October 27, 2008

How much of the Bubble was blown?

We have three related but somewhat distinct economic problems right now.

1. The first is a liquidity problem. Lenders are reluctant to lend money because they aren't sure who will be solvent tomorrow, so they may never see their money again.

2. The second is a solvency problem. Lenders should be reluctant to lend money because more than a few of their customers actually are or soon will be insolvent.

3. Finally, even after the first two problems are dealt with, there will remain the wealth problem. We aren't actually as wealthy as we thought we were 18 months ago. A significant fraction of our supposed wealth consisted of overleveraged homes and, in turn, financial instruments overleveraged on top of the overleveraged housing assets.

An important empirical question is how much of the pseudo-wealth that came into theoretical existence during the Bubble has already been consumed? This has implications for forecasting upcoming business activity.

For example, I never thought the increase in valuation of my house was real. For family reasons, I was in no position to sell it and move some place cheaper. And I always figured the bubble would burst eventually. So, I didn't spend the increase in home equity as if it were real money. For example, from 2001 through 2008, I can only recall paying for hotels or motels for 16 nights of family vacation, or an average of two per year. (I went tent camping about the same amount.)

So, I can't radically reduce my expenditures on hotels due to the Crash, because I wasn't spending much on them during the Bubble. If everybody had behaved like me, the oncoming crash in the vacation industry would be a lot less severe because the industry would never have expanded so much.

On the other hand, I suspect that my frugality in this regard was anomalous for Californians over this period. A lot of people took a lot of vacations with money that they thought they had, but didn't really, paying for them with home equity loans or putting them on their credit cards, expecting to be bailed out by the ever-rising value of their homes.

Granted, some expenditures really are investments. For example, two months ago I bought a second computer screen, a 24 inch giant, to work in tandem with the fast laptop I bought back in February. Together, they have greatly increased my productivity. (Where is the tangible evidence of that increased productivity, you might ask? Be patient. You'll see...)

But vacations are at the opposite pole of consumption v. investment -- they're gone.

Looking at all the shiny blinged-out cars on the road, my general impression is that, here in California at least, a sizable fraction of that now vanished theoretical housing and stock increase in wealth got spent on consumption. And that has dire implications for the size of the economic downturn.

Has anybody estimated how much of the Bubble wealth got spent?

My published articles are archived at iSteve.com -- Steve Sailer


Anonymous said...

There is no way to estimate that. It is, however, easy to look at the difference in savings rates and consumption and investment quotas in different countries (and repeat this comparison for different points in time).

Tino said...

This is an important question.

I don’t have data that can attribute saving decision to household housing bubble (although this can be done, if someone spends the time), we do have national aggregates of TOTAL savings. It’s bad, but not terrible.

Basically while the US households savings rate did decrease, total national savings was held up to some extent (although much lower that it should have been), because the corporate sector maintained a high savings rate throughout.


US savings rate as a share of GDP:

1990-2003 16.1%

2004 13.8%
2005 14.7%
2006 15.2%
2007 14.0%

As a reference investments are around 20%, the difference of 5-6% being the famous foreign current account deficit.

These are gross figures. Net savings rate was much lower (this is gross savings minus capital depreciation). Basically it hovered around 4-5% of GDP in the 90s and went down to 2% in the late 2000s. The lowest years correspond strongly with the real estate boom.

Interestingly it never went below zero on annual basis, which means good households compensated somewhat for the terrible behavior of the bad households, although barely by the end. (So now the voters will reward these responsible Americans by putting taxes on the savers and giving the money to the borrowers).

Personal savings used to be around 200 billion per year, and went down to around 50 billion per year 2005-2007. Net government savings have been negative 100-200 billion per year 1990-2007. Almost all the net savings has from the corporate sector, undistributed (reinvested) capital.

The good news is that the savings rate is going up. Households are adjusting fast. I predict that the current account deficit will be gone within 2 years.

Saving is really not that hard. Increasing savings is something the economy can do, if it wants to. If everyone saves 5% more of their annual income national savings goes up with 5%.

The bad news is that these are national aggregates, a lot of individual households probably did very badly, and will not recover anytime soon.

Also, these figures say Americans saved something, but it doesn’t answer if they saved enough with respect to what they need to maintain their lifestyle, for example to manage coming retirement.

Two interesting factoids, while we are at it:

Steves intuition is correct, as usual. Typically there is a phenomenon that households (on average, and historically I should add) don’t spend increased housing wealth the same way they spend other wealth. They are especially unresponsive to upward movement.

Despite years of low US borrowing from foreigners America is not still not in debt, the total value of American holdings in other countries and their holdings of US assets is roughly the same. The reason is that American investment in other countries have outperformed their investments here. Some people are lucky I guess.

Bruce Charlton said...

SS said: "A significant fraction of our supposed wealth consisted of overleveraged homes and, in turn, financial instruments overleveraged on top of the overleveraged housing assets."

Wouldn't this impy that we are in for inflation, since there is more money than stuff?

However, it seems that most of the economists (or whoever they are) are more worried about deflation - otherwise they would not be injecting 'stimulus' into the economy - which is, I take it, a deliberate way of inducing inflation.

Inflation in the UK is creeping up (currently over 5 percent, I believe), yet the govt. here is also talking about a 'stimulus' package.

I am worried!

Anonymous said...

tino wrote: "(So now the voters will reward these responsible Americans by putting taxes on the savers and giving the money to the borrowers)."

Indeed. It seems the Keynesian long run is upon us. Keynes worried about people hiding their money under mattresses, thus suppressing economic activity. Now all the money has been found and spent.

Anonymous said...

Let's say that the bubble was focused in US residential housing stock, which was about $22 billion in 2006. Also figure that mortgage equity withdrawal ran about $400 billion per year from 2002 through 2006 (there is no hard and fast number for this). So let's say $2 trillion, and figure that of that 50% went to consumption, so $1 trillion. On top of that, figure that there has been a nationwide 10% decline in housing values since 2006 (much steeper in some areas, of course). So I'd say $1 trillion vanished into vacations and restaurant meals, and $2.2 trillion in virtual paper wealth has been vaporized. So $3.2 trillion in total wealth disappeared, compared to what it would have been without the bubble. To put that number in perspective, total US assets total about $60 trillion.

Anonymous said...

Isn't this basically the same problem that arose after the stock-market bubble burst in 2001? How much does a decline in paper wealth affect current consumption expenditure? The answer then appeared to be: some, for a little while, but not much.

Anonymous said...

"Where is the tangible evidence of that increased productivity, you might ask? Be patient. You'll see..."

I must say I'm dying to and it better be soon, before Nov 4...

Anonymous said...

Another pivotal question I've been wondering about the Housing bubble is:

How much of the home mortgage meltdown is due to naked speculation rather than the unfortunate "homeowner" archetype that the MSM exclusively touts?"

By speculators I mean both greedy (a) non-owner-occupied investors, and (b) owner-occupied individuals who clearly were buying homes they could never afford.

I suspect, based upon historical patterns, that the incidence of responsible homeowners victimized by truly unforeseen events (e.g. major medical/death) would be in the low single digits percentage-wise for mortgage holders. The current economic crises may double or triple this to the high single digits.

The question is how can anyone make the arguement that the 90-97% of responsible mortgage-holding homeowners as well as 100% of renters and homeowners with no mortgage (which together account for 50% of all households) support a tiny fractions of reckless speculators like these:


Anonymous said...

Well if they didn't spend it by now then maybe they invested it, so in either case I'd say...just about all of it.

Anonymous said...

"But vacations are at the opposite pole of consumption v. investment -- they're gone". True, but the bailiffs can't take them away.