Creative Destruction: Too Far for Mortgages?

An Austrian economist, Josef Schumpeter, coined the term “Creative Destruction” in 1942, describing the process of capitalism which drives out the old to bring in the new.

This “incessant” drive for Better, Faster, Cheaper came at the expense of the incumbent industries and their workers. He pointed to Henry Ford’s assembly line as an example.

Silicon Valley Venture Capitalists have latched on to Creative Destruction, celebrating one technology transformation after another. These advances seem to arrive at ever-increasing velocity, but investors should be careful what they wish for, as the innovations often come with highly-destructive aftershocks.

Creative Destruction has paved the way for one of the world’s richest companies, Amazon, which exemplifies the phenomena as it has exploited technologies such as the Internet, AI, voice and robotics. The result: destroyed businesses, starting with bookstores large and small. Amazon can do this because it requires only one third the workforce per dollar of revenues versus its brick-and-mortar competitors.

Five years ago, at the end of the jobless recovery, a handful of experts were forecasting the elimination of up to half of the workforce both here in the United States as well as around the world. So far that has not happened. Unemployment has ticked down to a 50-year low of 3.5%. There has been a steady erosion of the Middle Class however, with low wage service jobs, such as home healthcare aides, becoming more numerous, while higher wage manufacturing jobs have shrunk to a 7% share.  

Implications for the Mortgage Industry

Creative Destruction impacts the mortgage industry in at least two ways:  First, it makes borrowers much more vulnerable, particularly in their ability to sustain a steady income. Second, property values become far more volatile, especially when exposed to Black Swan events. 

As jobs become obsolete, people will as well.

This will shorten careers as young people entering the market already have trouble getting a good job and displaced workers over 50 have a demonstrated problem finding them.  Some observers have gushed over the prospect that we will all have six different careers over our working lives, but who would truly welcome that, particularly if it pits an out-of-work 50-something coming down from a higher income versus a tech-savvy 25 year-old anxious to get a career started.  The problem for mortgage finance is to underwrite a projected income stream that is now based on an assumption that the borrower will enjoy one career for the rest of her life.

Creative Destruction Radically Distorts Property Values

A recent McKinsey report projects that 60% of job growth over the next decade will occur in just 25 cities and their peripheries across the country where the new economy thrives. In part due to the prominence of their technology driven universities, cities like Boston do well even as the companies which power their growth come and go. Thirty years ago, the Boston area dominated the mini-computer era through brilliant companies like Digital Equipment Corp. (DEC) and Wang, but has adroitly moved on to robotics, biotech and artificial intelligence. Like San Francisco, New York and other winners, Boston is choked with traffic and sky-high property values, meaning the best and brightest college graduates must cram into tiny apartments to get a foothold in the knowledge economy.

This defies logic given that the internet permits most of us to work from anywhere and that, in theory, jobs and capital should flow to areas that are declining in people and capital. A brief scan of Zillow shows dozens of four-bedroom houses in Youngstown, Ohio that are still in foreclosure or could be had for $30,000, while the median house price in San Francisco is $1,300,000. The next recession will undoubtedly pop bubble prices in the megacities, but will also grind down the communities at risk, resulting in even more abandoned homes.

Bill Kelvie

Bill Kelvie has had a long and varied technology career as a programmer, strategist, CIO of Fannie Mae, and CEO and founder of Overture Technologies. He currently is an advisor to technology start-ups and publishes a blog on technology disruption at AWWEW.com