Where Did The Money In The Housing Market Go?

In Depth

Your questions answered on:

A green plastic Monopoly house sits on a $100 bill.

When home prices fell, did the money disappear? Jessica Goldstein/NPR hide caption

itoggle caption Jessica Goldstein/NPR

In the suddenly topsy-turvy economy, sometimes the simplest questions are the hardest to answer. Like this one: When the housing bubble burst, where did all the money go?

A listener to NPR's Planet Money wrote in with a brainteaser about the housing bubble that I'm still thinking about. I decided to ask a couple of people to help me act it out. I started with one person who doesn't know a lot about the housing bubble — NPR reporter Laura Sullivan — and one who does — Russ Roberts, an economist at George Mason University.

To solve the puzzle of where the money goes, we first need a house, in this case a thumbnail-size one from a Monopoly game. "It's lovely, too," Sullivan says. "A nice shade of green. I'll take that house." She got the house.

Next, we need some money — but not toy money. I arrive with a small stack of $100 bills. "I'll have that, if you don't mind," Roberts says. He gets $200.

So that Roberts and I will be even, I take $200, too. Remember, Sullivan has the house.

Let's imagine that we're at the peak of the housing bubble. Sullivan bought the house years ago, for a cheap price — just $100. Now she turns around and sells it for $200, to Roberts.

"Here you go," Roberts says. "I'm looking forward to living in it."

Now imagine that a couple more years go by. Roberts watches his neighbors sell their houses for $300, $350, $400. Then the housing bubble pops. Sales stagnate. Prices fall.

"And I have to move, it turns out," Roberts says. Bad market or no, Roberts puts his house up for sale.

"Oh, I'll buy it from you, Russ," I say. "But I am just going give you $100 for it. I know you bought it for $200."

"But I was expecting $400," he says.

Never mind his expectations. This is a very realistic re-enactment of the housing bubble. He stalls. "Let me wait for a little while till the market comes back," he pleads. "So I wait, and it doesn't come back. So the best I can do is $100? All right, I'll take it."

"OK, give me my plastic house," I tell him, ignoring his pitch about the lovely formica landscaping.

I've got my house, for $100. The only question is where the money went.

I'm holding a $100 bill. Sullivan has $200. And Roberts got a $100 bill. We shouldn't be surprised — no money disappeared from the room. The bills just shifted hands. The house still exists.

But if this were all that had happened in the global economy, we would not have had a crisis. The problem, of course, is the house. It's worth less. Even though a house is not money, per se, many were turned into money. Roberts, for instance, assumed his little green house was going to double in value.

"I may have even acted as if I had the extra $200," he says. "I may have taken out a home equity loan, I might've bought a new car based on that. And then all of a sudden, that profit, that wealth never materialized. It did sort of disappear."

The financial world was particularly vulnerable to the drop in housing prices because of something that doesn't show up in our little game. That something is a factor economists call "leverage." Remember, we borrow money to buy houses. Lenders count on us to pay off our mortgages. The property serves as collateral, to back up the loan. When the bubble burst, that property was suddenly worth less than the amount of the loan — the backup failed.

But why can't we all just go back to believing the houses are worth more? Wouldn't that actually increase their value?

Roberts, the economist in the group, is skeptical. "Isn't that how we got into this problem to start with?" he asks. "We all kind of pretended these prices were going to go up and up and up. And that encouraged a whole set of behavior that turned out to be dysfunctional.

"You know, it's a funny thing," he continues. "When the bubble pops, everybody says, 'Where did the money go?' ... It didn't come from anywhere other than the belief that [prices were] going to keep going up. And when that belief didn't turn out to be true, the prices came down to their original level. So in that sense, there was no harm done. The problem was a lot of people made bets along the way. And when those bets didn't pay out, the ramifications of all that money not getting paid out like it was promised to be turned out to be very destructive."

Still, there were some people along the way who profited. In the end, I think of it like this: Where did the money go? It was borrowed from some rosy future that never came. And now we have to pay it back.

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