Historical Home Equity Percentages Since 1945
Home Equity Week - Article 1 - June 2009
There was a fundamentally justifiable reason why housing in the United States was perceived to be a safe asset class and house prices did not decline nationally for more than 60 years. The chart below illustrates a central financial underpinning for this historical low risk and price stability.
In 1945 housing as an asset class was conservatively capitalized with 84% home equity. This minimal use of leverage combined with the practical value of housing as a source of shelter contributed to its relative price stability for subsequent decades.
Increasing Leverage
Starting in 1945 Home Equity began to steadily decline.
Increasing leverage partially explains steadily rising prices during this period. The greater the percentage of leverage used, the more buyers could afford to pay for a house.
By 1995, the year of the Housing Bubble’s inception, home equity had declined to represent only 58.2% of total housing value. This 26% increase had dramatic implications for the housing market.
The higher the percentage of debt that is layered on an asset, the riskier that asset or asset class becomes. Increased leverage inevitably leads to higher volatility and a greater potential for price collapse.
The Bubble
When asset values are supported by high leverage, rapidly rising prices become possible financed through the use of increasing debt. This is what happened during the Housing Bubble.
The Collapse
A shrinking percentage of equity in the capital structure of an asset also creates the possibility of rapid price declines due to:
• Financial distress amongst owners who become unable to service the cost of leverage
• Panicked selling by overleveraged owners
• The expectation amongst potential buyers and lenders that prices will decline in the future
• Tightening credit conditions
• An increased cost of borrowing
This is the scenario we are presently enjoying.
Dismal Reality
An understanding of the centrality of Home Equity to housing stability provides an important perspective on the cause of the Housing Bubble/Collapse and expectations about the future.
The Home Equity conditions which contributed to 60 years of price stability, steady appreciation and low risk have evaporated. Regardless of the duration of our current economic downturn, housing as an asset class will continue to behave like a speculative, highly leveraged investment until Home Equity levels are restored to the historical norms consistent with price stability.
Tuesday’s Home Equity Week "HEW" Article: A Focus on Home Equity Since the Housing Bubble’s Inception
Wednesday's HEW Article: The Impact of Falling Prices on Housing Bubble Home Equity
Thursday's HEW Article: Could the Net Home Equity Value of the Entire U.S. Housing Stock Fall to Zero?
Weekend HEW Article: What Needs to Happen to Owner’s Home Equity for Housing to Stabilize Before 2014
There was a fundamentally justifiable reason why housing in the United States was perceived to be a safe asset class and house prices did not decline nationally for more than 60 years. The chart below illustrates a central financial underpinning for this historical low risk and price stability.
In 1945 housing as an asset class was conservatively capitalized with 84% home equity. This minimal use of leverage combined with the practical value of housing as a source of shelter contributed to its relative price stability for subsequent decades.
Increasing Leverage
Starting in 1945 Home Equity began to steadily decline.
Increasing leverage partially explains steadily rising prices during this period. The greater the percentage of leverage used, the more buyers could afford to pay for a house.
By 1995, the year of the Housing Bubble’s inception, home equity had declined to represent only 58.2% of total housing value. This 26% increase had dramatic implications for the housing market.
The higher the percentage of debt that is layered on an asset, the riskier that asset or asset class becomes. Increased leverage inevitably leads to higher volatility and a greater potential for price collapse.
The Bubble
When asset values are supported by high leverage, rapidly rising prices become possible financed through the use of increasing debt. This is what happened during the Housing Bubble.
The Collapse
A shrinking percentage of equity in the capital structure of an asset also creates the possibility of rapid price declines due to:
• Financial distress amongst owners who become unable to service the cost of leverage
• Panicked selling by overleveraged owners
• The expectation amongst potential buyers and lenders that prices will decline in the future
• Tightening credit conditions
• An increased cost of borrowing
This is the scenario we are presently enjoying.
Dismal Reality
An understanding of the centrality of Home Equity to housing stability provides an important perspective on the cause of the Housing Bubble/Collapse and expectations about the future.
The Home Equity conditions which contributed to 60 years of price stability, steady appreciation and low risk have evaporated. Regardless of the duration of our current economic downturn, housing as an asset class will continue to behave like a speculative, highly leveraged investment until Home Equity levels are restored to the historical norms consistent with price stability.
Tuesday’s Home Equity Week "HEW" Article: A Focus on Home Equity Since the Housing Bubble’s Inception
Wednesday's HEW Article: The Impact of Falling Prices on Housing Bubble Home Equity
Thursday's HEW Article: Could the Net Home Equity Value of the Entire U.S. Housing Stock Fall to Zero?
Weekend HEW Article: What Needs to Happen to Owner’s Home Equity for Housing to Stabilize Before 2014
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