The American psyche gets a lot of credit for fueling the boom in U.S. home prices, which ended in 2006. As houses increased in value, homeowners felt richer, and they spent more. Similarly, falling house prices led to declines in consumer spending as households found themselves poorer and less able to access credit, according to a new paper, “Wealth Effects Revisited: 1975-2012,” by economists Karl Case, the late John Quigley and Robert Shiller.
In this interview, Case explains this “wealth effect.”
Q: Why were our spending decisions influenced by our psychology during the housing boom?
Case: The increase in house prices was like magic. They went from the 1950s until 2006 without ever falling nationally. The numbers are astonishing. If you look at the Federal Reserve’s Flow of Funds Accounts, the value of the owner-occupied housing stock in the United States increased from $14 trillion to $24 trillion. All of a sudden the collective balance sheet of U.S. households had $10 trillion worth of assets that it didn’t have before. That’s a very big number.
The first thing I asked myself is, How did I behave? I bought a house in Wellesley [Massachusetts] for $56,000 in 1976. When I sold it in 1991, it was a $240,000 asset. I know my behavior changed. I was in my 40s, and I found myself with a quarter million dollars that I didn’t know I had. It made me feel wealthier, and I spent more and saved less than I otherwise would have. Home equity loans and second mortgages made it possible for homeowners to withdraw their newly acquired equity to finance a higher level of spending and/or a new or bigger home.
Q: How do we decide we’re feeling richer?
Case: Household wealth is made of many things: houses, cars, and financial assets. The value of any asset, including housing, is determined by what people are willing to pay for it. What determines that? Our expectation of whether it will go up in the future. If you have a house I think is going to go up 10 percent per year, I’m willing to pay more for it than if I think it’s not going up at all. That’s how psychology drives the housing market.
In annual surveys for another paper, we asked 5,000 people going forward 10 years, what do you expect the average annual increase to be in the value of your house? They said 8-10-12 percent per year. They were feeling better because their house was worth more. That leads to more spending.
Q: Is it fair to say the housing market was one of the primary influences on the economy?
Case: Absolutely. Our finding has been very controversial. Some people say housing’s wealth effect doesn’t exist. Our own earlier work suggested that it works when the housing market is on the way up but not on the way down. We now have evidence that it works in both directions. …Learn More
Americans with college degrees are more likely to overuse their credit cards, home equity loans and other debts than are people who didn’t attend college, according to research in the latest International Journal of Consumer Studies.
“I was really expecting the reverse,” Sherman Hanna, a professor of consumer sciences at Ohio State University in Columbus, said about the results of his research, conducted in conjunction with Ewha Womans University in Seoul and the University of Georgia in Athens.
The study also reveals the increasing fragility of Americans’ finances, particularly in the run-up to the 2008 financial crisis when overall debt levels surged amid what Hanna called a “democratization of credit” that made it easier – critics said too easy – to borrow.
The percent of all U.S. households with monthly debt payments exceeding 40 percent of their pretax income rose from 18 percent in 1992 to 27 percent in 2007. (Consumers have slashed their debt during the recent recession.)
Based on education levels, Americans with a bachelor’s or graduate degree had more than a 32 percent likelihood of being heavily in debt. That compared with 24.5 percent for people who graduated from high school and did not attend college, according to the study, which tracked U.S. households from 1992 through 2007. To make their comparison, the researchers controlled for the effect of incomes.
The researchers designated households in their sample as being heavily in debt if their monthly loan payments and other debt obligations exceeded 40 percent of their pretax income. That is a high share of income to devote every month to paying off loans, rather than buying groceries, saving for retirement, or utilities…Learn More
Michael and Erin Gallagher are just 26 years old but have made a strong start financially, socking away $50,000 by maxing out their 401(k)s while honoring a $20,000 budget for their October 5 wedding in downstate Illinois.
Jennifer and John Lucido, both 32 years old, now have $250,000 in the bank and have built a 2,500-square-foot home near Detroit.
By comparison, the typical U.S. household had saved $42,000 for retirement in 2010, according to the Center for Retirement Research, which funds this blog.
Both couples are members of that rare species of 20-something super savers, spurning intense peer pressure to spend money on consumer items, go out for dinner a lot, and run up their credit cards. Neither couple got where they did the easy way either. They worked hard, but they were also quick to catch on to important lessons about being frugal and saving – from their parents or from each other.
“I have clients in their 30s and 40s who don’t even have $200,000 in their 401k,” said Naomi Myhaver, a financial planner at Baystate Financial Services in Worcester, Massachusetts.
An August article in The Journal of Consumer Affairs suggests one reason people like them are so hard to find. Young adults are extremely vulnerable to peer pressure to run up credit card debt so they can support a high lifestyle and social life.
In the study, 225 college students were asked questions such as whether they have “very strong” connections to their friends or “feel the need to spend as much as [friends] do on activities we do together.” College students have an average of 4.6 credit cards and $4,100 in debt… Learn More
Nearly half of people who have cell phones pay more than $100 per month for the service and 13 percent pay $200 or more, according to a survey by an online coupon company.
That doesn’t include the cost of the physical phone, the app and music downloads, the extra data plans. A certified public accounting organization in Oregon, Oregon Saves, estimates that the total cost for a two-year contract can easily reach $3,000.
And then there are the rogue teenagers who go over the monthly limits on minutes set by their parents’ cell plans – eventually, the parents relent and buy an unlimited data/text plan, which drives up their monthly charges permanently.
Wow, this habit is getting expensive.
The cell phone isn’t the only electronic habit that’s costing us. We also pay hundreds for cable TV, the Internet on our home computers, the land line. The automatic withdrawals for these services suck hundreds from our bank accounts each month – and we may not notice how much we’re spending since the transactions are electronic…Learn More
Americans have been paying down their high-interest credit cards like crazy. Once you do, financial advisers say, think hard about the best use of that spare cash.
With mortgage interest rates at historic lows – they’re scraping 3.5 percent on 30-year fixed loans and 2.8 percent for 15 years – paying extra on the mortgage should no longer be a priority. This simplifies what is a difficult decision for many of us: what’s next?
Saving for retirement and paying off student loans are now the top priorities, in that order, according to two financial advisers interviewed by Squared Away. But paying off the mortgage is a mistake that many people continue to make: mortgage debt outstanding has also declined in recent years, from $11.1 trillion in 2008 to $10 trillion currently, according to the Federal Reserve.
“Paying off a mortgage – I’m not a big fan of that,” said John Scherer of Trinity Financial planning near Madison, Wisconsin. He proposes that his clients funnel the extra money that had been used to pay credit cards into other personal finance “buckets.” …
Perhaps because our summer vacations are over and it’s time to increase our 401(k) contributions, Squared Away is on a jag about saving money.
Amitai Etzioni is one of the last old-school public intellectuals. He hasdone everything from writing 24 books to serving in the Carter White House and currently directs George Washington University’s Institute for Communitarian Policy Studies. But this video captures the wisdom of an 83-year-old man who taps deeply into the psychology of money in the 21st century.
Etzioni also wonders why, when he suggests his prescription to people, they “get angry with me.”
Since everyone is unique – and uniquely motivated – you may prefer a video that ran last week.
To support our blog, readers may also want to sign up for our e-alerts – just one per week – by clicking here. And there’s always Twitter!Learn More
Since the 1950s and 1960s, the number of cigarettes smoked in the United States has plummeted by one-half but the number of obese Americans has tripled.
So which megatrend has a greater impact on U.S. health and life expectancy? Remarkably, the winner is the positive effect of the decline in smoking. And the additional longevity, as fewer Americans light up, will continue to play out at least through 2040, according to new research.
“The advantages of smoking reductions are expected to outweigh the disadvantages of increases in obesity for both sexes,” according to findings by University of Pennsylvania sociologist Samuel Preston and his colleagues at UPenn’s Population Studies Center and at Emory University’s Department of Global Health.
The declining popularity of smoking has driven down deaths due to lung cancer to 18 percent of all U.S. deaths. But currently obesity is nearly running neck and neck, causing 16 percent of all deaths.
“We have a horse race going on,” said Christopher Ruhm of the University of Virginia’s Batten School of Leadership and Public Policy, who commented on Preston’s paper at the Retirement Research Consortium’s conference in Washington earlier this month. “The winner of the horse race is that the smoking effect is going to dominate.” (The Center for Retirement Research, which sponsors this blog, is a consortium member.)
Estimates of longevity, in this particular case, should be viewed with caution. The mortality impact isn’t easy to calculate, Ruhm and Preston said, because many conflicting things are going on at the same time. For example, although obesity is rising, cholesterol-lowering statins and blood pressure medications are reducing the risk that any individual will die from obesity. …Learn More