According to Edward Wolff,
median wealth plummeted over the years 2007 to 2010, and by 2010 was at its lowest level since 1969.
I see this as a result of the policy of encouraging the middle class to take a highly levered position in housing. I had just been looking at an earlier paper by Wolff, which looked at the wealth data through 2007. In that paper, if you looked at the middle 60 percent of the wealth distribution, the gross value of their homes accounted for 65 percent of their wealth (because of mortgage debt, their net equity in homes was less than 40 percent of their wealth).
In my opinion, households would be better off if their savings were in diversified asset portfolios, including shares in funds that invest in stocks and real estate. Instead of making a mortgage payment, you should use that money for a combination of paying rent and saving in a diversified portfolio.
I think that the main reason that debt-financed home purchases are the standard savings channel for most households is that it is a mechanism for pre-commitment. Most households will not have the discipline to put money into savings every month. Moreover, of those that have the discipline, many will shy away from higher-yielding assets because of loss aversion. Taking on a mortgage is a way of pre-committing to sinking money into a risky investment (housing is indeed risky in real terms, even though nominal house prices typically rise), rather than spending the money or putting it into low-yielding safe assets.
If public policy wants to take a paternalistic approach to incent savings, we should be looking to create pre-commitment mechanisms that encourage people to set aside money that they invest in diversified mutual funds, rather than highly levered investments in their homes. Of course, such a policy would have to run the formidable gauntlet of the housing lobby.
Note that I would be rather uncomfortable with the idea that the government should take on this paternalistic role at a time when it is engaged in such heavy deficit spending. Politicians would be saying to households, in effect, “Save more so that we can do the spending.”
I’d argue that another reason people save via their own house is that they perceive it to be less risky. Some friends of mine bought an investment property to rent out … I asked them, why not just buy a residential REIT, and avoid the hassles of having to unplug toilets at 3am? They said, “the stock market? no way!”
I agree. However, you may be missing one key point. There is some safety in “running with the herd.” With such a vast proportion of wealth in housing (particularly among the middle class) the US simply cannot let home values fall beyond a certain point. I fully expect the government/Fed would use any measures possible to prop up values. They already have to some degree but I think they’d go far further if need be. I don’t think you can say the same for the stock market (or other asset classes).
1. What do you think housholds’ net exposure to housing cost is? Subtract the lifetime of monthly shelter liability and households are probably net short.
2. Cost of intermediation. A well functioning rental market may indeed be more efficient for labor mobility. But there is asymmetric information between renters and landlords, and being your own landlord eliminates that cost. If nothing else the crisis demonstrated that the agency cost in financial intermediation dominates outcomes.
3. If we eliminate mortgage interest tax deduction, do we make mortgage interest income tax-free? Or do we tax both ends, making mortgage finance not tax-neutral, and thus taxing the trade component of “specialization and trade”?