How Many Overvalued Homes Does It Take to Break the Economy?

A quick thought experiment: Let's suppose that on average an overvaluation of $100,000 was issued to sellers in the form of mortgages during the housing bubble. So when the housing market readjusts to a reasonable multiple of median income, $100,000 will have been lost.

How many houses makes up $1 trillion in lost money? Money that has already been issued to sellers? (i.e. some people got very rich)

The answer is 1x 10^12 divided by 1x10^5 = 1x10^7 or 10 million homes. When you consider the average house sheltering 4 people, that's 40 million people or 1/7th of the US population. Is it reasonable to say 14% of the U.S. got caught in $100,000 of overvaluation? Another way to put it is on average, if there are 70 million homes in the US, each one was overvalued by $14,000. Not a crazy amount.

Take this base amount of $1 trillion (an arbitrary number) and multiply by the illusory value of risk reduction in the form of packaged derivatives, and you have a potentially huge amount of money. Hence the IMF's declaration today that toxic debts could reach $4 trillion.

So the writing is on the wall and it's too ugly for anyone to point out the emperor's lack of clothes. The centers of the financial universe, large banks and other big players around the world, got caught holding tons of this crap when the game of musical chairs stopped. Huge swathes of money are owed which will never be repaid and this is going to wipe out individuals, towns, states and corporations.

People, like those who refinanced their home mortgages to fund buying another house, have lost amounts equivalent to 10+ years of savings from the drop in real estate values alone. With salaries not rising to match the cost of home ownership, one has to wonder who the people buying into these seller markets were expecting to buy the properties. Were they expecting large financial institutions (the only ones with access to the money required) to buy all these houses, which in effect they have?

Another way to think of it: if the price of your automobile had been skyrocketing each month, just now reaching $100,000 (and all this not due to limited supply) would you have sunk money into cars? It must be tempting, when your neighbor bought a 2002 Ford Focus last month at $30,000 and just sold it for $40,000.

But at some point you have to realize how insane the price is. The only option becomes to buy a horse instead and watch the world collapse around you. Probably too many people trusted that the powers that be would prevent the widespread fraud that went into the run up of housing prices.