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Has the Housing Bubble Created a Wealth Illusion?
February 2005
By: ChartingTheEconomy.Com
A previous ChartingTheEconomy.Com report “The Housing Market – Are We Blowing a Bubble?” concludes that a housing
bubble is forming. It also concludes that the bubble may continue to grow, burst, or just deflate and that the future of the
housing bubble primarily depends on interest rate movements. This paper is a follow up to that report and will investigate
whether the housing bubble has created a wealth illusion in the United States.
In order to make the case for the creation of a wealth illusion, wealth in the U.S. since 1999 is analyzed. First, all numbers
are presented on a per household basis to personalize the issue. Second, a baseline is set by showing mean household net
worth and how it has trended. Third, equity in household real estate is separated from all other equity to show how each has
changed since 1999. Through this analysis it is clear that equity in household real estate has been the only contributor to
wealth creation in the U.S. since 1999. It is also clear that without equity in household real estate on average we are much
less wealthy than in 1999 when adjusted for inflation. Because of this, it is concluded that we are ill prepared if there is a
sudden drop in equity in household real estate. So, if you believe that there is a housing bubble let’s hope it doesn’t burst.
Household Net Worth
The best measure of wealth is a net worth calculation (a personal balance sheet). It is as simple as adding up your assets
and subtracting your liabilities. What’s left is your net worth or wealth. 1
Let’s take a look at overall household net worth in the United States over the past several years. Essentially, household net
worth has remained almost flat from 1999 through the third quarter of 2004. So, the first conclusion is fairly straight forward.
Americans on average are only slightly wealthier now than in 1999. Chart #1 shows the overall trend in household net worth
during this period.
Household Equity in Household Real Estate
However, to fully understand the effect that real estate has had on household net worth in the U.S. since 1999 let’s dissect
the data from the above chart. First, let’s take a look at mean household equity in household real estate and how it has
changed over this period. For this, let’s turn to Chart #2.
Chart#2 clearly shows that real estate has bucked the overall trend in wealth creation in the U.S. during the past several
years. In fact, the average household equity in household real estate has increase nearly 45% since 1999. It should be
pointed out that the asset gains from household real estate would be even greater except for the enormous amount of cash
out refinancing, second mortgages and home equity lines of credit that have been taken out between 1999 and 2004.
According to Freddie Mac’s 4th Quarter Cash-Out Refi Report the total home equity cashed out for all prime conventional
loans was $543 billion over this period. When you add in second mortgages and home equity lines of credit the number
grows to $843 billion. 2 What have homeowners been doing with this money? Chart #3 shows the use of liquefied funds
from 2001 and 2002 refinancing.
By using Chart #3 we can better understand how cash out refinancing has affected household equity in household real
estate. Basically, the overall affect (among other things) has been to reduce equity in household real estate and to increase
equity in other assets. Using the $843 billion number that represents cash out refinancing, second mortgages and home
equity lines of credit between 1999 and 2004 and applying the percentages from Chart #3 across the entire period, we can
make some pretty good assumptions.
First, if we assume all liquefied funds used for home improvements and real estate/business investments were put back into
household real estate, then 55% was taken out. This represents almost $4100 per household. 3 This means that the actual
gains in household equity in household real estate shown in Chart #2 would have been larger absent the cash out craze of
the past several years. Second, most of the remaining funds that were liquefied were used to reduce other liabilities, make
financial investments, or purchase durable goods. Much of these went to increase household equity in other assets –
basically the numbers shown in Charts #4 and #5, below. It is difficult to precisely estimate the dollar value of this equity
because some of the consumer expenditures were not on items that created wealth, and because it is difficult to know how
the financial investments performed. Based just on the numbers for repayment of other debts and the dollars put into
financial investments, the amount is about $2750 per household. 4 Suffice it to say the cash out of household real estate
equity since 1999 represents a large shift in equity assets held by households. The significance there is that the increase in
equity in household real estate is accountable for even more of the wealth creation in the U.S. since 1999 than the numbers
show.
Household Net Worth Less Equity in Household Real Estate
Let’s turn to Chart #4. It shows mean household net worth without equity in household real estate. Without equity gains from
household real estate, mean household net worth in the U.S. was actually down from 1999 through the third quarter of 2004.
While we have made real gains in wealth in the past couple of years because of the turn around in the U.S. stock market,
these gains have not been enough to offset the losses from 1999 – 2002.
Inflation Adjusted Net Worth
Chart #5 shows Mean household net worth less equity in household real estate from 1999 through the third quarter of 2004
adjusted for inflation. This chart drives home the point that without the recent gains in real estate equity U.S. households are
not wealthier than in 1999, especially when adjusted for inflation.
So what does this mean? On a per household basis we are only slightly wealthier now than we where in 1999. When you
subtract out equity in household real estate we are actually less wealthy than in 1999 (at least as of the end of the third
quarter of 2004). In short, household real estate has been accountable for the majority of wealth creation in the U.S. since
1999.
Conclusion
So, is the wealth created by real estate an illusion or not? That comes down to what side of the housing bubble debate you
are on. What is clear is that without the gains in household real estate equity during the past several years, there would
have been no wealth creation. This just adds to the danger of the housing bubble. Essentially, we have not been creating
other wealth to go along with the increase in real estate equity. Therefore, if the housing bubble bursts, then we have not
created other wealth to fall back on. Remember, when you account for inflation the picture is even worse. Adjusted for
inflation the mean household net worth in the U.S. from 1999 through the 3rd quarter of 2004 is down substantially. It should
also be noted that median household net worth in the U.S. is far less than the mean. In 2000 median household net worth
was $55,000. 5 Accordingly, most households don’t have as big of a nest egg as the mean household net worth numbers
suggest.
The purpose of this paper is to personalize the housing bubble by showing its effect on wealth creation in the U.S. over the
past several years. It is also intended to show the effects on net worth if the equity in household real estate was to evaporate
in a burst of the housing bubble.
So again, has the housing bubble created a wealth illusion? It does seem that many Americans feel wealthier because of the
large increases in home equity in recent years. However, it is difficult to gauge how people feel about their wealth. The most
obvious way to demonstrate that we feel wealthier because of increases in home equity is by measuring how much equity
many Americans have pulled out of their homes in recent years. As we have seen in this paper, the numbers are enormous.
Most people will not use their homes as a piggybank unless they are feeling pretty good about your wealth (or if they are very
desperate – it doesn’t appear that many people fall into this category). Based on this, it is safe to say that most of us are
feeling wealthier these days because of the soaring prices of our homes.
Maybe the easiest way to decide if the housing bubble has created a wealth illusion is this way. If the housing bubble is an
illusion, then the wealth creation is real. However, if the housing bubble is real, then the wealth creation of the past several
years is an illusion. You decide for yourself.
Sources:
Chart #1: Federal Reserve Flow of Funds report table B.100 Balance Sheet of Households and Nonprofit Organizations.
Data for 2004 is through the third quarter. Data on number of households is from the U.S. Census Bureau and 2004 is
estimated based off prior data.
Chart #2: Same sources as Chart #1. Total number of households in the United States is used to calculate the mean
household equity in household real estate (not just owner occupied units).
Chart #3: Data is from Federal Reserve Board’s report Mortgage Refinancing in 2001 and Early 2002 by Glenn Canner,
Karen Dynan, and Wayne Passmore with research assistance by Jennifer Attrep and Gillian Burgess.
Chart #4: Same as Chart #1.
Chart #5: Same as Chart #1. To adjust for inflation consumer price index data from the Bureau of Labor Statistics is used.
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Endnotes:
1 Data on household net worth is from The Federal Reserve Flow of Funds report table B.100 Balance Sheet of Households
and Nonprofit Organizations. The Fed’s Flow of Funds report includes data on nonprofits so the household numbers may be
off slightly (but not materially). The Flow of Funds report is widely used as a reference for household net worth.
2 Freddie Mac estimated the total 2004 data.
3 The number of households for 2004 is estimated based off U.S. Census Bureau data for prior years.
4 This number uses the 2001 and 2002 percentages for use of liquefied funds from refinancing and applies these
percentages across the entire period from 1999 to 2004.
5 Note that in this report we use mean household net worth to show wealth trends since 1999 because data to show trends
based on the mean is more readily available. Mean household net worth is much higher than median household net worth
because of the high concentration of wealth in a very few super wealthy households. According to a March 2003 report by
the U.S. Census Bureau Net Worth and Asset Ownership of Households: 1998 and 2000 by Shawna Orzechowski and Peter
Sepielli the median household net worth in 2000 was $55,000.
