After a long period of declines in house prices, current data offers a glimmer of hope that the worst of the decline may be over, and that will lead to a broad economic recovery. Such optimism may be premature.
While house prices continued to fall, with prices down by double-digit amounts year over year, the most recent numbers show the declines latterly were the smallest in over a year. There are good grounds for skepticism about future trends and their effect on the general economy.
In the United States the Office of the Comptroller of the Currency, an organization that regulates banks, reported the amount of foreclosures rose significantly in the latest quarter, as did the number of prime mortgages with payments at least 60 days late. Our government continues to make strenuous efforts to start an anti-foreclosure program.
The motivation is partly political. The public wants the government to try to stem the fall in the price of houses, because of its importance in the grand scheme of things.
Equally important, there is a theory that the wealth effect is crucial. Households’ mainly hold their wealth in housing.
The current belief is that rising house prices make people wealthier, increasing the amount they have to spend over their lifetimes. They like to spend some of it in the present, because they wish to spread their spending approximately evenly over the course of their lives.
That belief forms an integral part of economic policy. There is a model that shows housing wealth influences consumer spending more than other aspects of wealth as determinants.
Some contradict this theory. Willem Buiter, of the London School of Economics, argued that in the past when house prices rise and fall there were both winners and losers, but no net wealth effect.
Three economists with the National Bureau of Economic Research claim the wealth effect is exaggerated, because “they do not account for the fact that people expect to earn more in the future and, therefore, bid up house prices.
“They may also spend more, but this extra consumption would not be caused by variations in housing wealth.”
It was stated there that the effects of housing wealth is smaller than the changes caused by fluctuating equity prices.
Nevertheless, it is understandable that governments emphasize the effects of house prices because a drop in house prices affects people’s ability to borrow.
Hence house prices could still affect consumption by assisting consumers’ ability to borrow.
It should be noted, too, that regardless of current optimism on house prices, adjustable rate mortgages presage rising interest rates on mortgages next year and that will affect house prices.
Overall then, one should not make a great deal out of any spurt in house prices and what that could entail for the entire economy.