Calculating Housing Losses

The NYT today fronts a big state-of-the-meltdown story, keyed off Merrill Lynch's losses yesterday. It doesn't quite come out and say that we're going to have a recession (David Wessel does that, in the WSJ), but it doesn't shy from throwing around some really big numbers.

At this juncture, economists say the troubles in the mortgage market could, all told, cost financial firms and investors up to $400 billion.
That is far more than the roughly $240 billion cost, adjusted for inflation, of the savings and loan crisis of the early 1990s, according to estimates of the combined financial toll of that crisis on both the federal government and private sector. The loss in total real estate wealth is expected to range from $2 trillion to $4 trillion, depending on how far home prices fall, according to several economists.
That would be significantly less than the losses suffered by investors in the stock market collapse earlier this decade, which erased more than $7 trillion, or about 40 percent, of market value.

This is well-phrased, since there are losses, and there are losses. If a stock goes up and then goes down, you can talk, as the NYT does, of market value being "erased" – but the only people who actually lose money are those who buy high and sell low. Similarly, unless and until your house is sold in foreclosure proceedings, you haven't really lost money, you just have fluctuating equity in your house.

Which isn't to say that people don't monetize their equity in other ways: there was the famous "wealth effect" during the dot-com boom, when people spent more because they were wealthier because their stocks went up. And in the case of housing the link is even clearer: many people have bigger mortgages now than they did when they first bought their house, because they've been refinancing at higher valuations, using the proceeds for anything from paying down credit cards to going on vacation.

So some significant but unknown portion of the drop in real-estate values will end up causing real pain to people who spent equity they now don't have. But the $400 billion number is much more concrete. If you buy $10 million of a security at 100 cents on the dollar and you mark it to market daily and it's now only worth 50 cents on the dollar, you've lost $5 million, and that's a real loss of real money.

Of course, all these numbers are estimates, with enormous error bars attached. $400 billion? It could end up being half that, or double. And the real-estate numbers are fuzzier still: are we aggregating the drop in value of all properties which have dropped in value? How do you determine how much a property was worth at the peak of the market? And if all that new construction drops in value because it's not new any more, does that get included too? (McMansions have always dropped in value the minute somebody moves in, although that drop in value can be erased by more generalized house-price appreciation.)

Direct losses in the housing market are much smaller than the trillions of dollars of value being erased:

The Joint Economic Committee estimates that the lost of real estate wealth just from foreclosures on subprime loans will be about $71 billion.

But even so, it does seem as though cash losses in this meltdown might well exceed those during the dot-com bust, not that either number is really calculable.

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