NYT tackles the “wealth effect”, finds that Las Vegas and Orlando are underwater

From the NYT piece Gloom Grips Consumers, and It May Be Home Prices:

In Orlando, a city that trades in upbeat fantasies, the housing crash has been particularly painful. The total value of area homes has fallen below the total mortgage debt on those homes, according to the real estate analytics firm CoreLogic. In the parlance of the real estate world, Orlando is underwater, a distinction matched by Las Vegas.

“I don’t know that it’s going to get better. We just have to get used to it,” said Sherry DeWeese, whose home in Ocoee, a northwestern suburb of Orlando, is worth less than she paid for it 13 years ago — and about a third of its value at the peak of the market. “It was nothing to buy whatever we wanted. Now we just think about what we really need.”

For the U.S. as a whole, the ratio of total mortgage debt to property value is about 70%, which means that Orlando at 100.2% and Las Vegas at 119.2% are certainly outliers. But the NYT article focusing on Orlando still seems relevant for any area hit hard by the decline in home prices. (By the way, four other Florida cities are among the worst ten major metros in the U.S.: Fort Lauderdale, Tampa, Jacksonville, and Miami.)

From the piece:

A 2007 review of existing research by the Congressional Budget Office reported that people reduce spending by $20 to $70 a year for every $1,000 decline in the value of their home.

This “wealth effect” is significantly larger for changes in home equity than in the value of other investments, such as stocks, apparently because people regard changes in housing prices as more likely to endure.

A recent paper by Karl E. Case, an economics professor at Wellesley College, and two co-authors estimated the decline in home prices from 2005 to 2009 caused consumer spending to be $240 billion lower in 2010 than it otherwise would have been. That figure is equal to about 1.7 percent of annual economic activity, enough to be the difference between the mediocre recent growth and healthy growth.

While the Times treats the wealth effect as something that is only now understood, economists have been studying it for a long long time, as discussed here.

But even if the Times is a little late in talking about how declines in overall wealth affect spending, the analysis today seems pretty good.