Fallout: The Financial Crisis

Loss of home equity is the crux of crisis

Marketplace Staff Nov 24, 2008
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Fallout: The Financial Crisis

Loss of home equity is the crux of crisis

Marketplace Staff Nov 24, 2008
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TEXT OF COMMENTARY

Kai Ryssdal: OK, so Citigroup is saved. The president-elect is alluding to a super-sized stimulus package. Unnoticed in today’s headlines, though, is this little tidbit: The housing market still stinks. Existing home sales fell another 3 percent last month. The average house today is worth just about what it was early in 2004. Commentator Dean Baker says attention must be paid.


Dean Baker: When our political leaders come up with proposals for fixing the economy, they better remember how we got into this mess. The core problem is the loss of housing wealth, not access to credit.

Homeowners have lost more than $5 trillion in real housing wealth in the last two years and are likely to lose another $3 trillion. That’s almost $110,000 in equity for every homeowner in the country. That loss of wealth led directly to the plunge in consumption which is pushing us into a deep recession.

The current fixation on consumer credit misses the point.

Yes, people are having trouble getting loans for cars and other big ticket items. They are also finding it more difficult to get credit cards or student loans.

But the primary problem is not the liquidity of the financial system. It’s that the loss of housing equity has made tens of millions of families less creditworthy.

People with equity in their homes don’t typically default on debts. If they face economic hardship, they will borrow against their equity in order to pay off a car loan or credit card balance.

People without home equity generally don’t have any other resources to fall back on, and therefore are serious default risks. All the homeowners who have seen their equity vanish, due to falling house prices, are now in this less creditworthy category.

So, it is no surprise that banks and other financial companies are now less anxious to make consumer loans.

Of course, even if banks did make the loans available, many families still wouldn’t buy. People who lost their life savings in the housing crash are more interested in rebuilding their wealth than buying a new car.

Consumer spending alone will not bring us out of recession. In fact, our problem was that we had too much consumer spending–driven by ephemeral housing bubble wealth. Recovery will have to be driven by other sources, like government spending and an improved trade balance.

Until then, the obsession over consumer credit is only a distraction from the economy’s real problems.

Ryssdal: Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C.

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