Many economists have spent a great deal of time trying to understand why, despite prodding from both the Federal government and Federal Reserve, the American economic "recovery" has been tepid at best. In an article entitled "The Housing Trap" by Dr. Zinna Mukherjee, Research Fellow at the American Institute for Economic Research, the author explains how the upsurge in home ownership in America led to reduced savings rates and has ultimately led to a deepening of the Great Recession.
Let's take a look at the first factor that is affecting the economic recovery; America's personal savings rate. Here's a graph showing the United States personal savings rate since 1950 from the St. Louis Fed:
You will notice that the savings rate peaked just after the mid-1970s recession at just under 15 percent and again, during the 1981- 1982 recession when it was more or less stable at around 12 percent. The savings rate fell throughout the remainder of the 1980s and most of the 1990s and ranged between 2.5 and 4 percent. It began dropping again in 2005, reaching a new low of 1.1percent. It wasn't until the onset of the Great Contraction in 2008 that the savings rate rose to between 5 and 7 percent. In its most recent data release, the Bureau of Economic Analysis data shows that the personal savings rate in January 2012 fell to 4.6 percent, down from 4.7 percent in the prior month.
For interest's sake, here is a graph showing the actual level of personal savings in billions of dollars:
You will notice right away that the number of dollars saved by Americans remained with in a relatively narrow band between 1980 and 2008, ranging from just over $130 billion to about $360 billion and that, despite the growth in the economy and population over the three decade period, Americans chose not to add to their personal savings. That all changed in 2008 when total funds saved shot up to nearly $700 billion.
According to Dr. Mukherjee, over the thirty year period, the savings rate dropped for several reasons:
1.) The decline in interest rates on low-risk savings options such as Certificates of Deposit reduced the incentive for individuals to save. Both nominal and real interest rates on such investments dropped with 6 month real rates dropping from 5.4 percent in 1981 to -1.2 percent in 2010. This is actually the outcome that central bankers are looking for when lowering interest rates; the less you save, the more you spend and the more that the economy grows.
2.) The massive growth in stock values drove many more conservative investors into riskier equities and out of bank fixed income products.
3.) House price appreciation reduced savings; during the 1990s, every dollar increase in housing prices boosted spending by 15 cents in contrast to financial assets which saw an increase in spending of only 2 cents for every dollar increase in value. The rise in the value of homes also impacted the savings rate; in some cases, the fall in savings was as high as 11 cents for every dollar increase in the value of a home.
Now, let's take a look at the second factor affecting the economic recovery; the rate of home ownership and how it interacted with the savings rate. Here's a graph showing the rate of home ownership in the United States since the mid-1960s from the United States Census Bureau:
Here is a graph showing the rate of home ownership by region for the fourth quarter of 2011 from the United States Census Bureau:
Notice on the second last graph that home ownership levels rose from below 64 percent in the mid-1960s to its peak at 69.2 percent in 2004. While it might not seem like a great increase, this is a large part of the reason why America's economy has not recovered since the Great Contraction. The increase in the home ownership level in America was largely a result of government policies. The Tax Reform Act of 1986 allowed for the continued deduction of home mortgage interest from personal taxes. On top of that, home owners can also deduct local and state property taxes from their gross income. As well, when a primary residence is sold at a profit, capital gains of up to $500,000 per couple are excluded from taxation. Coincidentally, if you look back at the savings rate graph, you will notice that home ownership levels rose as the savings rate fell. Government policies caused many Americans to view their homes not just as places to live, but as their source of wealth. While many upper income earners had other assets that complimented their real estate investments, the same cannot be said for lower and middle income Americans. This "wealth effect" of home ownership caused many Americans to divert their incomes toward home ownership rather than toward other forms of savings.
Now, let's go back to Dr. Mukherjee's paper. As I noted at the beginning of this posting, household savings rates had been in decline for the better part of 25 years, right up to the doorstep of the 2008 recession. It makes common sense that if a recession follows a period of low savings that households will have to borrow additional funds to maintain their lifestyles. With banks tightening their lending standards, this additional borrowing was not always possible. In addition, as house prices fell, the wealth affect associated with home ownership disappeared. For these two reasons, American households were forced to cut back on spending, resulting in an increase in the savings rate. As I noted above, during the Great Recession, the savings rate rose from 2.4 percent to nearly 7 percent and the total dollars saved rose from $130 billion to just under $700 billion, a 500 percent increase. The funds that normally would have entered the economy as consumer spending were saved instead, resulting in sluggish GDP and employment growth.
Let me summarize Dr. Mukherjee's thesis. Prior to the Great Recession, the housing boom (i.e. increasing levels of home ownership along with ever-rising prices) and the affiliated ability of mortgage holders to withdraw equity resulted in elevated levels of spending and economic growth and depressed levels of saving. Such was the case over the 25 years prior to 2008. Once the Great Recession was entrenched, the wealth effect associated with home ownership disappeared along with consumers ability to borrow additional funds by using the modest equity in their homes as an ATM. As a result, the personal savings rate rose during the recession and the total amount saved by American households rose 5 fold. As well, outstanding consumer credit showed a decline as seen on this graph:
This saved money is withdrawn from the economy, consumption drops and, as a result, the economy is unable to grow; this is particularly noticeable because consumer spending now makes up roughly 70 percent of U.S. GDP.
To conclude, I concur with the author's suggestion that the tepid economic growth that we are now experiencing is related to both the collapse of the housing boom and the rise in savings, two factors that were interlocked in the period leading up to the Great Recession. That said, there are many other factors that come into play when trying to explain why the so-called recovery has been unequally experienced by many Americans including the Federal Reserve's ultra-low interest rate policy, elevated government debt levels, an oversupply of over-priced housing and speculative investment in the housing market. I suspect that the issues facing the American economy over the coming year will provide plenty of fodder for further analysis.