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The Great Home Equity Fallacy

August 27th, 2002

US Home Sales Surged in July, prompting statements like this:
“A continued solid gain in prices of existing homes — a proxy for housing wealth– suggests that rising home equity will continue to buffer any weakness in equity wealth and sustain household spending,” said Maury Harris, chief economist at UBS Warburg.”
Exactly, the same argument has been pushed by Alan Greenspan.
In economic terms this simply doesn’t stand up. As the name suggests, households live in houses. The services of the housing stock are consumed by households, and any increase in the value of housing for one household is a loss for others. The only way the household sector as a whole can gain from rising house prices is to sell to immigrants or for non-residential use.
It follows that a consumption boom based on rising home prices is, in the words of the Bible, a house built on sand.
(This argument needs to be qualified by the special features of the US mortgage market, discussed below. Arguably, it’s not households who are in trouble but the institutions who lend to them. But the boom is just as unsound either way).

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