Housing has been the driver of economic growth during the current recovery from the 2002 recession. Were it not for the consumer’s ability to maintain a level of spending in excess of income by extracting equity from their home, many analysts agree that the recent recession would have been much worse and the recovery delayed.

While the role of housing in smoothing out the business cycle is widely recognized, a few economists and writers have reached the controversial conclusion that the US economy is undergoing a secular shift to a housing-based economy. The emergence of residential real estate as the ultimate source of economic activity and wealth creation is known among its proponents as “The New Housing Economy”.

Some experts believe that the current changes will be comparable in their scope to the two major secular shifts of the past two decades: the change from the Old Economy (based on manufacturing) to the Service Economy (based on the import of consumer goods paid for with credit), that took place in the 80; and then, the transition from the Service Economy to the New Economy (based on computers and the Internet) that took place in the '90s.

Housing will be more than the key driver of the New Housing Economy: it will eventually be the only form of economic activity. Other types of production, seen to be unnecessary, will be converted or diverted to residential real estate. The New York Times has reported:

Gregory J. Nickels, the mayor of Seattle, is battling the Port of Seattle and the longshoreman's union to close one of the city's three port terminals in a few years, saying it makes more sense to use the spectacular mountain-framed waterfront property for condominiums than cargo ships going back to Asia without full loads. He argues that even the $700 million of recent renovations on the port will not increase cargo traffic.

"The land values are such that when the port is only creating 13 jobs per acre, there may be a better way to create jobs," Mr. Nickels said.

The changing composition of the labor force illustrates the transition. The Wall Street Journal and other papers have reported that many unemployed professionals from fields such as information technology, management, and finance, are now leaving their old line of work to become real estate agents as they realize that their old job has moved off shore or is not coming back.

Eventually, most of the US labor force will be employed in one of a few types of work: real estate developer, building contractor, appraisers, real estate broker, and real estate agent. Some niches will still exist for stock brokers to trade the stocks of home builders. The work of the rest will consist of the construction, financing (and re-financing), purchase, and sale of residential real estate.

Day traders who used to trade NASDAQ issues during the height of the stock market bubble are now able to day trade residential real estate. The process, known as “flipping” used to mean purchasing for sale within weeks or months, but with liquid markets and continuous price quotes people are now able to turn over homes within days, even selling the same spec home several times before it has been built. In the future, it may not even matter whether the home is ever built, as day traders earn a substantial income by simply turning the same piece of paper over multiple times, making a 15-20% profit on each transaction.

The conversion of factories, transportation networks, and other capital goods, to residential real estate will yield significant economic benefits. Barbara Chossis, a Seattle real estate developer explained the thinking behind this, “We used to need shipping terminals because we used to have to produce goods to trade with foreigners to get things from them in return. But making things is a lot of work, and you have to save in advance to pay for it. How much fun is that? Now we just build houses and condos.”

One challenge that has been issued by critics is the likelihood of an excessive accumulation of debt. Only hard-core pessimists would question that home owners will be perpetually able to refinance and continue to extract home equity accumulated from rising home prices. However, a growing chorus of doubters has questioned whether increasing debt levels will limit the long-term growth of the New Housing Economy.

The depression-era generation of home owners looked forward to the final payment of their mortgage debt before they retired from the work force. Current home owners, by contrast, have a lesser percentage of home equity than at any time in the post-war era. Skeptics are concerned about this trend pointing to this trend in conjunction with an aging population of baby boomers nearing retirement who, it is argued should be saving. Falling equity, skeptics say, is even more alarming considering the recent consecutive years of strongly rising home prices and record-low interest rates.

The total amount of mortgage debt outstanding, now around seven trillion dollars, is at an all-time high. Critics are also alarmed that the fraction of income devoted to mortgage payments is also at historically high levels, and has been growing.

While some have argued that the fraction of income spent on mortgages must remain under 100%, not all economists agree. Dr. Hallucinatory R. Heartwarming (a mainstream economist) defended the New Housing Economy:

“Using the most modern econometric techniques, we can project where the mortgage payments of all home owner reach 100% of national wage income. Basically what we do is draw a graph of the percentage over time, lay a ruler over it, and draw a straight line. We use the point in time where the line crosses 100% as our forecast”, he stated.

Some have charged that this type of forecasting is devoid of any economic reasoning, and even that it violates common sense. How, for example, could mortgage payments reach or exceed 100% of income?

Dr. Heartwarming responded to these charges. “Home owners can simply extract equity from their home by refinancing and use the cash they take out to pay the difference between their income and their mortgage.” Home owners extracted $491 billion of equity from their homes in 2002 according to the Wall Street Journal. “Home owners are already using home equity from refinancing to meet ongoing monthly expenses”, he continued, “It is a small step forward to start using these funds for the mortgage itself.”

This view was echoed by Alan Nevin, Chief Economist of the California Building Industry Association: “"People have the ability to borrow against their homes," Nevin said. "If times get tougher, they could borrow a sufficient amount to pay their mortgages."

“Those worry-mongers who are always complaining about debt are laboring under the quaint notion that debt is supposed to be repaid,” added Dr. Heartwarming. “The purpose of going into debt is so that you can acquire more debt in the future. Governments have known this for a long time, but in a democracy, why shouldn’t ordinary people be able to take advantage of this as well?”

Fed Chairman Alan Greenspan, one of the leading thinkers in this new paradigm, has generally endorsed these changes, as the Wall Street Journal reported:

WASHINGTON -- Federal Reserve Chairman Alan Greenspan said Monday the finances of U.S. households are in "good shape" despite a steep rise in household debt and national bankruptcy rates over the last few years, suggesting that consumer spending isn't likely to fizzle out.

In a speech, Greenspan said that although nonbusiness bankruptcy filings have risen steadily over the last few years, they don't reflect the true state of household finances. Household debt, he said, has climbed in tandem with rising homeownership rates and rising home prices, allowing most households to carry the debt without stress.

"Overall, the household sector seems to be in good shape, and much of the apparent increase in the household sector's debt ratios over the past decade reflect factors that do not suggest increasing household financial stress," Greenspan told the Credit Union National Association in prepared remarks.

If the use of debt to fund current consumption is to be sustainable, continually rising housing prices are required so that a plentiful supply of home equity to be cashed out is always available, which requires continuously rising home prices.

This might sound like a perpetual motion machine to classical and Austrian economists, who have argued that wealth creation required savings and investment. But thanks to recent developments in economic theory, the use of permanently rising asset prices as a means of wealth creation now has a sound basis in economic theory.

Fed Chairman Alan Greenspan was one of the first to see how rising home values could be a source of economic growth:

As an economic consultant in the 1960s, Alan Greenspan had a novel insight about buying and selling homes. He noticed that when a house changed hands, the mortgage the buyer took out almost always was bigger than the one the seller was retiring.

Mr. Greenspan went on to conclude that this borrowing played an unexpectedly large role in consumer markets, by generating extra spending power backed by the value of homes. At the time, it was an arcane thesis that few other economists accepted or even understood.

[…]

Mr. Greenspan's analytic interest in housing dates to his days as a consultant at Townsend-Greenspan & Co. He noticed that total mortgage debt was increasing each year by more than could be explained by mortgages taken out on newly built homes, after he subtracted scheduled repayment of existing loans. The difference, he concluded, had to be mortgage borrowing secured by the equity in existing homes -- borrowing that consumers used for other purposes, from buying cars to investing in stocks.

Mr. Greenspan called this the "monetization," "liquefication" or "extraction" of home equity. He believed it could explain a lot of things -- stock prices, home prices and consumer spending -- better than other economic models did. "Capital gains from home sales are a potent force in consumer markets, far greater than ... stock-market gains," he told the National Association for Business Economics in Philadelphia in 1977.

[…]

"In the old days, housing wealth was relatively illiquid and the only way to realize it was to sell and move to smaller house," said Fed researcher Andreas Lehnert at a recent academic conference in Washington. "Now you can borrow against housing wealth." He calls this increased role of the home as a source of cash the "ATM effect."

In a groundbreaking 1996 article, the concept of using rising prices to create wealth was extended from rising home prices to rising asset prices in general. Economist Dr. Kurt Richebächer summarizes this article:

For the first time ever in the history of economic thinking, economists - that is, American economists - are claiming that growing asset prices represent fully valid wealth creation. In 1996, an article in Foreign Policy entitled Securities: The New Wealth Machine effectively explained that the financial markets have become the most powerful generator of wealth.

Verbatim: "Historically, manufacturing, exporting, and direct investment produced prosperity through income creation. Wealth was created when a portion of income was diverted from consumption into investment in buildings, machinery and technological change. Societies accumulated wealth slowly over generations. Now, many societies, and indeed the entire world, have learned how to create wealth directly. The new approach requires that a state find ways to increase the market value of its stock of productive assets. Several countries have successfully directed their economic policies toward that goal, achieving and sustaining faster growth rates than were once thought possible..."

The New Housing Economy brings concept of extracting wealth rising asset prices full circle: rising housing prices will drive not only the entire economy, but also ensure the further increase in housing prices. The Wall Street Journal noted that the net worth of households recently “surpassed the peak of $43.58 trillion reached in the first quarter of 2000,” due to “a rebound in the stock market as well as the rapid appreciation in home values in the past few years.”

Proponents of the New Housing Economy have argued that it will be more resistant to business cycles. Because homes cannot be imported, it will be immune to off-shore movement of jobs to India or China. Another case in point is that real estate agents must be local in order to be familiar with the neighborhood conditions.

However, some activists have raised concerns about what will happen to those individuals who fall through the cracks – those unable to get a mortgage or to find work as real estate agents or brokers.

Dispatching R. Brimmed, a community-based-social-justice-and-economic-fairness development activist recently spoke out: “We are in danger of an unequal society, one of real-estate haves and real estate have-nots.” Indeed, this would mirror the experience of Japan’s bubble economy, in which modest homes fetched millions of dollars. Only those who already owned a home had the means to purchase real estate. Those who had not purchased before the bubble were left behind.

To avoid the social costs that would result from housing inequality, the New Housing Economy will require additional social safety net programs to ensure that everyone can obtain a mortgage of any size, no matter what their credit-worthiness. Recent financial innovations such as zero-percent (no down payment) mortgages, interest-only mortgages, negative amortization, and mortgages written for greater than 100% of the value of the home will provide a basis for these new programs.

Here the New Housing Economy may borrow from recent financial innovations in auto financing. Car owners who are “upside down”, that is, owe more on their car than it is worth, they can roll the old debt into a loan on a new car. The new loan is often for more than the value of the new car.

These programs can even be combined, for example, to create an option-interest-only zero-percent mortgage. (The “option” refers to the payer’s option to stop paying the mortgage entirely.) This will enable the borrower who has no income, and is not likely to have any in the future, to qualify. Although the mortgage will negatively amortize by adding hypothetical payment amounts to the principal, this doesn’t matter to the home owner because he never has to make a payment on it. The mortgage will simply be packaged into a mortgage-backed security and sold to a foreign central bank so that the home owner can continue to purchase more Asian consumer goods.

The housing GSE Fannie Mae will continue to provide an important service to home buyers by in purchasing mortgages that are issued to finance homes, securitizing them, and selling them to the Chinese and Japanese Central Banks.

Former Fannie Mae CEO Franklin Raines was fond of emphasizing the important role of the GSEs in ensuring continually rising home prices. In a speech to the SIA, Raines calculated the supply of credit that would be available for mortgages. Raines then made an independent calculation for the demand for mortgage loans, based on the entirely reasonable assumption of continued home price appreciation.

According to Raines, credit demand would have exceeded credit supply by a significant margin. This would undoubtedly lead to a complete shutdown of the housing market, as home prices remained stuck at high levels that buyers could not afford. Fortunately, Fannie Mae was able to step in and provide the additional credit that was needed to make up the difference between supply and demand.

It was thought by older economists that supply and demand could not be permanently out of balance because the movement of prices would occur until supply and demand were matched. In this mode of thinking, supply, demand, and price were seen as interdependent phenomena. Indeed, without Fannie Mae, the price system would have been required to bear the full burden of bringing supply and demand into balance. This would have meant either higher interest rates, lower home prices, or some combination of the two.

Amos Bullock, a Portland, Oregon home owner who has recently retired from any form of productive activity, now lives entirely by refinancing his home on a monthly basis to extract equity. Bullock summarized the impact of the New Housing Economy on his own life: “Is this a great country, or what?”

© 2005 Robert Blumen
Editorial Archive