Housing wealth effect, Baker, Goldfarb and Waldmann
by Robert Waldmann
Everything is possible and I think that Dean Baker just lost a debate with a Washington Post reporter.
Post reporter Zachary A. Goldfarb wrote
The two economists compared what happened in U.S. counties where people had amassed huge debts with those where people had borrowed little. It had long been thought that when property values declined in value, homeowners would spend less because they would feel less wealthy.
But Mian and Sufi’s research showed something more specific and powerful at work: People who owed huge debts when their home values declined cut back dramatically on buying cars, appliances, furniture and groceries. The more they owed, the less they spent. People with little debt hardly slowed spending at all.
among other things. The link is his.
Dean Baker wrote
The housing wealth effect is one of the oldest and most widely accepted concepts in economics. It is generally estimated people spend between 5 and 7 cents each year per dollar of housing wealth. This means that the collapse of the bubble would be expected to cost the economy between $400 billion and $560 billion in annual demand.
among other things Again the link is his.
Baker’s main point is that low consumption by underwater home owners is not a plausible explanation of the sluggish recovery. However, he also confidently asserts that the housing wealth effect is linear based on “google it”. I think that he has decided that new empirical research is irrelevant, because he already knew how economies work.
My comment below the fold.
In the comment I define your disagreement with post reporter Zachary A. Goldfarb as a disagreement about whether reduced but still positive home equity causes a reduction of consumption on the order of between 5 and 7 cents each year per dollar of housing wealth or on the order of zero.
That is, I won’t address you valid points that the recovery of consumption was roughly normal while the recovery of house construction was not.
Notably Goldfarb cites empirical estimates based on micro data. He claims there is a significant change in the slope of the home equity effect on consumption at home equity equals zero. To say he is wrong, you must convince me that the 5 to 7 % estimate is valid for a sample containing only homeowners with positive equity.
An estimate with aggregate data just does not address the claim in the article which you criticize.
Notably, in this case the Washington Post cites specific research by named economists. You, in contrast, cite what all macroeconomists know.
I am shocked to find that I call this one for The Washington Post. Your conclusion may be correct, but your reasoning is based on the assumption that all functions are linear. I don’t like to be square, but that’s not true.
cross posted with Robert’s Stochastic thoughts
well, Robert, i cant go toe to toe with you or Dean on the studies, but i tend to agree with his premise, that stressed or underwater homeowners arent the reason for reduced demand…my evidence is totally anecdotal…
last week, the MBA released its Mortgage Delinquency and Foreclosure Report for the 3rd quarter; it showed the unadjusted mortgage delinquency rate for the quarter was at 7.64% in the 3rd quarter, .29% higher than the 7.35% delinquency rate in the 2nd quarter…some of that is seasonal, as delinquency rates tend to fall in the spring, & rise near christmas, as people postpone paying on their homes in order to shop…in addition, 4.07% were in foreclosure, and hence not even thinking about paying on their homes…
the QoQ jump can be explained by isolating september mortgage data, which can be done with the LPS Mortgage Monitor (pdf); it showed that the nation’s mortgage delinquency rate suddenly spiked 7.7% over August’s numbers, and no explanation for the surge was given…but the coincidence the MBA & LPS didnt notice was the 1.1% MoM increase in retail sales in september, driven by a seasonally adjusted 4.5% MoM increase in purchases of appliance & electronics…that strongly suggests that many of the buyers of the new iphone5 skipped their mortgage payment that month in order to buy the latest gadget…
Dean has a response:
The Housing Wealth Effect Estimate Are Based Almost Exclusively on Homes with Positive Equity
written by Dean, November 23, 2012 11:30
Robert,
I gave a link to the google scholar pages for “housing wealth effect.” There are many dozen articles that give estimates of the size of the housing wealth effect. Almost all of these estimates would be based almost entirely on people with positive equity in their homes because in times prior to the collapse of the bubble, almost no one had negative equity in their homes. Pick an article, there’s a range of estimates, but I don’t think you’ll find any where the estimates for the wealth effect are zero or anything close to it.
Oh crap how did Baker find out about my post. I did say “link his” and did extra work so the clickable link was still clickable after my cut and paste.
I figured out his point about how historical estimates must be based on people with positive equity on my own, but didn’t update my post.
Oooops.
it seems to me that Arne (Dean?) is right.
in any case i would not expect a “linear” or “nonlinear” relationship. i would expect that some households respond to the wealth effect, and some do not. During unusual time the proportions, or selection, is likely to change.
robert
maybe i am not thinking clearly here, but if “people with little debt hardly slowed spending at all” that seems to suggest that “positive equity” does not explain the lack of wealth effect.
presumably the value of the houses of those with positive equity has gone down… just not enough to create negative equity. the wealth effect would predict that they would slow their spending. since this part of the sample is “based on people with positive equity” it should not, by prediction, be any different from “historical data.”
which would make me suspect… not at all sure… that the historical data on wealth effect is actually measuring the effect on spending of those whose equity is at least close to the positive-negative divide.
Robert,
Dean’s response is one I cut and paste from his blog wherein he responded to your comment there. Perhaps I goofed, but it seemed a pertinent update.
Arne,
I would observe that Dean’s main point is that changing behaviour of only underwater mortgagees is not enough to explain the gap and so he gives more numbers.
Deans use of the wealth effect is an aggregate. Mian and Sufi’s analysis digs deeper, but does not cover the entire range of home equity (or disequity), so they do not necessarily conflict anyway.
I do find that “People with little debt hardly slowed spending at all” is too vague to actually be wrong, but should have more scrutiny. An owner who just found out he equity is only $50K not $100K is less likely to remodel the kitchen.
Related: why the dot-com crash didn’t wreak the havoc of the housing crash, even though the raw-dollar effect was about the same: when an asset is posted as loan collateral, a decline in its value creates a greater decline in the asset holder’s spending power.
I know, they call that leverage, but fwiw…
Steve people with disposable wealth (they thought) from paper gains on tech stocks maybe, kinda, didn’t totally overlap with people drawing on HELOCs to buy stuff for their house (or it’s accouterments which they might have thought of as the same thing).
I know that figures on whiteboards argue that stocks and flows fluidly stock whether those dollar signs relate to bottom lines on 401k statements and not being able to make payments on your mortgage. Then again last I heard you still have the houseboat in Seattle and I am homeless in Berkeley. Then again you picked up the tab for drinks and appetizers for picking my brain on SS that day on union Bay (even as we got slaughtered on Trivia Night)
Such minutia aside just about everyone got smacked in the housing crash in ways most people didn’t in the tech crash or it’s predecessor the S&L crash. Basically punters/investors got bailed out both time while holders of stolid solid household assets got Roto-Rootered.
Most ignored word in finance: “incidence”. Oddly it matters who gets plunged. Investors losing portfolios is a damn shame. People losing housing is a tragedy.