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Underwater Homeowners Can't Rescue the Economy

Sunday, 02 December 2012 12:42

A NYT editorial today argued that helping out underwater homeowners is essential to the recovery. This does not make any sense as can be seen with simple arithmetic.

There are roughly 11 million underwater homeowners. Suppose that eliminatiing all of their underwater debt caused them to increase spending by an average of $10,000 per family per year. This would be a very substantial increase in spending for a group that has a median income of close to $70,000. Depending on the whether we use the Core Logic estimate of underwater equity ($700 billion) or the Zillow estimate ($1.1 trillion), it would imply a wealth effect of between 10 and 15 cents on the dollar, which is roughly 2-3 times conventional estimates of the wealth effect.

Even in this case, the increase in spending would still come to just $110 billion a year. Assuming a multiplier on this spending of 1.5 that get us to $165 billion in additional output or a bit more than one-sixth of the gap between potential and actual GDP. That's helpful, but far from getting us back to full employment. And given that the actual impact is more likely to be about half of this size, it's pretty hard to come up with a story where underwater homeowners provide the key to recovery.

In fact, consumers are spending at an unusually high rate relative to their disposable income. It is just lower than during the consumption boom years at the peak of the housing bubble.


 Source: Bureau of Economic Aanlysis.

There are still good reasons for helping underwater homeowners, as I've long argued. But this is not what is holding back the recovery.

Comments (2)Add Comment
written by jerry, December 02, 2012 12:34
Isn't it more a question of what percentage of disposable income is being spent on housing (and debt service more generally)? It's not that consumption levels are too low, but rather what is it that's being consumed and how helpful that is to the economy as a whole?

If you add up all the mortgage debt, student loan debt, credit card debt, etc., you have private debt at over 250% of GDP (down from a peak of over 300% before the crash). While I'm sure your numbers are right here and that underwater mortgage debt won't spur a recovery in and of itself, I don't think you can downplay the importance of some form of private sector debt writedowns right now.

Isn't it essentially the same thing as saying the stimulus wasn't big enough? The debt writedowns aren't big enough!
written by urban legend, December 03, 2012 3:32
It seems to me you are not considering the upward effect on home prices generally that write-downs would cause, and, therefore, on perceived wealth held by all homeowners. A high spending rate for the wealth effect seems reasonable under these circumstances as emerging from a big recession would suggest high pent-up demand for things put off in hard times.

Given that we are talking about wealth-effect spending by 100 million homeowners instead of just 11 million who are under water, it would seem we could easily double that $165 billion figure in additional output. I'm not sure how that translates into jobs, but at $100,000 per job, that would mean 3.3 million additional jobs, bringing unemployment down to something more like 5.8% than 7.8%. That may not do the whole job, but it ain't peanuts, either.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.