There is another video on the Big Subprime Mess making its way around the personal finance blogosphere. It doesn’t really compare to the now legendary Crisis of Credit Visualized, and in fact most of what it has to do with subprime mortgages is that it is called “Subprime”. But it has appeared on (at least) two blogs, Clever Dude and MoneyNing.
So let’s make that three blogs.
It’s a clever bit of animation. But it’s not exactly a cogent argument that, in the words of MoneyNing “sums up what everyone was doing during the last decade but it also brings up a good point – When is enough really enough?”
People like to explain history, particularly recent history, as cautionary tales with a moral. And the popular explanation of what went wrong in the housing bubble appears to be that lots of folks bought great big McMansions that they could not afford. For their sin of pride they, and almost everybody else, were punished.
Although I don’t like seeing economic events as morality plays, that explanation is not far from the truth. But there is one meaningful modification I would like to make. Although lots of people spent more on a house than they could afford, the problem was not that those houses were inappropriately giant and luxurious. They weren’t, or at least typically weren’t. By and large, people got in trouble buying the same old normally-sized houses that they had always lived in. They just paid way too much for them.
As I’ve said before, just about the only really useful index of house prices is the Case-Shiller Home Price Index. According to that index, house prices, after adjusting for inflation, went up 86% between 1996 and 2005. And it is important to keep in mind that that index does not include any new construction. It is an index of existing house sales only. (Case and Shiller have nothing against new houses. The way the index works is to measure the change in the price of a house from one sale to the next. There’s no way to include a house that has sold for the first time in the index.)
Of course a lot of new houses were built, many of them large and ugly. But that was in reaction to the run up in prices for houses in general, not a cause of it.
What happened in the ten years of the housing price run-up was a garden variety speculative bubble. Increasingly, people bought houses not just to live in them, but to later sell them at a profit. Bubbles happen when buyers/investors start to ignore the fundamental value of assets and believe in the Bigger Fool Theory. (Whatever you pay for it, there’s a bigger fool out there who will pay more later on.) Once you decide that houses will go up 10% a year, there is no such thing as spending too much for a house. The more you spend, the richer you will get.
Inevitably, the bubble burst, as they always do. We all know the rest. But it is important to remember the nature of the greed that got us all into this trouble. It wasn’t that people bought mansions. They bought ordinary houses. Houses that ought to have sold for $200,000 but were purchased for $350,000 on the theory that they would soon be worth $400,000.