According to the S&P/Case-Shiller index of housing prices, home prices have fallen by about 6 percent in the United States on average over the last twelve months. By my rough calculations, that means that home owners have lost about $720 billion in wealth as a consequence. That is about $2,400 for every person in America, and $18,000 for the average homeowner.
Relative to stock market declines, however, that loss of $720 billion over the course of the year doesn’t look quite so big. The total market capitalization of U.S. stock markets is the same order of magnitude as the total value of the housing market (between $10 and $20 trillion). In one week during October of 1987, the U.S. stock market lost over 30 percent of its value.
The $720 billion figure is also about the same magnitude as the amount of money the U.S. government has spent on the war in Iraq.
If you are a homeowner, how bad do you feel about this? You should feel pretty bad, but I’m guessing you would feel a lot worse in the following scenario: home prices did not fall at all last year, but one day you took $18,000 out of the bank to pay cash for a new car, and someone then stole your wallet with the $18,000 in it. At the end of the day, your wealth would be the same (down $18,000, either from depreciation of the value of your home or because the money was stolen), but one loss is psychologically far worse than the other.
There are many possible reasons for why it doesn’t hurt so much to lose money on an asset like a house. First, it isn’t very tangible, since no one really knows what their house is worth anyway. Second, it hurts less whenever everyone else is also losing on their houses. I once heard a very rich person say that he didn’t care about his absolute wealth, only what his ranking was on the Forbes list of richest people. Third, you can’t really blame yourself for house prices falling, but you could second guess your decision to carry around $18,000 in cash. Fourth, the fact that a thief has your money might make it worse than the money just evaporating into space, like it does when house prices fall. There are probably other reasons as well.
More generally, the economist Richard Thaler coined the phrase “mental accounts” to describe the way in which people seem to treat different assets as non-fungible, even though in principle it seems like they should be. Although my economist friends make fun of me for it, I definitely use mental accounts myself. For me, a dollar made playing poker means much more than a dollar earned from the stock market going up. (And a dollar lost playing poker is likewise far more painful.)
Even people who deny that they are affected by mental accounts often fall prey to them. I’ve got a buddy in that category who won a big bet on NFL football (big relative to his usual football bet, but very, very small relative to his overall wealth) and the next day he spent the proceeds on a fancy new driver.
What does this all mean for housing prices? Well, if prices start going back up, it would be a lot more fun if the price increases came in the form of little packets of cash dropped outside your front door with the morning newspaper, rather than via house appreciation. A fact that, I suppose, all those people who took out home equity loans figured out a long time ago.
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I tend to think of my house as just another one of my long term investments. When my self-directed IRA loses money in a quarter, I don’t panic. I don’t even really think of it as lost value. Over the long term, I know it will work out to my benefit. Maybe I’m being too optimistic in assuming the housing market will improve. I can see how people who purchase homes as a temporary investment could be panicking. For me, I’m in it for the long-haul, so I’ll just wait it out…
While mental accounting may have a role here, I don’t think it is the main issue.
As someone who owns exactly one home, why should I care about house prices?
I have an asset called a house. But I also have a liability – I need somewhere to live for the rest of my life. These two things are roughly the same, so I am immunized against any housing price movements. In other words, once I own a home, changing housing prices do not affect my lifetime consumption.
In fact, I should even be happy when housing prices fall because I have kids. Those children will also have to buy houses someday (to offset their housing need liability) so I am essentially short the housing market.
(Falling housing prices could affect people who are cash constrained, but that’s another story.)
While mental accounting may have a role here, I don’t think it is the main issue.
As someone who owns exactly one home, why should I care about house prices?
I have an asset called a house. But I also have a liability – I need somewhere to live for the rest of my life. These two things are roughly the same, so I am immunized against any housing price movements. In other words, once I own a home, changing housing prices do not affect my lifetime consumption.
In fact, I should even be happy when housing prices fall because I have kids. Those children will also have to buy houses someday (to offset their housing need liability) so I am essentially short the housing market.
(Falling housing prices could affect people who are cash constrained, but that’s another story.)
Fifth: you still own the asset and the chance of it recovering the value at some point is a reasonable one.
Fifth: you still own the asset and the chance of it recovering the value at some point is a reasonable one.
The flaw in your analogy is the assumption is that we all value assets according to their dollar value. But I tend to value an asset like my house in terms of its usefulness to me and the pleasure it brings me and my wife.
My house is not worth any less to me than it was when I bought it early in 2007. I still have the use of all the rooms, all the appliances and systems still function to keep me comfortable, it is still close to my family and to places I enjoy visiting, and the view is just as spectacular. So it isn’t worth any less to me, no matter what the “market” may say. I’m not about to trade it in for cash and blow all the proceeds on other types of consumption so its market price is irrelevant to me.
The flaw in your analogy is the assumption is that we all value assets according to their dollar value. But I tend to value an asset like my house in terms of its usefulness to me and the pleasure it brings me and my wife.
My house is not worth any less to me than it was when I bought it early in 2007. I still have the use of all the rooms, all the appliances and systems still function to keep me comfortable, it is still close to my family and to places I enjoy visiting, and the view is just as spectacular. So it isn’t worth any less to me, no matter what the “market” may say. I’m not about to trade it in for cash and blow all the proceeds on other types of consumption so its market price is irrelevant to me.
Actually, a more likely explanation for why people (should) care less about the value of their house is that everyone has to live somewhere; even more to the point, most people would consider themselves to be fairly geographically constrained as to where they can live. (This is assuming one does not want to leave his/her job.) So if the value of my house goes up (along with the rest of the market), it’s not like I can really sell it for a profit — I will have to buy another house which will now cost me more.
Given this, I never understood the obsession with housing prices among those who already own a house…