To paraphrase the words of the SteadyHand blog, is this a financial crisis well wasted? Last week, ING in Canada and the UK warned of the possibility of a real estate bubble in the residential and commercial real estate market spurred by the low interest rate environment. Beside the obvious bubble and double recession concern (a theory I subscribe to), the issue with rising real estate values is that it tends to act as a negative influence on a household’s ability to save more money.
The reasons are both obvious and not so obvious. Household savings rates were quite robust (9.6% in the 1970’s) until our paper net worth began to multiple manifold in the 1990’s with the real estate and stock market boom. From the 1990’s onward, we ceased really to save and more often than not consumed instead.
However, studies show a negative correlation between the increase in our net worth and our savings rates. This effect is most pronounced for real estate than the stock market. A 2004 study found that for each $1 increase in real estate worth, we saved 8 cents less. While for each $1 increase in our stock portfolio, we saved 2 cents less (the link to the paper is quite buggy so I did not link it but google “Real Estate Versus Financial Wealth in Consumption” by Benjamin, Chinloy and Jud to read at your own risk).
Some of the reasoning is obvious. Purchasing a home costs a lot of money and we tend to save less money since we have to make a down payment, pay for movers and new stuff for the house. The more subtle reason is that, for most middle class households, we are restricted in tapping our stock portfolio since the majority of assets are locked into non-accessible vehicles like pensions, RSP’s, 401(k). Finally, on a more marco level, it is easier to save more money when interest rates are higher (like the 1970’s) since there can be a healthy return investing in high interest savings accounts; conversely, low interest rate environments encourage leveraging and its associated effects of increased costs of borrowing on a household budget.
From a practical perspective, one tip to save more money would be to simply to turn a blind eye to the value of your home or, more accurately, remember its only paper wealth and not cash in the bank. If you live in a region with depressed real estate valuations, do not bother looking at the price of your home. Instead, enjoy it.
For those trying to be better savers and living in healthy real estate markets, ask yourself if you really need to buy a larger home rather than wanting a larger home. A lot of people I know are rushing to buy real estate because of favorable interest rates, an external stimulus justifying a want, not because they need a larger home, an internal condition necessitating the fulfilment of a need.
From a larger contextual perspective, if the stimulus has worked too well, and a spike in house hold savings rate is only temporary because the government says its time to consume again, then we truly have short memories and we have no one but ourselves to blame if we suffer another financial stress we cannot recover from. Money in the bank smoothes over a lot of personal finance mistakes.
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