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America has always allocated its resources according to the so-called market mechanism—if the price of oil goes up, people start building more oil rigs. And if more computer programmers are needed in Silicon Valley, the "price" of programmers goes up, motivating more college students to study computer science and more programmers to move from New York to San Francisco. But in the wake of our country's subprime meltdown, many are questioning the market's magical ability to allocate capital—we've got too many suburban tract homes and not enough R & D labs and bridge upgrades. Looking to the future, there may not be much capital to be allocated at all: With credit scarce, aspiring Googles and eBays will have a lot more trouble scratching together the funds to open shop.
And now it turns out that the current crisis might also undermine the efficient redeployment of human resources. A well-timed recent study by economists Fernando Ferreira, Joseph Gyourko, and Joseph Tracy finds that homeowners who have "negative equity" in their homes—that is, a mortgage that exceeds its resale value—are 50 percent less likely to move than those who can afford to pay off their mortgages with a home sale. Given where the housing market is headed, millions of workers may be locked in place in the years to come, throwing yet more sand into the gears of America's market economy. A great job opportunity in Charlotte, N.C., isn't worth much to you if you can't (or won't) sell your house in Tampa, Fla.
There are both financial and psychological explanations for why having an outsized mortgage on a relatively modest home reduces mobility. First, if you owe more on your house than you'll earn by selling it, you may not have the cash on hand to close the deal, let alone put a down payment on a new home. Higher interest rates will have a similar effect, pushing the cost of a new mortgage out of a potential homebuyer's reach. And if your mortgage is "underwater," odds are you'd be selling your home at a loss, a psychologically painful prospect to contemplate (what behavioral economists appropriately refer to as loss aversion). Rather than absorb that loss, people who bought at the market's peak tend to set high asking prices and, as a result, are forced to sit much longer on unsold homes or hold off on selling entirely, clinging to the hope that real-estate markets will recover.
Of course, these factors can be offset by the forced relocation that comes with default and foreclosure—when an owner is unable or unwilling to continue making mortgage payments, whether to move is no longer a matter of choice.
As a result of these counteracting forces—the "positive" impact of foreclosure or the negative effect of loss aversion and financial constraints—the overall impact of negative equity on mobility is a matter for the housing data to decide. The researchers use data from the American Housing Survey, a biennial survey of homeowners in metropolitan areas across the United States that has been conducted since 1985, with results available through 2005. Respondents were asked for the value of their mortgages and to estimate the current resale value of their homes—if the first of these was the bigger number, then the researchers classified the unfortunate owner as having a negative equity stake in his home. And since the surveyors returned to the same homes year after year, it's easy to figure out when houses have changed hands.
Earlier housing booms and busts may seem like mere blips compared to the current crisis. But the authors were able to identify many local real-estate ups and downs over the two decades when the survey was conducted. For example, a Californian who bought a $250,000 home in 1989 could expect to get only around $200,000 if he put it on the market eight years later. Buyers in other volatile markets like Boston and the oil cities of the South saw similar fluctuations.
The authors calculate that every two years, about 12 percent of home-owning Americans moved. But for those with negative equity—about 2.6 percent of respondents during the 1985-2005 period of study—the probability of moving is cut nearly in half.
What does this tell us about the current crisis? The authors are appropriately circumspect about extrapolating their findings to the current mortgage meltdown. The magnitude of our housing problems is unprecedented: Given the free and easy credit flowing into the housing market in recent years, many buyers purchased their homes with minimal down payments. Even a modest decline in home values—say, one that brings them back to their 2002 levels—will push many homes purchased at the peak into negative equity. Also, buyers with outsized mortgages in the past were less likely to resemble the high-risk borrowers that the subprime mortgage market brought to home ownership. This new class of borrowers may be much less able to soldier on, making payments on houses that they could never afford in the first place. As a result, we've already seen a lot more people slip into default and foreclosure—nearly 91,000 of them in August 2008 alone. So there will soon be a lot more workers on the move, whether they like it or not.
But forcing people from homes they'd like to keep may not be any better for the efficient functioning of labor markets than locking in homeowners who would like to move. Foreclosed workers may be uprooted from jobs in which they're happy and productive in their desperate scramble to find a place to live (which, in turn, may not be in a place that offers particularly attractive employment prospects). The dream of American homeownership may yet turn into even more of a nightmare for the efficient workings of the free market.