Many American policymakers, not least at the Federal Reserve and the Treasury, continue to pin hopes for a robust economic recovery on the housing market. They should consider that one demographic particularly badly hit by its collapse has a long memory. That's because they're young. They'll be around for a long time, and will bear the scars of the crash both financially and psychologically.
The change in home ownership rates from the 1996 trough in the Case-Shiller Price Index to its 2006 peak was by far the greatest among the under-30s. Total household home ownership rates increased 3.4 percentage points over this period, to 68.8%. For 25 to 29-year-olds, however, the increase was a much higher 7.1 percentage points – to 41.8%. For under-25s, it was 6.8 percentage points – to 24.8%. The rise in home ownership among the young was particularly remarkable given the lower base from which it started.
The cause is clear: easy credit. During this 10-year period when house prices were rising robustly, the young were an obvious target for aggressive mortgage pitches, backed by generous government subsidies. They had little in the way of capital to fund down payments but solid enough earnings prospects, at least in a buoyant market, to make monthly interest payments.
In 2006, the year in which under-30 home ownership rates peaked, more than 25% of home loans required no down payment. From the perspective of young labour-market entrants, home ownership may have made little practical sense, as they were likely to be itinerant and experimenting with careers, but it did look like a sure route to quick wealth.
What effect did the housing bust have on them? Household balance sheets among the Facebook generation were the hardest hit: between 2007 and 2009, half of those under the age of 35 lost over 25% of their wealth. A quarter of those under 35 lost over 86% of their wealth. Not surprisingly, they have been badly hit by the foreclosure tsunami; the median head of household in foreclosure being eight years younger than the median not in foreclosure. Younger households typically started off with less wealth than older ones and, following the bust, ended up with much less.
This bodes badly for their future, and the country's. Even young people who shunned zero-down loans and avoided foreclosure are now disproportionately highly leveraged, given that they have paid back little principal and participated little if at all in house price appreciation. Those who never joined the house-buying craze face much tighter credit generally, and in housing in particular. By 2008, fewer than 10% of mortgages required zero down payments – the only time this was true over the prior 10 years.
It is surely a good thing that credit terms in housing now better reflect default risk – the American economy has paid a high price for credit growth having gotten out of hand since the early 2000s.
Yet, the fact that young adults have been hit disproportionately by the housing downturn means that policymakers may be underestimating its long-term effects. After residential mortgage debt as a percentage of gross domestic product peaked in 1930 it took over 50 years for it to recover. Given how reluctant the Facebook generation will be to enter, or re-enter, the housing market, it may take particularly aggressive government use – or, more accurately, misuse – of Fannie Mae and Freddie Mac to generate another housing-based recovery.
This will be tempting for policymakers. But, to be sure, we don't want to go down the same route advocated a decade ago by economist and New York Times columnist Paul Krugman, when he entreated the Fed to promote economic revival through "housing, which is highly sensitive to interest rates".
Such revival having remained weak in 2002, he opined that the Fed "needs to create a housing bubble to replace the Nasdaq bubble". Wish granted. We know the results.
What we do need is a revival of corporate long-term fixed-asset investment, which, as a share of corporate liquid cashflow, is near a 72-year low. Research by Yale's Lisa Kahn found that, even long after leaving college, those who graduated into a bad economy suffered a significant earnings gap. The longer business investment remains moribund, the worse the already bleak outlook for the cohort just entering the workforce will be.
Benn Steil is director of international economics at the Council on Foreign Relations and co-winner of the 2010 Hayek Book Prize.
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