The collapse of the housing bubble will likely wipe away most -- if not all -- of the wealth families have accumulated over the last two decades, according to a new report from the Center for Economic and Policy Research.
While younger households stand to lose more, the economic-policy group found that Baby Boomers approaching retirement will feel worse effects, since they have less time to accumulate additional wealth or change spending and savings patterns. As a result, tens of millions of Americans may be almost entirely dependent on Social Security and Medicare in their golden years.
The group projects that most families' wealth will drop to 1989 levels, if not lower. Even if home prices stay flat through 2009, the median household headed by someone between the ages of 45 and 54 will have 25% less wealth than their counterparts five years ago. If prices fall 10%, those households will have 35% less wealth.
"This extraordinary destruction of wealth will have tremendous implications for millions of families," says CEPR economist and co-founder Dean Baker. "Coupled with a very low personal savings rate, this means that many people, especially those near retirement, will only have Social Security and Medicare to rely on once they leave the work force."
Americans saved about 8% of disposable income during the four decades before the 1990s. The rate started to plummet as consumers expected a continued stream of wealth from stock investments toward the end of that decade. At the same time, Americans were also facing stagnant wages while taking on more credit-card debt.
Once the stock bubble dissipated, home values soon began to climb, based on expectations that wealth from yet another non-cash asset would support certain lifestyles and behaviors.
Families would have no simple way to distinguish bubble-generated wealth, which would prove ephemeral, from real wealth, which could be expected to endure," says the report. "As a result, tens of millions of families likely ended up saving less than they would have considered prudent, had they recognized that their wealth was temporarily inflated."
Since the peak of the housing market in mid-2006, more than $4 trillion worth of housing wealth -- or over $50,000 per family -- has evaporated. Real home prices are still dropping at a rate of about 2%, or $350 billion, per month.
This bursting bubble promises to be much worse than the recession caused by the stock-market decline at the start of the decade, according to Baker, simply because homeownership is much more common than stock ownership, even when factoring in 401(k)s and mutual funds.
This economic cycle is "likely to be a much worse downturn than what we saw in '01 and '02," Baker adds.
The rate of homeownership increases with age, and Baker believes that proposals to cut Social Security benefits for near-retirees or current retirees will not come to pass simply because those consumers will have nowhere else to turn for financial support. Those who are looking to retire from 2025 onward have more room to strengthen their finances and adjust expectations for government aid.
The economist notes that in past generations, his parents and grandparents would have purchased a home in anticipation of paying off the mortgage in full. In recent years, it was common to refinance homes or take out debt on home equity that no longer exists.
"People took a very big hit," he says. "The problem is, coming off both bubbles, people were not saving. They had changed their behavior because they had thought all this money would be there, and then it wasn't."
Now that many have lived through two "ephemeral" bubbles, Baker expects that younger generations will develop better saving habits. He advises older consumers to cut back, save more and adjust expectations for a tough road ahead. He says it's "foolish" to hold onto a home believing that prices will escalate again, if there's a need to downsize, upgrade or simply relocate.
"The most important thing is to think realistically," he says. "It's foolish for people to hold out thinking the prices are going to come back. That would just be compounding the harm to their financial situations and their lives."