Band-Aid Solutions – Negative Equity for Homeowners

Posted by Puru Saxena

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BIG PICTURE – Lets face it, governments always try to ‘kick the can down the road’.  Rather than deal with economic issues in the here and now, they prefer to postpone the pain.  Unfortunately, in their attempt to avoid painful economic recessions, the policymakers sacrifice the purchasing power of their currencies and they end up creating even bigger troubles for the future. 

Look.  The ‘Great Recession’ in the developed world was brought about by excessive debt and consumption. In the boom years, millions of Americans borrowed copious amounts of money to buy real-estate; they used their homes as a source of funding (home equity withdrawals) and spent way beyond their means.  In those heady days, everyone was convinced that real-estate prices could not decline on a country wide basis.  Unsurprisingly, the bankers gladly supported this misconception by providing cheap fuel to the raging speculative fire.  The end result was that unworthy debtors were able to purchase several properties and real-estate prices appreciated considerably.

Unfortunately, when interest-rates went up and credit became scarce, the house of cards collapsed.  When boom turned to bust, millions of American homeowners were left with negative equity (Figure 1) and the entire banking system came to its knees.  When that happened, the American policymakers embarked on a fear-mongering campaign and they misled the public into believing that it was essential to save the banks.  During the depth of the financial crisis, we were repeatedly told that the ‘too big to fail’ banks had to be saved, or else the consequences would be dire.

Figure 1: American homeowners in negative equity

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