HOW DO FALLING HOUSING PRICES AFFECT LOCAL BUDGETING? After almost doubling since 2000, home prices peaked in mid-2006, and then started to decline

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1 Carol W. Lewis and W. Bartley Hildreth, Budgeting: Politics and Power, 2nd ed. New York: Oxford University Press HOW DO FALLING HOUSING PRICES AFFECT LOCAL BUDGETING? After almost doubling since 2000, home prices peaked in mid-2006, and then started to decline (see figure 1). About 12 million or nearly one out of every six homeowners had negative equity (meaning that their mortgages were higher than the house was worth) by the close of 2008, the year that the Concise Oxford English Dictionary added subprime and credit crunch to its dictionary. (Double this number owned the home free and clear, without a mortgage.) Prices then stabilized but fell 4.7 percent in SOURCE: Council of Economic Advisors, 2012, p Figure 1. House Prices All told, more than $7 trillion was lost in housing wealth since The United States had never before suffered such a sharp drop in national house prices (Economic Report of the President, 2011, p. 33). The real decline is far larger than the decline during the Great

2 Carol W. Lewis and W. Bartley Hildreth, Budgeting: Politics and Power, 2nd ed. New York: Oxford University Press 2 Depression when general price levels also fell. The 2012 Economic Report of the President (p. 110) describes the effect of the decline in housing wealth on minority households: Shocks to housing wealth not only affect more households than other wealth shocks; they also apply disproportionately to those at the lower end of the wealth distribution. A Pew Research Center report issued in July 2011 provides a stark illustration of these trends, concentrating on the disparate effects of the burst housing bubble on the wealth of minority and white households. Because home equity accounts for a much greater share of household wealth among minorities 59 percent for African Americans and 65 percent for Hispanics in 2005, compared with 44 percent for whites minority households experienced much greater losses from the housing downturn. These losses were further compounded by the uneven geographic distribution of house price declines. As underscored by the Pew report, more than 40 percent of the nation s Hispanic households resided in the five states with the steepest price drops Arizona, California, Florida, Michigan and Nevada while only about one in five of all white and African American households resided in those states. For Hispanics in those five states, declining home prices have nearly wiped out household net worth, with median values collapsing from about $51,000 in 2005 to just $6,000 in Homeowners with mortgages more than the value of their house labeled as underwater could no longer use home-equity loans to bail them out of mounting credit card debt, and many faced the prospect of paying their mortgage and property taxes late or not at all. If they can neither make their payments nor refinance the loan, then they confront the likelihood of foreclosure. The 2008 Economic Report of the President (p. 54) defines foreclosure as a legal process in which a lender seeks recovery of collateral from a borrower (in the case of home mortgages, the home itself is the collateral), with several possible outcomes, including that the borrower sells the property or the lender repossesses the home. Foreclosure laws are based on the statutes of each [s]tate. Real estate foreclosures in the United States rose 75 percent in 2007, to an average rate of more than 1 percent of all households. By the end of 2008, almost three percent of all U.S. mortgages were in foreclosure, with Florida, California, and Nevada taking the lead (Heffley and Lenon, 2009, p. 9). In 2011, about 1.6 million properties were seriously delinquent, in foreclosure, or

3 Carol W. Lewis and W. Bartley Hildreth, Budgeting: Politics and Power, 2nd ed. New York: Oxford University Press 3 owned by lenders (Economic Report of the President, 2012, p. 51). Although mortgage rates in the United States hit historic lows in 2011, underwater mortgages usually cannot be refinanced. Figure 2 shows the geographic distribution of underwater mortgages across the country. SOURCE: Council of Economic Advisors, 2012, p Figure 2. Underwater Mortgages by State in 2011 Foreclosures affect local budgeting in several ways (see figure 3). The collection of local property taxes may be delayed while properties are tied up in foreclosure. Some properties may be abandoned and owed taxes accumulate. Although the taxes will be paid sometime in the future, the revenue is not available to support current programs and services. The result is that spending and services must be cut or taxes on other properties must be increased.

4 Carol W. Lewis and W. Bartley Hildreth, Budgeting: Politics and Power, 2nd ed. New York: Oxford University Press 4 Housing values fall in areas with many foreclosed properties. The result is a lower tax base to support the local government. Property taxes provide more than 70 percent of local governments revenue. Falling housing values reduce people s net worth and sense of financial well-being, which may affect charitable donations. The result is reduced revenues for local charities and nonprofit agencies. With a reduced tax base, governments may reduce subsidies to or service contracts with local nonprofit agencies. This puts further pressure on local charities and nonprofit agencies. Personal financial pressures may increase the demand for local services such as school medical and nutrition programs, shelters, food pantries, soup kitchens. Foreclosures put pressure on rental housing in the area; increased rents may push out lower-income residents, effectively exporting pressures to other communities. Figure 3. Foreclosures Affect Local Budgeting

5 Carol W. Lewis and W. Bartley Hildreth, Budgeting: Politics and Power, 2nd ed. New York: Oxford University Press 5 References Council of Economic Advisors, 2008, 2011, Economic Report of the President. Heffley, Dennis and MaryJane Lenon, Foreclosures and Falling Home Prices. ConnecticutEconomy 17, 1: 8 9. Web Site Resource See the Web site video, City of Boston, Ways & Means Committee, on the effect of the economic downturn on Boston s budget for FY 2009.