. Median incomes have not kept up with inflation during this housing boom. The richest among us are pulling up the averages. Can the median homeowner really afford the median home? I'm thinking the answer could turn out to be no. If so, that will pose great problems for Bernanke's magical prosperity printing press. Inflation isn't going to solve a problem of affordability. In my opinion, inflation makes it worse.

Picture what's going to happen to that chart if home prices drop 15%. The word ugly does not do it justice. Much of the damage would be immediately inflicted on the green section. The yellow and red sections could also take damage though, especially if the bankruptcy word becomes popular once again.

Normally I'd look at these charts and want to scream deflation at the top of my lungs. I guess we'll see just how much yellow and red pain Bernanke and our government are willing to allow. Bankruptcy is not the only "b" word that comes to mind. Bailout and banks do as well.

You will note that I was a good American in these charts. I didn't attempt to work in our rising national debt. Let's just continue to ignore that problem since we're not really sent a bill for that directly. It just shows up in the price of oil sometimes and may bleed over into food. Who knows!

See Also:
Calculated Risk: Fed: Existing Household Real Estate Assets Decline $67 Billion in Q3

Source Data:
FRB: Flow of Funds


Anonymous said...

Nicely done Mark, Just watching fox, MSM seems to be catching on.

Anonymous said...

I wonder if it is possible for property to fall 15%. What if there are only two possible states - somewhere in the neighbourhood of 5% or else somewhere in excess of 50%? In other words, either you avoid a vicious circle, or you don't. But a slightly malevolent circle is not on offer.

Stagflationary Mark said...

Yeah, it does seem we are at some risk for more than a 15% drop. Since we're well above the mean now we might actually end up being well below the mean for a time. History would back that theory. It is certainly evident in the charts.

If we're 15% too expensive now, we're at some risk of being 15% too cheap at some point. That could imply a 30% drop from peak to trough.

I worry about your "two possible states" theory when it comes to inflation/deflation debate, as do many others no doubt.

Teri said...

And, while we are at it, let's build several hundred thousand more houses than we need! Let's have oversupply and wonder why they can't keep the prices up.

Stagflationary Mark said...


And if we really sprawl those houses out a lot, we can use even more oil to heat the people within them and burn even more oil commuting to work!

Win, win, win! (If you like doom and gloom that is, otherwise, well, oh oh.)

Anonymous said...

The thing about the land is technical the government owns all the land the houses are sitting on the land is rented by the yearly payment of property taxes. If the taxes are not paid the government takes the land along with the home that is sitting on it so in reality everyone is a renter:-(


Stagflationary Mark said...


You will never become the Chief Economist at the NAR with that type of thinking!

I won't either obviously. Welcome to the club. ;)

Anonymous said...

Perhaps they should be called the "transfer of funds" or the "illusion of funds."

Anonymous said...

Perhaps they should be called the "transfer of funds" or the "illusion of funds."

Anonymous said...

Without the tether of a gold standard, money can expand infinitely. All that is required is a willingness to take on debt, profligate politians and an accomodative central banks. The world has all three in spades.

Stagflationary Mark said...


Too bad oil can't be expanded infinitely.

Anonymous said...

I worked for a home builder when I was in high school and college. I have seen house and land prices fall before. Looking at the chart, its easy to see land prices falling dramatically. A builder will work for smaller profits, but not for free. Take a new (500k)house with 250K land costs, $200K construction costs and 50K profits. If profits are discounted 20%, the builder can only lower the sales price 10K. This is a 2% drop (490K)compared to existing homes and forclosures selling for say 20% less (400K). To be competitive, future land costs must drop to around 160K. This is a 36% haircut on the land. I've seen it before and I'm seeing it now. The situation is worse if building costs rise due to inflation. I still predict a return to the mean. This will be painful for many.

Stagflationary Mark said...

This feels like an elaborate hoax on the American public.

The goal was to get as many people into homes to rescue the economy as was humanly possible. Shock and awe succeeded. Mission accomplished.

Now what? Quagmire?

Anonymous said...

It does feel like a hoax and at times I find myself railing at the asymetrical response of the FED and our political system. At the end of the day though, I think most people are just gullible or just like to gamble. Look at lottery tickets, casinos, church bingo, weight loss pills, aging creams, even steroids. While there may be no such thing as a free lunch, it sure seems like SELLING free lunches is profitable.

Recognizing and exploiting these "something for nothing" desires is the true secret to wall street's success. I have yet to see genius from wall street. Our national wealth really does grow although probably not at the rate the fed advertises. I just can't figure out why people, including investment professionals, are continually buying into the latest weight loss scheme from wall street. By definition, wall street is negative alfa. Only the degree of negative alfa is debatable.

Stagflationary Mark said...

My biggest gripe is with the "nothing for something" specialists.

I'm reminded of the inflation protected bond fund that my bank offered me. It had ~1.7% annual fees on an investment that was only expected to pay ~5%. Good luck keeping up with inflation when the fund consumes a third of the income. In sharp contrast, the vanguard fund of similar style has a 0.2% annual fee.

Anonymous said...

Years ago people were paying 4% upfront load charges on S&P 500 index funds. This is on top of 1% yearly fees. A fool and his money are soon parted indeed. When I get time I'll tell you about a personal experience at a discount brokerage. Keep up the good work. SOME people will listen.