Is Home Equity a Form of Saving?
In a recent NYT article Tyler Cowen wrote:
The fundamental problem in the American economy is that, for years, people treated rising asset prices as a substitute for personal savings. The thinking went something like this: As long as your home’s value rose every year, you didn’t have to set aside so much from your paycheck.
This is true, insofar as it goes. And indeed in the sharp debate on Kudlow’s show between Arthur Laffer and Peter Schiff, the same point came up; Schiff criticized the “saving” of rising home values as illusory while Laffer thought the economy was in fine shape.
Incidentally, this insight helps explain the shockingly low (even negative) “savings rate” of American households in recent years. These Keynesian-type aggregate statistics don’t count rising asset values as part of income, and so make people appear as spendthrifts. For example, suppose your salary is $75,000, your house appreciates $25,000 in market value, and you consume $75,000 worth of goods and services (fancy dinners, vacations, etc.). According to the standard macro accounting, your savings rate is 0%, but according to a broader measure that includes assets, your savings rate is 25%, because your total income (broadly defined) was $100,000 and you only consumed $75,000 of it.
Now it’s true that because of the recent episode, it appears that treating home equity as “saving” is crazy. But I think that’s the wrong conclusion. Really the mistake was “investing” in an asset that would soon drop sharply in price. If you really try to come up with a principled way to criticize the person for treating home equity as savings, you’re going to tie yourself in knots.
Let’s return to our example above. The guy normally makes $75,000 a year. But this year is special, and he gets a bonus of $25,000. His wife wants him to spend it on diamonds and a two-week blowout trip to Paris, but he thinks that would be irresponsible. “No no honey,” he says, “let’s instead build that extra guest room like we’ve been talking about. I’ve talked with real estate agents, and they tell me it would pay for itself; the market value of our house would go up by the $25,000 it would cost us. Instead of blowing the money now, let’s invest it in our house so it will be there when we sell the place and move to Florida for our retirement.”
I’m saying if his wife agrees to this plan, then their saving rate for the year is 25%. His income was, hands down, $100,000, and they only consumed $75,000 (at most). Now is this economically different from the first scenario, where the guy’s paycheck was always $75,000, but the market value of his unaltered house went up by $25,000? I don’t see how.
There is no such thing as a truly safe investment. Even the US federal government might default on its bonds, especially with the clowns we have in there right now. So you certainly can’t say, “Putting your money into bonds is saving, but putting it into real estate isn’t.”
The people who “legitimately” saved, and put some of their paychecks into Fannie Mae and Bear Stearns stock, also got hammered.
I anticipate one possible objection that says, “C’mon, you can’t withdraw the equity on your house very easily, so that’s why it’s not really saving.” But by the same token, you can’t withdraw contributions to your 401(k) very easily, either. It’s still saving though, right?
On an individual level, there is nothing wrong about treating a capital gain as part of one’s income–indeed a standard definition for income is, “How much one can consume in a period without impairing the capital stock.”
Now it’s true, something seems illusory in an entire nation importing foreign goodies (like cars and computers) while they sell off ownership claims to their assets. That seems like cheating, versus the nation devoting some of its resources to producing tools and machinery. But I think this reflects an unsupportable prejudice, comparable to someone saying, “You can’t have a strong economy without a strong manufacturing sector. A nation of programmers and musicians isn’t really productive.” (For more on this last point, see my article here where I show that a libertarian community would probably run perpetual trade deficits.)
