Thursday, October 25, 2007

Up to $4 Trillion Decline in U.S. Household Real Estate Value Predicted

by Calculated Risk on 10/25/2007 01:41:00 PM

Update: Dean Baker says maybe up to$8 Trillion. (hat tip Lindsey)

Last week, in the comments, I noted that some economists were predicting financial losses of $100 Billion from the mortgage crisis. I joked that maybe they dropped a zero - and I also noted that that estimate didn't include the $2 Trillion or more that will be lost in U.S. household net worth.

The NY Times had an article this morning that provided new estimates for these losses: Reports Suggest Broader Losses From Mortgages.

Note: Tanta excerpted part of the same NY Times article this morning on Foreclosure Predictions.

The article includes these projections of financial and household losses:

... economists say the troubles in the mortgage market could, all told, cost financial firms and investors up to $400 billion.

That is far more than the roughly $240 billion cost, adjusted for inflation, of the savings and loan crisis of the early 1990s, according to estimates of the combined financial toll of that crisis on both the federal government and private sector. The loss in total real estate wealth is expected to range from $2 trillion to $4 trillion, depending on how far home prices fall, according to several economists.
These unnamed economists didn't add a zero - yet - to the earlier projections, but they are getting closer!

Let's look at these projected U.S. household real estate losses. Currently (end of Q2) U.S. household real estate was valued at $20.997 Trillion (Fed: Flow of Funds report). So a $2 Trillion dollar loss is about a 10% decline in total U.S. household real estate value. A $4 Trillion dollar loss is a 20% decline.

Real U.S. Household Real EstateClick on graph for larger image.

This graph shows the real (inflation adjusted using CPI less Shelter) value of U.S. household real estate since 1952. The real value increases because new homes are built each year, older homes are improved, and, in general, the value of land increases (especially in dense areas) faster than the rate of inflation.

Even adjusted for inflation, the value of U.S. household real estate increased sharply in recent years.

Nominal U.S. Household Real Estate
The second graph shows the nominal value (not adjusted for inflation) of U.S. household real estate. This is useful because the $2 Trillion to $4 Trillion in potential losses described in the article are nominal values.

Just to put these numbers into perspective, I've plotted the two declines - $2 Trillion and $4 Trillion - assuming the price declines happen between now and the beginning of 2010. Note that this doesn't add in any new homes or home improvement.

A decline of this magnitude in U.S. household real estate value seems very possible.