Smaller economy

There was a good documentary on CNBC last night called "House of Cards" that spelled out how the flow of credit led to the housing bubble. Of course the biggest issue in the whole process was the simple fact that the frenzy allowed people who normally would never qualify for a mortgage to get extremely large ones and encouraged people to pursue excessive life styles using the growth in housing prices.

Since the whole system was dependant on home prices rising ad infinitum, when they did stop going up, the bubble crashed. We have been seeing the aftermath of that for the last couple of years.

Now as far as housing prices go, the correction in prices is either over, or almost over in most parts of the country. This is obviously debatable, but one of the things driving average prices down is the re-establishment of the spread between the high end of the market and the low end. The initial crisis impacted to low end of the market dramatically. Now of course, in some states such as California, the low end of the market has valuations that are higher than the high end of the market elsewhere, but still, the first houses impacted were generally the low end of the market. This crash in prices increased the spread between entry level housing and higher levels of the market.

Now even as the real estate bottoms have started to stabilize, we are going to have a period where the higher end of the market will have to adjust down. I don't expect this to be as catastrophic as the price drops in the low end, but it will continue to feed the impression that housing is in trouble. Many of these houses are owned by people who don't necessarily have to sell. Also, in many cases they still have significant equity in these houses, so even when they sell at values lower than the peak, they are still ahead of the original basis.

What continues to be the most problematic aspect of the housing problem is the fact that so much of our economy was based on people spending paper wealth. I've shown statistics previously where the amount of discretionary income available has not changed dramatically. Now even if a larger percentage of this amount was diverted into savings, you would only have a small economic contraction. However, consumer spending in the bubble years was tremendously supplemented by housing wealth and that spending is simply not coming back anytime soon. That is why we need to adjust to an economy that has to be viable at about 85% of the prior levels.

This will lead to unemployment higher than it used to be, but not necessarily at an unsustainable level. We do have a chance to help the economy dramatically by investing heavily in the renewable energy area.