Your Home is No Longer Your Savings Account | Financial Advisors

Your Home is No Longer Your Savings Account

For several decades now housing prices have appreciated rapidly, mostly due to easy credit policies that have allowed more people to own their own home. The trend accelerated until recently, when problems in the subprime mortgage markets brought the party to an end. But from 1994 to 2005, some 3.2 million households were able to buy homes thanks to subprime mortgages or other gimmicky loan products, according to an analysis by Moody’s, making the American dream of homeownership a reality for a record percentage of households.

As the housing market gained momentum and lenders loosened mortgage requirements, the homes got bigger. Keeping up with the Jones’ was also another American phenomenon. You watched your neighbor build or move into a bigger home, so naturally you wanted one, too.

Today, there is a term for these elephantine dwellings: McMansions. Would you like to supersize that home? asked the builder. I thought that McMansions were anything over 5,000 square feet until recently when, in the course of a conversation Roe and I were having with our decorator, she mentioned she was working with a client who had just built a 22,000-square-foot extravaganza. Rosanne asked her how many people lived in the home and the decorator said just two, adding that the owners of this huge home were actually unsure they have enough room to do everything they want to do. So much for the 1,200-square-foot Levitt Homes built in the 1940s and 1950s here on Long Island, the original suburbia. Today that would rate as a walk-in closet.

Rapid Rise in Housing Prices Created Wealth

The rapid rise in housing prices over the past few decades has allowed many people, especially Baby Boomers, to think of their houses as something of a savings account. It was a good pretext for rationalizing meager retirement savings or the absence of a meaningful reserve for college costs. That worked for their parents, who purchased their 1,200-square-foot homes in the 1950s and sold them at much appreciated values, using the proceeds to buy a much less expensive condo in Florida and depositing the balance into a savings account or investment portfolio. That portfolio produced income to supplement payments from pensions and Social Security. In affect, this unexpected appreciation in the value of their homes represented a significant kind of saving for these folks and now their children, the Boomers, have come to think of it as a permanent fixture of the financial landscape.

The basic assumption that a house, or property in general, would always be an appreciating asset seemed to be playing out nicely … until recently. That’s when America’s free-wheeling mortgage lenders – giddy from a steady flow of cheap money – were suddenly called to account, sparking a liquidity crisis in the mortgage and mortgage derivative markets. The extent of the fallout from this latest shock to the real estate markets is uncertain, but it will be significant. That includes a wave of foreclosures that could affect well over a million households.

The impact of all these houses suddenly coming back onto the market will be to further depress housing prices, sharply diminishing the piggy-bank effect of homeownership that Boomers have come to count on. Also remember that most Boomers do not have the traditional defined benefit pension plan their parents relied on. And Social Security, which already requires Boomers to wait longer before collecting full benefits, will not be as generous as it once was.

I believe this credit crisis will be the watershed event that will see a fundamental decline in real estate values that could last for years and maybe a decade. American families’ net worth exploded to $54 trillion from $10.8 trillion between 1982 and 2006. However, the period prior to 1982 (1965 to 1982) was a period of net worth reduction (wealth destruction) in the United States. So my point is that history tells us that boom-and-bust cycles happen over many years, as in the periods discussed above, and are largely unnoticeable to the general public.

Increase of Wealth is no Longer Automatic

In the next economic cycle wealth appreciation will not come from the increase in the value of real estate, and it may take most Americans three to five years to realize it. The problems in the housing market, together with other factors such as higher energy costs, a weakening job market and low wage growth, will serve to focus the minds of America’s reflexive consumers on the need to save and save aggressively. In the future, wealth appreciation will come from saving, which is and has been non-existent here in the United States. In fact, due to high levels of debt, America’s collective savings rate was actually negative in 2005 and much of 2006, something not seen since the Great Depression.

Once Americans realize that their wealth is shrinking they will rediscover the virtues of saving, which will require planning, discipline and, very likely, the need to work much longer then they had anticipated before being able to retire. But for many the task will be a daunting one as the time to retirement grows short.

Impact on the Economy

An increase in consumer savings will lead to a reduction in consumer spending. Consumption as a percentage of our gross domestic product (GDP) has been rising for 15 years, and has recently been at its highest in history. As stated above, our national saving rate has been zero for some time now. When that reverses it will have a detrimental impact on the economy because it will cause a reduction in consumption, which accounts for approximately two-thirds of GDP.

Whenever workers decide to work longer, that decision, by a growing number of workers, will have the affect of increasing the supply of labor on the market. If demand for the services this labor pool provides does not increase it will lead to lower wages, which is deflationary. Some of this deflation will be off-set by the increased demand for labor providing geriatric services the Boomers will need as they age. However, that will be provided by a younger work force, composed largely of immigrant labor. In addition, the demand in real estate will be for geriatric care facilities to house the Boomers and lower-cost housing for the first generation of new immigrants who come here to provide the services the Boomers will be demanding.

We have already seen this with the downsizing of corporate America. In the 1990s skilled workers were being laid off. Then, after a year of unemployment, they accepted lower paying jobs. What happened here was what has been termed Creative Destruction, a concept introduced in 1942 by the economist Joseph Schumpeter, who described the process of transformation that accompanies radical innovation. In Schumpeter’s vision of capitalism, innovation driven by entrepreneurs is the force that sustains long-term economic growth, even as it destroys the value of established companies that enjoy some degree of monopoly power.

While Creative Destruction will always be present, our economy will also have to contend with the reality of a graying workforce and a slowing of GDP growth due to the increase in savings and a decrease in consumption.

The Good News

Not all is negative with this scenario. The weaker U.S. dollar will allow us to pay down our deficit more easily with devalued dollars. In addition, increased savings will stoke investment in stocks, bonds and other assets that promote economic growth. That will increase the value of stocks and reduce the yields on bonds and cash longer-term. Lower rates will start a new credit cycle and perhaps a new real estate boom. But all of this is many years away. For now, we have to keep our eye on potential global inflationary pressures and the so-called moral hazard being created by the Federal Reserve in their attempt to alleviate the subprime liquidity crisis. As I write this, Bear Stearns, Citibank and Merrill Lynch are writing off billions of dollars of bad debt because they let greed get in the way of sound business sense.

As your advisor, we want you to know that we take our responsibilities seriously and you can rest assured that your portfolios will be restructured in a timely way to take advantage of these trends in a considered and appropriate manner.

For now, just enjoy life and enjoy watching these trends unfold to the surprise of those unaware of the facts. By the time the turn of events becomes generally apparent it will be too late for most folks to capitalize on these developments. The proverbial horse will have already left the barn.

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