Imagine that your home is now worth $40,000 less than what you paid for it just two years ago. In fact, the value is now less than what you owe on your mortgage, a condition referred to as being “underwater.” To make matters worse, your landscaping business- which was raking in the dough during the housing boom- went bust when the credit crisis hit and you've been looking for a job for the last six months while burning through your savings.
Then, out of the blue, you get a call from an old buddy who says the company he works for has an opening for someone who knows how to install irrigation pipe. The income isn’t close to what you were making, but that’s not the big issue. The real problem is that the job is on the other side of the country. Do you:
A) Stay put and hope you land a job where you currently live
B) Give your home to the bank and relocate for the job?
This dilemma has real- and expensive- implications for government policy.
You can see in the graphs below that the financial crisis, largely caused by mortgages being approved for individuals who were marginally qualified, spread like a virus. As it became increasingly apparently that millions of homeowners were not able to afford their mortgage payments, default rates rose sharply and housing prices collapsed.
In just three years, the conditions exploded. In 2007, only six states had more than 5% of homes underwater. By 2009, almost every state had 5% of its homes underwater. However, “17 states had more than 20%, and a staggering 12 states had more than 40%” of homes underwater, according to Senior Research Economist Yuliya Demyanyk at the Federal Reserve Bank of Cleveland. To put this another way, by the end of 2009, nearly 1 in 3 American households had “negative or near-negative equity in their homes.”
Five states had the dubious distinction of holding the largest concentration of underwater mortgages. Nevada topped the list with a whopping 70% of homes having negative equity followed by Arizona at 51%, then Florida (48%), Michigan (40%) and California (35%).
Then, so-called “experts” began to notice something interesting. “Mobility,” a measure of how many people move into and out of a state, had been declining for two decades. However, according to The Washington Post, by the end of the first quarter of 2009, America was experiencing “a labor stagnation not seen in half a century.” People had virtually stopped moving for work. The Post reported that “policymakers are increasingly worried that the slowdown is not just a symptom of the nation's economic struggles but also a barrier to overcoming them.” The story quoted Assistant Treasury Secretary Alan Krueger as saying, “In the past, people tended to move to where the jobs are. Now it is necessary to have more of a strategy to move the jobs -- and create new jobs -- in areas where the people are."
Coincidentally, many states with the highest levels of underwater homes also had some of the lowest rates of mobility and the highest rates of unemployment.
The convenient conclusion was that if unemployed individuals have an underwater mortgage, they will be reluctant to move in order to accept a new job because they would lose money on the home. This theory was even given a catchy name: The Lock-In Effect.
The Lock-In Effect was the excuse politicians had been looking for on why the national unemployment rate was so high: It’s because people who can’t afford their mortgages (which greedy bankers should never have given them to begin with!) don’t want to walk away from their homes.
If you buy into this line of thinking, then the real cause of persistently-high unemployment is not tax increases, mandatory health insurance and other policies that discourage business expansion, it’s the collapse in real estate prices.
The obvious solution? Focus federal money and/or policies on states hit the hardest by the real estate bubble. Create programs to convince lenders that it’s in their best interest to reduce what borrowers own on their mortgage so they are less reluctant to sell. This will make people more likely to move elsewhere for a job and- voila!- reduce the unemployment rate.
It’s exactly what President Obama proposed a year before the 2012 election. In an Oct. 24, 2011 column The Washington Times reported:
“The administration announced new rules with the Federal Housing Finance Agency, the regulator for Fannie Mae and Freddie Mac, to make it easier for borrowers to obtain cheaper loans even if they have little to no equity in their homes…The initiative announced Monday by Mr. Obama is at least the 10th housing-relief program that the administration has introduced in the past three years, none of which has made much impact on the beleaguered market. Mr. Obama promoted the changes in mortgage rules in Nevada, the state with the nation’s higher foreclosure and unemployment rates and a political ‘swing state’ that has backed the winning candidate in the past eight presidential elections.”
In fact, the connection between underwater mortgages, mobility and stubbornly high unemployment doesn’t exist. The Lock-In Effect is a myth.
Ironically, the truth was produced, not by the private sector, but by the federal government itself. In the just-released report, “Keeping the House or Moving for a Job,” a research team led by Demyanyk at the Federal Reserve Bank of Cleveland found that:
“…if an unemployed homeowner with negative equity is able to find a job in another [area], he or she is highly likely to accept this job because the net benefit of moving (getting a higher income minus paying the cost of selling the house) outweighs the benefit of staying put, remaining unemployed, and keeping an underwater mortgage.”
The key phrase in the above quote is “if an unemployed homeowner with negative equity is able to find a job.” While the real estate bubble burst put a lot of people out of work- carpenters, roofers, realtors, mortgage brokers, and others working in jobs related to the housing market- it is not the reason unemployment has remained so high in so many other sectors of the economy. The jobs are not there! Perhaps if we directed policies and energy into creating a more business-friendly economic environment, “mobility” would pick up. In the meantime, we need to stop using the decline in home prices as an excuse. Or, as Demyanyk’s team puts it:
“We conclude that negative equity does not limit job-related mobility and, hence, is not a major reason for elevated aggregate unemployment in the United States.”