Economists look for correlations to infer causations for macro-economic events. Unfortunately, most macro economists fail to look at the individual incentives, the micro reasons, some events occur. What’s even more amazing, or amusing, is how much effort and study they put in to trying to understand these correlations without having the foggiest notion what they’re talking about.
The biggest misunderstanding in macro economics today centers around the idea of a “wealth effect.” Economists noted that people spend more money when asset values rise and less money when they don’t. Of course, times of rising asset values also correspond to times of general prosperity, so it’s difficult to identify what’s really causing people to spend more, the fact that their assets increased in value or that they just made more money.
Carl Case and Robert Shiller are pioneers in the study of the wealth effect. They noted that stock prices had little effect on people’s propensity to spend; however, house prices have a strong correlation to people’s spending habits. The conventional interpretation is that rising house prices make people feel more confident than rising stock prices, so rising house prices has a greater impact on people’s desire to spend. That interpretation is partially true because prior to the housing bubble, house prices had never gone down while stock prices had crashed repeatedly. A rising house price appeared more stable. However, that isn’t what’s really going on.
If stock prices go up, people don’t have ready access to that money. They would have to sell some of that stock and pay taxes on the gains in order to obtain the money. That’s work. That’s a hassle. That’s why the correlation between stock price gains and consumer spending is so weak.
If house prices go up, it’s a different story. When credit is loose, lenders will loan 100% of the value or more of a house with a HELOC or second mortgage. This gives homeowners immediate access to cash, and it doesn’t have any tax implications. That’s easy. That’s convenient. That’s why there is a strong correlation between house price gains and consumer spending.
There’s only one problem. It’s a Ponzi scheme! It’s theft! Remember, Neighbors stealing from neighbors: HELOCs make a comeback. Don’t let the euphemism, wealth effect, distract you from the more accurate dysphemism, Ponzi effect. The boost to the economy is real and quite visible. The economic instability and outright theft is hidden.
Perhaps we will get lucky this time around. If lenders keep prudent lending standards in place and don’t allow unlimited HELOCs at 100% LTV, we won’t be asked to bail the banks and their borrowers out again. If that happens, the “wealth effect” will be weaker than it was during the housing bubble.
Rising House Prices, Not Stocks, Make People Feel Wealthy
By Michael S. Derby — January 23, 2013, 2:30 PM
As a key influence on households’ spending decisions, the health of the housing sector trumps stock-market moves, a paper released this week by the National Bureau for Economic Research claims.
The study, written by prominent economists Karl Case, John Quigley and Robert Shiller, refines their existing study of what is called the wealth effect. Case and Shiller are well known names, especially on housing issues. Quigley, another luminary, died in May, before the research’s publication.
Most economists and policymakers agree asset price gains can be big drivers of consumer spending power. Rising home or stock prices are generally agreed to increase consumer spending, while falling asset prices cut the other way.
If most economists agree, then it’s probably wrong. Rising asset prices only contribute to consumer spending if they sell the asset and covert it to cash or if they borrow against it. Nobody takes a look at their stock portfolio and decides to deplete their cash savings to buy a car because their stocks went up.
That said, economists and policymakers have had a hard time quantifying the wealth effect.
That’s because it’s an illusion created in their own minds.
That’s problematic for many reasons, but it’s even more so due to the fact that the housing market’s crash and apparent recovery are considered central to the overall fate of the economy.
To that end, the Federal Reserve is pursing a policy course deliberately aimed at driving up all manner of asset prices in hopes its actions will boost household spending to power better overall growth.
OMG! The wealth effect is now being used as justification for the federal reserve inflating asset bubbles in all asset classes. Amazing!
In the paper, the economists update their decade-old work, drawing on a wider and more up-to-date set of data ranging from 1975 to the second quarter of 2012. The broader information changes and clarifies what was once thought about the wealth effect’s influence.
There is “at best weak evidence of a link between stock market wealth and consumption,” the economists wrote.
In other words, when their is no direct way to spend the increase in value, there is no increase in consumption. The wealth effect is not real.
“In contrast, we do find strong evidence that variations in housing market wealth have important effects upon consumption,” they said.
Yes, because with housing, some dipshit lender would give the owner 100% of it’s value in a cash-out loan, and the government would not tax this as income.
“An increase in real housing wealth comparable to the rise between 2001 and 2005 would, over the four years, push up household spending by a total of about 4.3%,” the paper stated. Meanwhile, “a decrease in real housing wealth comparable to the crash which took place between 2005 and 2009 would lead to a drop of about 3.5%.”
As with any Ponzi scheme, it works great while its inflating, but when it’s deflating, not so much. This is the best evidence available that housing finance is a Ponzi scheme, assuming anyone is willing to consider the truth revealed in the data.
This finding upends the old understanding that housing gains tended to push spending higher by a wider margin that home price declines depressed spending, the economists wrote.
The Ponzi effect was more pronounced during the housing bubble because the behavior was much more widespread. Lenders actually encouraged Ponzi borrowing and made it very easy for anyone with a house to obtain all the free money they wanted.
The paper’s conclusion provides some additional hope that a nascent housing sector recovery could in fact be a meaningful contributor to a broader acceleration in growth over coming years.
WTF? This is where people really don’t get it. Should we hope for another massive Ponzi scheme requiring bailouts for bankers and loanowners alike? People are looking for the short-term visible effect without considering the long-term hidden impact of mortgage equity withdrawal.
It may also explain why even as the stock market has scored strong gains in recent years on the back of extremely aggressive monetary policy, growth to date has been so middling and disconnected from the story told by equities.
A note from Deutsche Bank sees housing contributing strongly to a better economy. “The wealth effect on consumer spending could be substantial” this year, the bank told clients.
Remember to short Deutsche Bank stocks after the underwrite a bunch of HELOCs this year… Oh wait, I forgot, they are too-big-to-fail.
“We are projecting home price appreciation of 5-10% in 2013, which translates into a further increase in household assets, i.e. wealth creation, ranging between $860 billion and $1.720 trillion.”
“Through its direct and indirect effects, the housing sector alone could potentially contribute as much as 2% to real GDP growth this year,” Deutsche said.
I would like to see homebuilding recover for professional reasons, but if that means we will see more Ponzi borrowing on HELOCs, I’d prefer a continued recession. The “wealth effect” is the most dangerous euphemism in economics.
The wealth effect in action
The former owners of today’s featured property did their part to stimulate the economy. They paid $236,000 on 1/11/2001 using a $219,849 first mortgage and a $16,151 down payment. Through a series of refis and HELOCs they managed to inflate their mortgage balance to $395,000 while their property increased in value. They haven’t been contributing nearly as much to the local economy over the last six years, and now they are losing the property to foreclosure.
The Ponzi effect on the economy is certainly real. The former owners of today’s featured property extracted about $175,000 over a four-year period and most likely pissed it away in the local economy. The combined effect of all the people I’ve profiled and the millions I didn’t made strong contributions to the local economy. But ask yourself is that the kind of contribution we want as a society? Do you want to pay the bills of these Ponzis next time around? What about the collateral damage (literally) from the resulting foreclosures? Prudent homeowners were harmed by this behavior too. No, in my opinion, the price is much too high.
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Proprietary OC Housing News home purchase analysis
25 VIA LAMPARA Rancho Santa Margarita, CA 92688
$414,900 …….. Asking Price
$236,000 ………. Purchase Price
1/11/2001 ………. Purchase Date
$178,900 ………. Gross Gain (Loss)
($33,192) ………… Commissions and Costs at 8%
============================================
$145,708 ………. Net Gain (Loss)
============================================
75.8% ………. Gross Percent Change
61.7% ………. Net Percent Change
4.6% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$414,900 …….. Asking Price
$14,522 ………… 3.5% Down FHA Financing
3.47% …………. Mortgage Interest Rate
30 ……………… Number of Years
$400,379 …….. Mortgage
$118,976 ………. Income Requirement
$1,791 ………… Monthly Mortgage Payment
$360 ………… Property Tax at 1.04%
$100 ………… Mello Roos & Special Taxes
$104 ………… Homeowners Insurance at 0.3%
$417 ………… Private Mortgage Insurance
$302 ………… Homeowners Association Fees
============================================
$3,074 ………. Monthly Cash Outlays
($339) ………. Tax Savings
($633) ………. Equity Hidden in Payment
$16 ………….. Lost Income to Down Payment
$72 ………….. Maintenance and Replacement Reserves
============================================
$2,189 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$5,649 ………… Furnishing and Move In at 1% + $1,500
$5,649 ………… Closing Costs at 1% + $1,500
$4,004 ………… Interest Points
$14,522 ………… Down Payment
============================================
$29,823 ………. Total Cash Costs
$33,500 ………. Emergency Cash Reserves
============================================
$63,323 ………. Total Savings Needed
The property above is available for sale on the MLS.
Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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30 Responses to “The “wealth effect” is the most dangerous euphemism in economics”
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Actually, with their models based-on academic case studies, it’s the economists themselves who’re the most dangerous.
———————————————————-
Squatter Occupies Bank Of America-Owned $2.5 Million Boca Raton Mansion, Hilarity Ensues…
The robosigning/fraudclosure fiasco came, saw, and eventually left……
Yet while it did manage to artificially boost prices, the process succeeded in one thing: making a mockery out of property rights, as it became quite clear that nobody knows who owns what, hence demanding a global settlement release from the very top. But not even the 10th incarnation of Linda Green could possibly conceive of the following episode showing just how surreal U.S. housing reality can be, when one mixes combustible and outright idiotic property laws, with a real estate market that, when one pulls away the facade of “made for TV pundtiry”, is in absolute shambles.
http://www.zerohedge.com/news/2013-01-24/squatter-occupies-bank-america-owned-25-million-boca-raton-mansion-hilarity-ensues
Overhanging unresolved mortgage debt is the problem. Foreclosure is the solution nobody is willing to undertake.
Fannie Mae: Slow Economic Growth May Be the Near-Term Norm
While some are asking when the economy will return to normal, others are wondering if this prolonged period of below-potential GDP growth is actually the “new normal,” according to a report from Fannie Mae’s (FNMA/OTC) Economic & Strategic Research Group.
For 2013 and 2014, Fannie Mae projects a continuation of below-potential economic growth, with a 2 percent growth rate expected for 2013, similar to the lackluster performance seen in 2012.
“What we view as sub-par economic growth may actually continue to be par for the course for the near term,” said Fannie Mae Chief economist Doug Duncan. “We expect the fiscal policy climate to act as a drag on growth this year with possible implications on the direction of the economy in the long term.”
We’ve been here before. This is what they all said during the 70s, too. Until Reagan proved them 100% wrong.
I predict the “new normal” will last until January 2017. In fact, I’ll be more specific: it will last until January 20, 2017.
Higher Mortgage Rates May Stall Housing Recovery
Positive economic and housing news lifted fixed mortgage rates to their highest level in months this week.
According to Freddie Mac’s Primary Mortgage Market Survey, the average interest rate for a 30-year fixed-rate mortgage (FRM) was 3.42 (0.7 point) for the week ending January 24, up from 3.38 percent last week. The last time the average 30-year reading was this high was September 29 of last year, Freddie Mac said.
The 15-year fixed average also rose, climbing to 2.67 percent (0.7 point) from 2.66 percent previously.
Interest rates on adjustable-rate mortgages (ARMs) were stationary in the last week: The 5-year ARM averaged 2.67 percent (0.5 point), and the 1-year ARM came in at 2.57 percent (0.5 point).
Frank Nothaft, VP and chief economist for Freddie Mac, said the rise in fixed rates is unlikely to deter the housing recovery.
“Fixed mortgage rates were up slightly over the holiday week but remain highly affordable and should continue to aid in the ongoing housing recovery,” Nothaft said. “For instance, existing home sales totaled 4.65 million in 2012, showing a 9.2 percent increase over 2011 and the strongest pace in five years. In addition, the Federal Housing Finance Agency’s purchase-only house price index rose 5.7 percent over the 12 months ending in November 2012, marking the largest annual increase since June 2006.”
One of the traps that Bernanke is to talk up the economy while printing more and more money. Now, everyone is on the band wagon and more questions are building on why we are printing more and more money. Once he is pushed to turn off the printer, rates have to increase, reversing the “recovery”.
371 days until the rein of Bernanke is over.
Problem is, printing money only facilitates liquidity, NOT insolvency.
“Now, everyone is on the band wagon and more questions are building on why we are printing more and more money. Once he is pushed to turn off the printer, rates have to increase, reversing the “recovery”.”
You aptly described the dilemma of central banking after reaching the bottom of the interest rate cycle. We witnessed this problem over and over again after WWII. For 35 years this push and pull went on until the currency collapsed and Paul Volcker had to raise interest rates to save the dollar. The 35 year period that followed — the age of Greenspan — was the era of falling interest rates where the economy could always be juiced by lowering rates. The interest rate cycle is very long, so we are probably on our 35 year journey from the bottom back to the top. I wonder who the Paul Volcker of 2050 will be?
2050? Hardly.
We’ve held rates too low for too long.
The Fed will lose control of the interest rate market.
The banks will need bailouts for housing loans but especially for their involvement in the Over The Counter Derivatives market – ‘reverse repos’ where a slight uptick in interest rates will test their solvency.
If a sustained rise in rates has actually begun, BAC and the other zombies will finally be forced to sell REO and other comically mispriced assets. Aggressively!
You can’t judge it based on right now. Interest rates spiked last year this time, too. Banks aren’t stupid. They know the house-buying season has just opened, and anyone on the leading edge — making offers in January — is less price-sensitive than people who wait until later. So they’ll crank the rates up a bit now, and lower them later when more price-sensitive buyers start acting.
I don’t know why these perfectly predictable seasonal trends escape the notice of the media so often. Every spring, just before April 15, the stock market climbs. Why is that? Well, duh, everybody’s doing their taxes, including corporations, so you get a rush of 401(k) and IRA money in the weeks leading up to April 15.
Two conclusions suggest themselves: (1) economic reporters are morons, or (2) they indeed know this, but they need news, so they report the perfectly predictable fluctuations as if they are signs ‘n’ portents of something big. It’s raining — could it be another Biblical Flood? Let’s get a quote from somebody building an Ark. Details at 11.
Fed balance sheet hits record $3 trillion in assets
1/24/13 4:14pm
For the first time, the Federal Reserve pushed its balance sheet beyond $3 trillion in assets.
Holding of Treasuries rose to $1.7 trillion from $1.69 trillion a week earlier and mortgage-backed securities also rose to $983.17 billion from $948.61 billion last week.
Holdings of agency securities rose to $308.11 billion, up from the prior week’s $306.74 billion
On Jan. 11, the Fed paid the government a record 488.9 billion in 2012, reaping gains from Treasury bonds and MBS purchases.
The Fed net income was $91 billion, of which it sent $88.9 billion to the Treasury. The largest portion of the Fed’s revenue was derived primarily from $80.5 billion in interest paid on MBS and Treasuries that were purchased, according to Fed preliminary unaudited results.
In December, the Federal Open Market Committee decided to continue to purchase additional agency MBS at a pace of $40 billion per month. The Committee also decided to purchase long-term Treasury securities at a pace of $45 billion per month.
The FOMC minutes revealed that Fed policy makers are likely to slow monthly purchases of $85 billion in mortgage bonds and Treasurys sometime in 2013.
The minutes provided a timeline, indicating the order in which the Fed will wind down its open-ended third round of quantitative easing, which so far is making the government big profits.
No they don’t. The minutes are a propaganda tool, meant to convince people with savings that you better take that money and buy something right now, because QE is coming to an end Real Soon Now. Go buy a house! Buy some stocks! Stimulate the economy, damn you! Wealth effect!
The Fed cannot end QE until the Federal government drastically reduces its spending — ha ha ha, I know, I can’t say that with a straight face either — or there is some magic Reaganesque 4-6% economic growth that starts up and pulls Federal revenue back from the graveyard.
I think OC it’s more about the image than anything else. Actually saving is not valued only spending. I thought the recession would have changed that, but I was completely wrong.
Bernanke and his zero percent interest rates don’t provide much incentive for spenders to find religion and become savers.
You’re not wrong, the recession has not been allowed to run its course. It will in time. Belt tightening will commence.
While I do agree with you about Ponzi borrowers stimulating the economy, I have to disagree with you that there is no “wealth effect”.
A number of my more sober friends, who did not inflate their mortgages, did greatly reduce their saving rates during the run up in the imputed ‘worth’ of their houses in coastal OC. They explained that they would retire on the money that they got from selling the house and moving to someplace cheap (NV, AZ, seizure world). And they therefore stimulated the economy by spending money that had formerly been saved for retirement or other investments.
Were they smart? No. But I bet this ‘spending’ of the wealth effect was in fact more common than the “Ponzi” spending.
Right. Our home’s value increasing, 401ks increasing, and other stocks increasing gave us the comfort needed to spend nearly our entire savings to refinance our townhouse. In the absence of that “wealth effect,” we would still be holding onto that cash for liquidity/solvency reasons.
If that is true, then rising house prices may provide some economic stimulus outside of the Ponzi effect.
I think Ponzi borrowing will be much less prevalent in the future because rising interest rates will make it cost prohibitive. Previously, people were able to refinance and roll their Ponzi borrowing into a new first mortgage at lower interest rates keeping their payment the same. That is simply not possible in a rising interest rate environment. If people start to Ponzi borrow, they will implode much more quickly because the rising costs will do them in.
Speaking of new home developments, do any of the insiders here know what’s going on with Orchard Hills?
The property taxes have to be eating them alive, so they may open it soon.
The Irvine Company, like any good developer, ties up their future development in Williamson Act tax reductions. The Williamson Act reduces tax rates about 90% as long as the land is used for agricultural purposes. The Irvine Company times the construction of new developments to correspond to the end of their 10-year Williamson Act obligations.
When Orchard Hills got developed, the appraised tax rate went up significantly, and right now, the project produces income only from the commercial center and apartments. This financial pressure will compel them to build it out as soon as they believe prices are high enough to make the profit they want. At the rate prices are going up in Irvine, that will probably be sooner rather than later.
Cloudy future for REO-to-rental asset class
By Christina Mlynski January 25, 2013 • 10:37am
While the single-family/real estate-owned rentals could grow in the short term — absorbing excess inventory through shadow inventory pipeline — the long-term outlook remains cloudy.
For single family rentals to develop into a sustainable asset class, property managers and investors will need to show the advantages of scale in operating efficiencies compared to individual investors who manage bulk rentals in a single location of the nation, Barclays ($18.87 0%) said in its housing and residential credit outlook. An in-depth analysis ran in the December 2012 issue of HousingWire magazine.
Non-agency mortgage-backed securitizations are slightly concentrated in parts of the Sun Belt region of the U.S., with the exception of Florida. As a result, the impact on defaults and severities are expected to be limited.
The opportunity in rentals remains bright over the next two to three years as slow inventory pipelines are projected to keep a steady supply of distressed properties. Debate remains on how monetizable this asset could be, long term, on the secondary market. Moody’s Investors Service already warns that the asset class may pose risks not typically found in traditional (multifamily) CMBS and (single-family) RMBS.
Given the massive rally in non-agency bonds during the last six months of 2012, unleveraged yields in the residential mortgage-backed securitization spaced converged to about 5%, even as single-family rentals continue to provide roughly 7% unleveraged yields.
Another opportunity in rentals is the decline in homeownership from 69% to 65% as well as adjusting for shadow inventory to 61%, Barclays noted.
In regards to the economics of buying to rent, staying in areas with strong housing fundamentals is key. As a result, areas with depressed land shares and positive demographics.
The potential for a strong recovery is highest in the fast-growing, though depresses metropolitan areas such as Atlanta, Las Vegas, Phoenix, and Tampa, which also exhibit high rental yields.
The biggest threat to single-family rentals is operational risks, even though the overall yield looks attractive on paper.
The primary risk from an operational standpoint is whether the rental yields can be maintained while achieving large enough scales. As a result, keeping operating and maintenance costs under control is a primary factor.
“Acquiring scale can lead to market impact costs with investors either paying up or being less selective about the properties they acquire,” the report stated.
Paging all median data lovers– aka OC: realtors/brokers/bulls et-al
Highest US household income by County: (per latest avail US Census Bureau stats)
#1 Loudoun County VA: $119,134
#64 Orange County CA: $72,293
per DQ…
Loudoun County Dec 2012 SFR closed sale price: $548k
Orange County Dec 2012 SFR closed sale price: $527k
tic…..
Before I die, I would like a couple of questions answered:
a) The mystery of the great pyramids.
b) How it is possible for the median income to buy the median house in the O.C.
Whats even more interesting is to drill down by zip code.
(Woodbridge)
http://www.melissadata.com/lookups/TaxZip.asp?zip=92604
I picked zip 92604 because its where I happen to live.
Note that incomes are unspectacular and in line with el 0′s overall O.C. data.
Picking “high end” zip codes will, of course, show a bump.
(Shady Canyon and Turtle Rock)
http://www.melissadata.com/lookups/TaxZip.asp?Zip=92603
(Corona Del Mar)
http://www.melissadata.com/lookups/TaxZip.asp?Zip=92625
But even these incomes can’t really support some of the WTF asking prices
in these areas.
So, how on earth are the WTF properties selling?
a) Everyone else (except me!) has their own personal gold mine in the
back yard.
b) Near zero interest rates and vodoo financing are alive and well.
c) Even above median wage earners are living paycheck to paycheck.
I just don’t get it.
That’s the question I keep pondering as well. Heck, I don’t even know how people buying “cheap” houses out in the valley do it. All my friends there drive leased luxury cars, send their kids to private schools and/or have nannies. During the boom I assumed they were all living on HELOCs, but now that they’re all underwater wth? Maybe everybody I know is either running up crushing debt or has rich parents who are bank-rolling them.
Well, one obvious answer is two wage earners. The second is that a large fraction of those below the median aren’t in the house-buying market at all because they’re too young or in transit, or their income is the second in a house and should really be folded into the family income used to buy a house. The third is that if the median income bought the median house, then the bottom of the income would buy the least expensive houses, and everybody would be able to afford a house — not just the median earners.
Like this: say the median income is $70,000, broken down thus:
John, recent college grad, first job, renting and hanging out with his buds while he decides whether to move East or go to graduate school: $40,000.
Mary, just divorced, credit trashed, trying to put her life together, renting a dingy pad while she tries to sharpen rusty job skills: $30,000.
William, husband and father of two young kids, just got promoted, stable job, would love to move from rental to a real houjse, $70,000.
Sue, wife of William, working but wants to quit to stay home with the kids after they buy a house, if possible. $50,000.
Joe, dentist, ex-husband of Mary, $150,000. Had to sell the family home, looking for another.
John, junior partner to Joe, just married, looking to buy with his lawyer wife., $90,000.
Leigh, lawyer wife to John, $110,000.
Now John and Mary aren’t even in the market for a house, and of the other five, four are combining income to buy a house, so our buyer pool looks like:
William & Sue: $120,000 combined income.
John & Leigh: $200,000 combined income.
Joe: $150,000 income.
We only need three houses to sell, and the median house price can be whatever you can buy with $150,000 income, because that’s the median income of our buyer group.
I see your point about the median income of the “buyer pool” being more relevant than the overall median income – but the median incomes reported include people married filing jointly. Maybe a lot of two-income houses don’t do that?
The median is only the income of the OC household that falls right in the middle of all OC households. I would guess the mean (average) would be higher. The households in the upper half of the income spectrum make-up the vast majority of house owners and house buyers, skewing the median price paid for OC homes.
The 10 year note is getting close to 2% yield again. More QE in the near future?
Really….. The last QE cycle was at 2 months , soon it will be monthly and then weekly….Oh my ! What then shall we do …… UP , UP & AWAY %%%%%%%
Ink Jet Ben is really starting to rub other Central Banks & Governments the wrong way…
http://www.moneynews.com/FinanceNews/fears-world-currency-war/2013/01/25/id/472963/