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The Making And Unmaking Of The Bubble

Technology investor Glenn Hutchins had a useful essay in Fortune a few weeks back on the causes of the bubble. Some of the statistics he pulls together really help make things concrete:

From 1930 to 1997, U.S. house prices grew by .7% annually. From 1998 to 2006, they rose at an 8% clip. This was of course enabled by cheap mortgages of all stripes offered to less and less creditworthy borrowers. Much of this borrowing was used to subsidize consumption as homeowners extracted equity from their homes, driving mortgage equity withdrawals to over 10% of disposable income versus 3% a decade earlier and the equity content of the U.S. housing stock down from nearly 70% in 1965 to 43% - the lowest level since records have been kept. ...

In the past, mortgages typically had defaulted at around a 1% to 2% rate during good times and climbed to approximately 6% to 7% during recessions. Most bank balance sheets were constructed and stress-tested to withstand this. And that is almost precisely what happened in the prime conventional market: fixed rate mortgage defaults approached 2% and adjustable rate defaults grew to nearly 7%.

However, there was a new pest in the house - subprime mortgages - where default rates rose to levels never experienced or even contemplated. Subprime fixed rate mortgage defaults neared 10%, subprime adjustable rate defaults exceeded 25%, and option adjustable rate defaults approached 60%. ...

The decline in the prices of stocks and values of homes robbed American households of nearly $11 trillion in net worth - which equals the combined output of Germany, Japan and the U.K. - and perhaps $30 trillion globally. Since consumers usually spend about 5% of their net worth a year, the negative "wealth effect" likely caused them to reduce spending by about $550 billion domestically and perhaps $1.5 trillion globally. [emphasis added.]

That home equity figure is especially eye-popping given how much home prices were appreciating (which should have massively increased equity). Looks like people were cashing out their equity at an even faster pace than the bubble was creating it...

--Noam Scheiber