Will Inflation Bail Out Underwater Homeowners?


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Zillow just came out with their third quarter estimate of home values and according to their “Zestimates” about 1/3 of Chicago single family homes are underwater on their mortgages. A few caveats about this data. As I mention, it’s only for single family homes, which are a smaller part of the total housing market in Chicago. In addition, their conclusion is based upon their Zestimates, which are notoriously innacurate. However, in the aggregate they may not be so bad because they are based upon a statistical analysis of aggregate data.

I guess the myth that real estate is a great investment was busted long ago – 5 – 20 X leverage cuts both ways, doesn’t it? However, the magnitude of these numbers highlights the problem that Chicago homeowners are having right now. Their equity has been wiped out or worse. What this means is that more short sales and foreclosures are coming and many people are stuck in their homes because they don’t have the equity to put down on their next home. This latter issue simultaneously cuts the supply of homes for sale (the ones they currently live in) and the demand for homes (the ones they want to live in). And if one third of homeowners are underwater then a far larger percentage have so little equity as to make it impossible for them to move to the next place.

So I can’t help but wonder if the Federal Reserve’s easy money policy, also known as quantitative easing or QE2, isn’t intentionally targeted to bail out these homeowners. Presumably the purpose of this policy is to get the economy back on track by forcing interest rates even lower. However, interest rates are already pretty low and don’t seem to be doing much good. Whether or not the goal of the Federal Reserve is to create inflation that is certainly the outcome – or at least it’s resulting in the expectation of inflation. By every possible measure the financial markets are expecting pretty high inflation. Just look at what’s happened to the prices of commodities – agricultural and metals – and the prices of TIPS (treasury inflation protected securities) and the value of the dollar. See the price of gold below.

gold prices

Inflation, which pushes down the value of the dollar, helps homeowners by raising the value of their homes and, in the long run, their incomes. Of course the price of everything else rises as well and inflation ends up being an insidious transfer of wealth from lenders and savers to borrowers and spenders. Borrowers can essentially pay back their debts with cheaper dollars.

Is this what the government is really trying to do?

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