Underwater House Values

I've seen several columns on Huffington saying that it is not your fault if you owe more on your house than it is worth, it is the fault of predatory banks who need regulating.

Let's go back several steps. Houses are durable. If you own a house, chances are, it will outlast you. What's more, the value of houses tends to go up faster than inflation. There are reasons for this. One is that the cost of new houses constantly rises due to rising labor costs. Another reason is competition for land. the old mantra: "Location! Location! Location!" is based on this. Growing cities and ones with legislation designed to slow or stop urban sprawl increase the competition for land and therefore prices.

Regardless, none of this constitutes a real bubble. That is when prices rise so fast that the price-rise starts becoming self-sustaining - people no longer care about the underlying item, they begin buying in order to profit from future price rises (think of flipping a house). Eventually the price increases become unsustainable and prices crash. Bubbles have been happening for centuries. In the 17th century in Holland, there was a tulip craze with the price for rare bulbs reaching astronomical heights. In the late 1990s, it was Beanie Babies. There is probably a bubble going on in gold prices right now.

The problem with the housing bubble is twofold. First, people can choose not to invest in Beanie Babies but they have to have someplace to live. The second problem is that the housing prices reached astronomical heights and the drop is more than many people can afford. Even though this was mainly limited to five states, it is still affecting the world economy.

But, back to the basic question - who is to blame?

Banks did a lot of things wrong but I have trouble assigning them primary blame. There are several reasons for this. A big one is that people paying inflated prices for houses should have known that they were paying too much. Let me give an example. Vancouver is in the middle of its own housing bubble. The price for modest houses is now over $1 million. Someone in Vancouver illustrated this by creating a quiz Crack Shack or Mansion? and its follow-up Crack Shack or Mansion II? None of these million-dollar mansions would be worth a fraction of that amount anywhere else. Eventually the prices on these over-priced houses will drop and pull down the value of all of the Vancouver properties.

So where should banks fit into this? Should they stop lending based on inflated prices? If so, who decides when a price becomes inflated? Keep in mind that this decision has its own costs. If banks stop accepting the appraised price on houses, that will hurt housing values all by itself, potentially cutting off all house sales.

One other factor is involved when looking at underwater house values - second mortgages. It is true that banks encouraged people to treat their house as a piggy bank and take out loans based on the increasing value. At the same time, the people who took them up on these loans acted as if they were getting something for nothing. that never works.