Since the first quarter of 2006, the value of home equity has fallen from $13.5 trillion to $6.2 trillion, a 54% decline.

All of this has had a profound impact on the economic environment, investment environment and even the psychological outlook of Americans.

Since the start of the recession in December 2007, construction employment nationwide has fallen by 1.9 million jobs, or 30% of the 6.6 million jobs lost. This from a sector that even at its peak only ever accounted for 5.7% of U.S. jobs. However, even this understates the impact of the housing slump on employment, as it ignores the ancillary industries that have been impacted by the decline in housing, along with all the employment effects caused by the impact of a collapse in housing market wealth, confidence and the stock market.

Since the middle of 2006, home building has fallen from 5.9% of nominal GDP to just 2.2%.

Falling home prices have also had a profound impact on consumer confidence. Statistical work over the last decade suggests that a 10% change in year-over year average existing home prices tends to move the consumer sentiment index by approximately 6.4 index points in the same direction, even after accounting for feed-though effects of housing on the stock market and employment. For reference, the consumer sentiment index was at a level of 57.5 in early October 2011, almost 30 points lower than its average level of the last 40 years.

Perhaps most important, declining home prices have undermined the confidence of both lenders and borrowers, impeding any healthy recovery in housing and restraining a rebound elsewhere within the economy.

Measures Of Value
While no one should understate the pain and destruction caused by the bursting of the housing bubble, it has had one undeniable effect: Across a wide range of measures, it has left the United States with its cheapest housing market in decades.

One of the simplest measures is just to look at home prices relative to average household income. The chart below shows the relationship between average, per-household personal income1 and home prices over the years. Since 1966, the median price of an existing single family home in the U.S. has varied between 150% and 251% of personal income per household. However, roughly three-quarters of the time it has been in a relatively narrow band between 185% and 230%. In September 2011, the ratio was just 153%, implying that to get back to an average price to income ratio, home prices would have to rise by about 27%.


However, price is only part of the story. Economic malaise, bond market complacency and the active intervention of the Federal Reserve have reduced mortgage rates to their lowest level in modern history. During the week of October 7, Freddie Mac reported that mortgage rates had fallen to an average annual level of 3.94%. Assuming the use of a fixed rate mortgage with 20% down, this would make the median mortgage payment on a single family existing home just 6.9% of per household personal income, compared with an average of 14.4% since 1966. This is not to imply that home prices would have to double to get to "normal" levels - any revival in housing will likely push mortgage rates higher along with home prices. However, it does emphasize the potential long-term financial gain for those who buy much-cheaper-than average housing while also locking in much-cheaper-than-average long-term financing.


A third way to look at home valuations is to look at the cost of renting versus the cost of owning. Since the late 1980s, as part of the Current Population Survey2, the Census Bureau has asked the owners of vacant properties whether they are trying to rent or sell the property and, depending on that answer, what they are asking for rent or asking as a sale price for the property. Assuming a 20% down payment and prevailing 30-year mortgage rates, this allows us to calculate the monthly mortgage payment necessary to buy the median vacant home and compare it to the cost of renting the median house or apartment. As shown in the bottom chart to the right, from the start of 1988 to the start of 2005, these two numbers tracked each other very closely, with the implied median mortgage payment just 5% higher than median rent. However, in 2005 the housing market began to soar and by mid 2007, the implied median mortgage payment was about 50% higher than the asking rent. Then housing began its long swoon, and by the third quarter of this year, we estimate that the implied median mortgage payment had fallen to just 78% of the median asking rent. In other words, at current mortgage rates, home prices would have to rise by 35% just to get back to their average relationship to rents.