Tyler Cowen thinks about the business cycle:
No one made homeowners treat rising asset values to be the same in value as accumulated monetary savings. But many of them did. And the mechanism may be this: in private terms people treat accumulated money and rising asset values as the same. But in social and macroeconomic terms the implications of those two forms of savings are very different. In particular the social risk of saving through asset values is higher, given the correlation of market values and returns. Nor are their liquidity properties the same if everyone needs to "rush for the exits."
Insofar as you think people are tricked by "savings that aren't really there," asset values are the most likely the relevant mechanism. This idea has played a surprisingly small role in business cycle thinking over the last century, although it has been floating around since at least the 1930s.
Right now everyone in London is wondering if a real estate bubble is about to pop. Or does UK tax law, combined with greater international mobility, mean the new prices are more or less permanently high?
The UK may turn out to be a very special case. Its real estate values are largely driven by London, which has a huge fraction of the population in and around it. So far London, like New York, has resisted price declines; analysts in both places think that this may be because international demand is supporting the market.
I'm still pondering the savings question, which has certainly been folk wisdom among journalists and some analysts, but as far as I know, has never been rigorously tested. Do people in places where the bubble didn't reach, like the rust belt cities, save more than their counterparts in bubblier territory?
Living in the rural midwest, I pay much less for my mortgage than people in many places pay for their property taxes.
My net worth by age is much higher than the mean, but I wonder if I'm getting ahead or merely holding even since my home's value has not increased meaningfully relative to my net worth.
On the other hand, my wife was able to take several years off work after the birth of our son, and I doubt that would have been possible with a huge mortgage payment.
In response to your question, my guess would be that since rising home prices are a kind of passive savings, people who live where property values are stagnant have to consciously decide "I'm going to put the money that I would put into my house if I lived in California into stocks," and most people don't do that.
If they do, though, perhaps they're getting the better end of the deal.
Hi -
The effects that savings has on consumption - the wealth effect - is fairly well documented.
This development is interesting, and shows the danger of believing that buying a house is an investment: it isn't, it's speculation, as long as you live there. An investment generates a cash flow, buying a house doesn't, unless you rent it out (and no one does the internal bookkeeping) and have purchased it for that commercial reason.
What people were doing was foolhardy at best: it's like buying stocks (again, speculation!) and then spending their "profits" without actually having sold the stock.
Of course, the financial "experts" who made this possible really took advantage of this foolhardiness.
Megan, there was certainly enough "HELOC now!" and similar crap coming out of the banks that I wouldn't even say "no one made homeowners treat rising asset values to be the same in value as accumulated monetary savings." The bloody financial system for years certainly kept shoving that equation down people's throats until it all turned pear-shaped.
"Who, me, officer? Nah, I'm just a drug pusher, you can't blame ME if people buy the stuff...."
It's hard to discern the difference between net worth generated by asset appreciation and net worth generated by income savings invested in such assets. Whether my house or stocks appreciate $1, or I save $1 and invest it in a house or stocks, I still end up with $1 savings that is exposed to equity or home value swings.
[N.B. the earnings capacity that affords the $1 of savings is of course more valuable than $1 of savings or the $1 of appreciation.)
London, like NYC or San Francisco, has an international demand component that will support higher prices, but that is no guaranty of constant appreciation. The UK practice of short reset uncapped floating rate mortgage debt does give the BoE a bigger hammer for adjusting consumer behavior, though.
It's hard to discern the difference between net worth generated by asset appreciation and net worth generated by income savings invested in such assets. Whether my house or stocks appreciate $1, or I save $1 and invest it in a house or stocks, I still end up with $1 savings that is exposed to equity or home value swings.
[N.B. the earnings capacity that affords the $1 of savings is of course more valuable than $1 of savings or the $1 of appreciation.)
London, like NYC or San Francisco, has an international demand component that will support higher prices, but that is no guaranty of constant appreciation. The UK practice of short reset uncapped floating rate mortgage debt does give the BoE a bigger hammer for adjusting consumer behavior, though.
"the social risk of saving through asset values is higher, given the correlation of market values and returns"
This assumes relatively low inflation, right? In a situation of high inflation, "accumulated money" becomes more risky, doesn't it?
In fact financial folks did afford many homeowners an opportunity to treat their home asset accumulation as the equivalent of accumulated savings.
They did so by developing very cost-efficient methods of refinancing mortgages,methods that had not been available to people prior to the 70s. The second TDs, beloved in California as ways of helping to finance houses, became in the home equity loan a way to cash out. Then refinancing of mortgages became easier and one didn't even need to go the home equity loan route. Since there was little impact from a tax perspective in using the accumulated equity, it was an obvious choice.
Prior to the new technologies of refinancing, homeowners with equity accumulation had very little way of getting at it without an outright sale. Mortgages didn't allow prepayment in most cases,so people were locked in until the sale.