All Real Estate, All the Time

It has been widely reported that housing has been holding up the economy during the recent period of weakness, and that were it not for the consumer's ability to keep spending by extracting equity from their home, the recession would have been much worse.

However, few commentators realize that these reports are evidence that the US economy is undergoing a secular shift. The emerging reality, slowly being recognized by economists, is becoming known as the Housing Economy. This term recognizes the emergence of residential real estate as the driver of economic activity.

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

The changing composition of the labor force illustrates the transition that is taking place. The Wall Street Journal and other papers have recently 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 offshore 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. Their work will consist of the construction, financing (and re-financing), purchase, and sale of residential real estate. Day traders who now trade NASDAQ issues may be able to day trade residential real estate if sufficiently liquid markets and continuous price quotes are available.

Housing will be more than the driver of the Housing Economy: it will be the only form of economic activity. Other types of production, now seen to be unnecessary, will be converted or diverted to residential real estate, as the New York Times has reported in a recent story:

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 conversion of factories, transportation networks, and other capital goods, to residential real estate will yield significant economic benefits. A Seattle real estate developer contacted by this publication 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 production is a lot of work, and you have to save and invest. Now how much fun is that? Why not 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 skeptics question that home owners can perpetually refinance and extract home equity from their rising home prices. However, a growing chorus of doubters has raised the issue that increasing debt levels will limit the long-term growth of the economy.

Past generations of home owners looked forward to the final payment of their mortgage debt prior to their exit from the work force. Of concern are the following trends: in recent years, home equity as a percentage of home values has sunk to an all-time low, in spite of the aging population of baby boomers nearing retirement, several consecutive years of strongly rising home prices, and a period of record-low interest rates.

The total amount of mortgage debt outstanding, now around six to seven trillion dollars, is at an all-time high. Critics are increasingly 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. A mainstream economist asked to comment on the issue, defended the Housing Economy.

"Using the most modern econometric techniques, we can project where the mortgage payments of all home owner reaches 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. The point where the line crosses 100% is 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?

The mainstream economist 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 last year 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."

He continued, "Those worry-mongers who are always complaining about debt are laboring under the quaint notion that debt is supposed to be repaid. 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.

This might sound like a perpetual motion machine to old-school economists, who have argued that wealth creation required savings and investment. But thanks to recent developments in economic thinking, 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 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 Housing Economy have argued that it will be more resistant to business cycles. One case in point is that it will be immune to offshore movement of jobs to India or China. Real estate agents must be local in order to be familiar with the neighborhood conditions.

However, some social justice 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.1

One community-based 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 specter of housing inequality, the 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) mortgages2, interest-only mortgages3, negative amortization4, and mortgages written for greater than 100% of the value of the home5 will provide a basis for these new programs.

Here the 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, 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.

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

Fannie Mae CEO Franklin Raines has emphasized 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.

One home owner, who has retired from their line of work and now lives entirely off their home equity, summarized the impact of the Housing Economy on his own life: "Is this a great country, or what?"


  1. Some people will always find something to complain about.
  2. I'm not making this up.
  3. Or this.
  4. Or this, either.
  5. Or this.

March 8, 2004

Robert Blumen (send him mail) is an independent software consultant based in San Francisco, where he rents an apartment.