Boom, Bust, Boomers

Housing Boom, Housing Bust, and the Boomers
Dated September 2008, a paper published by the Center for Retirement Research at Boston College examines "The Housing Bubble and Retirement Security."

The general conclusion for "older households" is that about a third of them will suffer from the housing bubble through less secure retirements.

The authors tracked the decisions by homeowners (across all age groups) during the housing boom years (2001-2006), and found that close to 40% had some kind of "mortgage activity," meaning refinancing or extracting home equity.

Among those with activity, about a third spent the money on home improvements, about a third repaid other debts or made new purchases, and about a third made an investment in the stock market or real estate or a business.

Based on age in 2004, the age group 50 - 62 saw the greatest housing gains between 2001 and 2006. This age group also led in extracting home equity and then led in consuming (paying other debts or making new purchases). At least according to the formula in this paper, the near-retirement group who extracted home equity have lower net worth after the housing bubble.

The paper (which opens as a PDF file) includes easy-to-understand charts that illustrate the impact of the housing bust on age groups. It also explains the predictable human response to a housing boom: housing gains promote spending.


Below are some excerpts from this Boston College study, and the address to read the entire report is http://crr.bc.edu/images/stories/Briefs/ib_8-12.pdf if you wish:

The Impact of Rising House Prices

...At first glance, one would expect the housing bubble to have had an enormous impact on the net worth of households...

...First, housing is the major asset for most households in the United States. Measuring assets very broadly to include the present discounted value of benefits from Social Security and defined benefit pensions, housing accounts for more than 20 percent of total assets for the typical household approaching retirement (age 55-64) Excluding the two benefit streams, the house accounts for half of the typical household’s property and financial wealth...

...If the housing boom caused more people to increase their borrowing, the question remains whether they invested those proceeds or spent them on consumption. A number of studies suggest a strong positive relationship between swings in the value of houses and aggregate consumption.

Thus, the evidence suggests that the housing boom caused people to increase their borrowing, to extract equity from their homes, and to raise their level of consumption. The following section moves from aggregate data to individual households to sort out what happened and the characteristics of the players...

Rising House Prices and the Extraction of Housing Equity

...What types of households were extracting equity?...These effects were as follows:
...Households that experienced large gains in their house value relative to their income had a higher probability of taking cash out. The intuition is simply that households tap their gains only after they become a meaningful amount...

...Households that had a large liability on the other side of their balance sheet were less likely to extract equity, suggesting that households may sense that they are not as rich as their house appreciation suggests... Homeowners with children were more likely to extract, possibly to pay education and other expenses.

Conclusion

Households responded to the extraordinary growth of house prices by increasing their debt exposure. In the aggregate, households extracted 18.8 cents and consumed 6.4 cents out of every dollar of increased home values. In dollar terms, the overall result of the housing boom was an increase of mortgage debt of about $1.2 trillion and increased consumption of $410 billion.

Housing booms are good things for consumers because they can extract equity without hurting their balance sheet. But when housing booms are followed by housing busts, many households will have borrowed against gains that they may never realize. Hence, housing "bubbles" can damage balance sheets.

Households who extracted equity behaved in a predictable fashion. They were more likely to extract equity if they enjoyed large gains on their house, had children under 18 at home, and were credit constrained.

They were less likely to do so if they were risk averse (not comfortable with financial markets), college educated, or nonwhite... About a third of the extracted equity was used for consumption.

The increase in mortgage debt exposure has affected the retirement preparedness of households. For the typical household aged 50-62 in 2004, the extraction of home equity during the housing boom resulted in a 14 percent decline in net worth... between 2001 and 2008.

If the extraction of home equity continued to be concentrated among the 30 percent of older households who extracted equity during 2001-2004, the decline in net worth would be much larger for the affected group. For older households, the housing boom provided some liquidity. But a significant proportion of those entering retirement today – and perhaps over the next several years – will have a fragile balance sheet in a time of depressed home prices and poor financial market returns.