On September 3, 2001, a little more than a week before the attention of the United States would be justifiably diverted from domestic issues to fighting terrorism, Forbes Magazine's Stephane Fitch wrote a fascinating article titled, "What if Housing Crashed?"

Looking back to this time in 2001, there are a few important things that frame the country's mood just prior to the terrorist attacks. George Bush had been elected the prior year defeating Vice-President Al Gore in one of the closest presidential elections in history (as you likely remember, Gore actually won the popular vote while Bush ultimately won Florida and carried the critical electoral vote).

When the Bush team took office, they were dealing with an economy that had just been through the "dot-com" bubble, where high-tech and Internet stocks were laughably valued at insane prices despite their inability to generate anything near a profit. The bursting of this financial bubble after a decade of growth had helped put the economy in recession. 

The recession was attacked on two fronts. First, the Federal Reserve lowered interest rates - the standard response when there is a slowdown in economic growth along with no sign of inflation. Second, Republicans in Congress joined with the Bush White House on a series of "temporary" tax cuts designed stimulate investment in the economy. While the stock market sputtered along, Fitch noted that housing prices were rising dramatically and that this was having an impact on the economy. In the lead to the story,

If you need proof of the housing boom, just walk out onto your driveway. Pick up the newspaper and read about how this vibrant sector is propping up an otherwise teetering economy. Carpenters are busy. Home equity lending is supporting a lot of consumption. Those For Sale signs your neighbors are putting up could be just big spenders wanting to cash in on the wild appreciation homeowners have enjoyed in the past six years--40% in Atlanta, 54% in New York City, 68% in Boston, 71% in Denver and 100% in San Francisco, says research firm Case Shiller Weiss in Cambridge, Mass. 

Even before the 9/11 attacks, the concern at the time was that the recovery was fragile and that a real estate correction would be very damaging to the overall economy. More so than even the dot-com bust. Fitch quoted in 2001 from Yale economist Robert Shiller:

Shiller--famed for his astute calling of the Nasdaq stock bubble in his 2000 book, Irrational Exuberance, but a long-time scholar of the real estate markets--believes consumer confidence could take a bigger hit from a real estate crash than from the stock market correction. It was the boom in housing, he argues, more than the Nasdaq's 175% runup in the 18 months leading up to March 2000, that made consumers feel so flush and spend so freely. Go back as far as 1975 and compare ebbs and flows in retail spending in all 50 U.S. states and 15 foreign countries, and it is clear housing markets directly affect consumer spending, while stock market fluctuations don't, he says.

An excellent graphic was included with the article that related home prices to layoffs. At the time, unemployment was rising. Unemployment hit 5% in September of 2001, up from 3.9% to begin the year. If unemployment continued to rise, it seemed likely that housing prices would drop and the recession would be deeper and more prolonged.

Shiller relates these statistics and is quoted making the case for a crash in real estate.

Shiller worries about an ominous mix of overdevelopment, inflated home prices and rising consumer debt. Add two other factors that historically have presaged a big drop in home prices--the plunge in stocks and massive layoffs, (see chart)--and the case for a crash gets stronger. It won't happen right away. It takes a while for people to let go of optimism--not to mention an emotional attachment to their home--and embrace economic reality. "They're in denial until they take a direct hit," says Barton Smith, an economist at the University of Houston. 

Looking back, we came out of the recession - to a degree - with the mix of low interest rates and tax cuts, both of which continue to this day. It appears now in retrospect that the low interest rates - along with some creative financial packaging to bundle risk along with government subsidies and supports to maintain housing prices - did in fact create a real estate bubble. Not only, but that bubble allowed homeowners to make up for stagnating incomes with increasing debt. 

In the first quarter of 2001 half of all households that refinanced incurred debt at least 5% larger than the original loan. That cash is helping to finance things like sport utilities and big-screen TVs. Great for the consumer economy, but a potential calamity if housing values drop or even plateau. 

This is not simply a gratuitous trip down memory lane. While we have seen a fall off in housing prices, we have yet to see a "crash". Is this because we are now in recovery, or is this because - as Barton Smith was quoted above - "it takes a while for people to let go of optimism and embrace economic reality." Do we all just want to believe that our homes are worth what we believe (hope) they are worth. As long as we don't have to sell, we can go on believing.

"They are in denial until they take a direct hit."

How likely is a crash today? Consider this graphic from the NY Times published back in 2006. Our same Yale economist Shiller, before the housing crisis, showing how home values (indexed to inflation) were at historic highs.

The answer to this question is of utmost importance to America's towns and neighborhoods. The current land use model we have in this country relies on rising debt and new growth to sustain towns (see the Strong Towns explanation on the Mechanisms of Growth). An unemployment-fueled housing crash will not only devastate the consumer economy, it will ravage the finances of our towns, many which are already hanging on by a thread waiting for new growth to carry them through. As Finch wrote in the 2001 article, "a potential calamity if housing prices drop or even plateau."

Remember, this was all written in 2001 when "high" unemployment topped 5%. With today's unemployment looking to stay over 10% for some time (reportedly over 17% if you count those no longer eligible for being included in the unemployment rate), we should be asking some serious questions of ourselves.

America's towns need to adopt a Strong Town model for their future growth and development. Whether or not we see dramatic declines in housing values, we are not going to "recover" from this recession but transform to some new state of equilibrium. Those communities that adopt a growth strategy that first and foremost seeks to maximize the return on existing infrastructure investments will be the ones best-positioned to capture prosperity in the coming decades.


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