Monday, March 12, 2012

Home Ownership and The Savings Rate: Their Impact on the Recovery

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.


  1. When you say "This saved money is withdrawn from the economy, consumption drops and, as a result, the economy is unable to grow," that is a description of a consumer-driven economy, which is probably doomed to contract sooner or later.

    I hope that we will be moving to a more diversified economy, with more agricultural exports, and more manufacturing done right here.

    I also wonder whether the percentage of home ownership is less important than some other aspect, like other assets or mortgage vs. income. The wealth effect of home ownership certainly left us with a horrible hangover that's likely to last a decade at least. Maybe there's been a lesson learned, and not just by consumers, but also by lenders.

  2. It's a complex issue. I think your analysis is correct. At the same time, there are also other things going on that prevent the economy from improving. One factor that seems relevant to me is the fact that so many good paying jobs have disappeared, and the limited jobs that have been created since, often pay lower wages. So, many people are making less money, or are still unemployed. In that environment, the economy can not improve much. Housing prices will likely continue to decline until they reach an equilibrium point. Another potential scenario is that we'll see a fundamental shift in home ownership occur, back to where fewer Americans will own homes.


  3. As was said, this is just one factor that contributed to the Recession, and often an overlooked one.

    One other interesting idea to look into is the rate that houses were refinanced. Starting in the 1980s, the rate that we borrowed skyrocketed. This led to the high number of bankruptcies by around 2005. In fact, I had wondered why a crash didn't occur back then until I learned of homeowners using their homes as a money source.

    Personally, I attribute a large portion of the crash to the entire economy being inflated by pure debt-sourced purchases. Basically, the causes Lou refer to should have caused a much earlier, but smaller recession. However, people were using their savings to buy houses and their credit cards to buy when jobs disappeared and incomes stagnated.

    By 2006, every other method of acquiring the cash to keep spending up had dried up excluding refinancing. due to this, housing was doubled down both as a job creator, a savings deposit, and a revenue source via refinancing (think about the last two: you give up saving to buy your house, then you refinance it often to make more purchases). Helps explain why housing prices bubbled.

    Eventually, housing prices went too high to be sell-able and the loan defaults started. The last pillar holding the entire economy up fell.

    To mark your last statement, Lou about the 'economy not improving much', it shouldn't. The last economy was unsustainable by design. The ONLY way to get back to 1980-2005 levels is to create another bubble.

    The economy will grow slowly. Cheer for it. FEAR if it 'bounces back', similar to how you fear when a friend you spent 5 years getting out of debt suddenly pulling out a credit card and yelling "Drinks are on me!"

    We MUST have a 'new normal'. We have some room to recover a bit more, but soon we'll need to say "This is it. this is 'stable now'" like the McMansion owner who realizes the 1 room apartment really IS their new home.

    Then we start the long, painful road NOT to 'recovery', but to a new start. I wince at what it means for me, and I cry at the Lost Generation below me due to this. We CAN become rich again, with a big house and several cars and everyone well.

    But for now, at least the apartment has no roaches. Dibs on sleeping on the couch.

    1. I agree with the "new normal" so I don't understand why you say "We CAN become rich again, with a big house and several cars and everyone well." This isn't what we should expect or aim for.

      On the other hand, we don't need to be rich, have a big house or several cars. A more modest, balanced lifestyle is preferable if it means having a lower, more reasonable level of debt.--Writing from my modest condo

  4. Well said, Anonymous Mar 13, 2012 07:21 AM. :)

  5. Thanks for all of your thoughtful comments. I think that from all of the research that I have done over the past couple of years, that we are going to find ourselves in a "new normal" with higher baseline unemployment and lower but probably more sustainable housing prices (except, I do believe that some markets are still over-priced in terms of affordability).

    The fly in the ointment will be interest rates. While central banks can do what they want to keep interest rates low, the bond markets ultimately hold the control - just ask any of the PIIGS nations. The fact that China is no longer investing in USD/Treasuries at the rate that they did over the past decade may be foretelling what will lie ahead. After all, it is the demand for sovereign bonds by central banks around the world that has kept interest rates for overly indebted nations at multi-generational lows and this factor alone, has allowed governments to accrue dangerous levels of debt.

    As well, I agree, the causes of the Great Recession were multi-faceted. I just thought that Ms. Mukherjee's approach was different than what we normally see in the MSM.

    Thanks again for your thoughtful insights!

  6. Great post. I’m so lucky today that i was able to read your post which gives me a lot of ideas that I’ve been looking for. I hope to read more of your future post. Thanks a lot.

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  7. I recently read that some financial gurus say its better to rent than buy a house, even for the long haul. I still think I would rather partake in home ownership, since it does build equity!

  8. Thanks for the information. Great help for us in finding house. You can also check out this video for saving tips.

  9. Good post overall, important information for men like me who plan on owning a home soon.