Stealing Christmas

Dean Baker
The Guardian Unlimited, November 26, 2007

See article on original website

The staggering economic impact of the housing crisis in America is making for a bleak holiday shopping season.

Retailers are getting increasingly worried about their prospects for the US holiday season. The early reports from the Thanksgiving weekend are mixed. Several major retailers have recently reported disappointing profits and downgraded their sales targets for the holiday season.

While economists will not doubt express surprise if sales turn sour, there is not much mystery as to why consumers are growing reluctant to spend. After increasing at an unprecedented rate for a decade, house prices have turned around and are now heading south. The prospect of declining house prices has made tens of millions of homeowners concerned about their financial prospects and far less anxious to engage in a holiday splurge.

They are right to be concerned. The basic facts are quite scary. As house prices soared, homeowners borrowed against their new equity almost as rapidly as it was created. The savings rate fell to almost zero in 2005 and has hovered near this level ever since. This is the lowest savings rate since the beginning of the Great Depression. Until the 1990s, the savings rate typically hovered near 8% of household income.

In the short-term, this consumption boom was good news for the economy. Soaring consumption, along with the surge in the housing sector, provided the fuel to lift the economy out of the recession and get employment growth on a positive path in 2003. The recovery never really took off, in the sense of providing solid wage growth for the bulk of the workforce, but it would certainly have been much weaker without the demand stimulated by the housing bubble.

However, any short-term benefits from the housing bubble came with a very substantial long-term cost. Citigroup and other major banks are now taking huge losses on complex financial instruments that they apparently did not understand. The parade of major financial institutions announcing multibillion-dollar write-downs of mortgage-related debt would be almost comical if it were not associated with the plight of millions of homeowners losing their homes.

And the worst is yet to come. House prices are dropping nationwide, and are falling at double-digit rates in some formerly hot markets. By virtually any measure - vacancy rates, the supply of unsold news homes, the number of existing homes for sale - the excess supply of homes for sale is at record levels. This means further downward pressure on prices, which is likely to cause the rate of price decline to accelerate in the months ahead. This means that the economists, analysts and other experts who are surprised by the extent of the problems in the subprime market will be even more surprised by an even bigger rash of write-downs six months or a year from now.

This continuing trend of declining house prices means that tens of millions of homeowners will soon find that they have little or no equity in their homes. The ratio of homeowners' equity to value stood at less than 52% at the end of the third quarter, an all-time low. This number, which measures the portion of a house that homeowners have paid off, was always near 70% until the last decade. With the bulk of the baby boom cohort now in their 50s or 60s, we would expect the ratio of equity to value to be at an all-time high, not an all-time low. Workers near retirement should be close to paying off their homes. The drop in the ratio of equity to value is especially striking since the enormous run-up in house prices over the last decade translated directly into equity for homeowners.

But homeowners listened to the experts and assumed that the good times would continue. They thought that their house prices would just keep appreciating indefinitely. This meant that they didn't have to save for retirement; their appreciating home prices would do the trick for them.

Now that reality has interceded and exposed the run-up in house prices as just a transitory bubble, it is not surprising that the holiday shopping season is not looking very good. Homeowners are beginning to realise that they are not as wealthy as they had expected to be. Tens of millions of families have to try to catch up with their savings plans in their remaining work years. The sooner they realise where they stand, the better chance they have to make up their lost savings. But increased saving by homeowners will not make the retailers happy.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer ( He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.