Wealth Effects
I don’t think I would agree with all the conclusions he draws from this, but Dean Baker makes the excellent point that there’s a lot more than a “credit crunch” going on to explain the onset of recession — the simple effect of asset prices tumbling is to make people reduce their spending and therefore the economy contracts:
This is truly incredible. Homeowners have lost more than $5 trillion in housing wealth. There is a very well established wealth effect whereby $1 of housing wealth is estimated as leading to 5 to 6 cents of annual consumption. This implies that the loss of wealth to date would cause consumption to fall by $250 billion to $300 billion annually (1.7 percent to 2.0 percent of GDP). If you add in the loss of around $6 trillion in stock wealth, with an estimated wealth effect of 3-4 cents on the dollar, then you get an additional decline of $180 billion to $240 billion in annual consumption (1.2 percent to 1.6 percent of GDP).
These are huge falls in consumption that would lead to a very serious recession, like the one we are seeing. This would be predicted even if all our banks were fully solvent and in top flight financial shape. Even the soundest bank does not make loans to borrowers who it does not think can pay the loans back (except during times of irrational exuberance).
To argue from the personal case, as you may recall I bought a condo recently. Obviously, to make the downpayment and meet my closing costs I was going to need to liquidate some of my savings in the stock market. I had planned to sell more stock over and above that in order to get cash to buy furniture and other moving-related expenses. But because of what was happening in the stock market it was an inopportune time to be selling shares so I sold fewer than I’d planned and bought cheaper furniture, figuring I might just buy nicer stuff later on if at some future point the animal spirits of the market drove my net worth up. Thus someone missed the chance to sell me a coffee table (pictured above) that I liked very much but that cost a lot of money. Their loss was Ikea’s gain, but that kind of decision drives GDP down.
63 Responses to “Wealth Effects”
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November 9th, 2008 at 5:18 pm
“First they came for the Trustfund Scumbags
and I said nothing, for I was not a Trustfund Scumbag…
November 9th, 2008 at 5:18 pm
So what you’re saying is… the downturn is all your fault?
November 9th, 2008 at 5:21 pm
How would we ever have understood this issue if Matt had not moved out?
November 9th, 2008 at 5:29 pm
Think back to September 12th, 2001 (or was it the 13th?)
We got attacked, and our august president told us to go shopping.
And like everyone else, I was reading discussion of this in Salon. Pretty much everyone agreed the president was being absurd to answer the attack with a trip to the mall, until somebody pointed out that there was a recession on the horizon, and that if it happened, the first to suffer would be the underpaid sales clerks in those malls. So maybe it was okay for us to go shopping on the 13th.
But the 14th?
The 15th?
If our economy cannot function without people frittering their money on stupid crap, the problem isn’t that people stop shopping. The problem is that we need them to, and that is where policy had to be formulated to address this. We’ve had 7 years to think about it.
November 9th, 2008 at 5:32 pm
“…This is truly incredible. Homeowners have lost more than $5 trillion in housing wealth…”
The “wealth” was an illusion, created by a speculative bubble in housing prices, the result in turn of idiot lending/borrowing that was not sustainable. Consumption that is propped up by such means is likewise an illusion.
November 9th, 2008 at 5:36 pm
What the hell happened, has Meggy McArdle started guest-writing Matt’s columns?
November 9th, 2008 at 5:40 pm
Yggie is one of the great bloggers, no question. But that is one ugly piece of furniture.
Sorry if I’ve harshed anyone’s Sunday evening mellow.
November 9th, 2008 at 5:43 pm
Glass-top coffee tables, basically without exception, are douchey.
That is a douchey table.
November 9th, 2008 at 5:43 pm
I don’t shop furniture at Ikea (and I LIVE in Sweden) but that coffee table pictured is not so attractive.
November 9th, 2008 at 5:49 pm
DivGuy, there comes a stage in your life where what you need is a douchey table.
November 9th, 2008 at 5:59 pm
What’s happening now is fundamentally driven by a wealth effect. Yes, we currently have a liquidity crisis and an insolvency crisis. The government throwing money at the liquidity crisis might well help, and there’s some possibility of it helping the insolvency crisis.
But there’s no way no how the government wasting money will help the fundamental problem: the wealth crisis. That’s only going to be dealt with by years of hard work.
People now realize they aren’t as wealthy as they thought they were. Something like one-tenth of the national wealth was made up of ridiculous valuations of homes. That’s gone. It ain’t coming back for decades. Another, harder to estimate, fraction of the national wealth was made up of ridiculous valuations of financial instruments based on the ridiculous valuations of the homes. That’s gone, too.
They are gone because they never really existed in the first place. They were just mass delusions that 500 sq. ft. homes in Compton were worth $340,000, or that complicated mortgage-backed securities and credit derivatives based on the expectation that the guy who got the $340,000 mortgage on that one-bedroom house in Compton was pretty damn likely to pay it all off, were worth what Moody’s said they were worth.
Both consumption and investment spending up through the first half of 2007 were driven by estimates of how much we could afford based on our wealth that we now know were ludicrous. Economic activity will therefore contract to the level appropriate for our smaller level of wealth.
November 9th, 2008 at 6:00 pm
Owned a glass top coffee table once. Never again — MUCH too difficult to clean. Matt, Bush’s mismanagement of the economy has done your living room a favor.
November 9th, 2008 at 6:01 pm
Right on Omri @4. Money is not wealth. Money is now a particularly perverted symbol for wealth. It’s even perverting coffee table purchases. Is nothing sacred?
November 9th, 2008 at 6:20 pm
Re Steve Sailer’s comment “But there’s no way no how the government wasting money will help the fundamental problem: the wealth crisis. That’s only going to be dealt with by years of hard work.”
————-
Actually, even that may not be enough. There’s a heavy penalty to pay for wasting 8 years — and $6.5 Trillion — while failing to do ANYTHING to address Peak Oil , the rise of economic competitors (China, India) and the aging of the baby boomers.
There’s a heavy penalty to pay for letting religious nuts with tax-free organizations dominate US politics — and letting them be free from any criticism because criticism would be “anti-Christian”.
Personally, I think it’s about time we start feeding some motherfuckers to the lions.
November 9th, 2008 at 6:25 pm
that coffee table sucks very much. Get a better one.
November 9th, 2008 at 6:36 pm
The most sobering thought is that only fictional wealth was created during the bubble, but actual wealth and jobs are being lost as the bubble bursts. I don’t know if any economist has explained this, but my guess is that during the bubble actual wealth was transferred from ordinary people to China, Wall Street, and a bunch of over-paid company executives — leaving those ordinary people to hold the bag now.
Rectangular glass-top coffee tables with sharp corners that stick out as in Matt’s picture are very easy to hurt your shins against — more so for your guests who are not used to your space.(I have a scar from a hotel lobby glass table that proves this). Get a round one.
November 9th, 2008 at 6:51 pm
You should be the king of craigslist given your career. My family got a perfect crate and barrel large basque table for 400.
As per wealth creation and destruction… This is a much more complicated topic than anyone here is talking about. I am sorry, but the wealth was never there to start. I get back to the question “what is wealth?” and my answer doesn’t have much to do with suburbans and hummers.
November 9th, 2008 at 6:59 pm
NEVER invest money in stocks that you plan to use in the next 5 or 10 years. NEVER. Be glad you learned this while you were young.
November 9th, 2008 at 7:00 pm
I’ll bite, mickslam. What is wealth?
November 9th, 2008 at 7:41 pm
Re wiley’s question “I’ll bite, mickslam. What is wealth?”
————–
Wealth is tangible products that have REAL value.
Like Assault Rifles and large capacity magazines for them. Also, large capacity magazines for pistols.
A discussion from an online site:
“My gun show report for today is as follows.
As a friend and I pulled onto Highway 2 from 9 heading to the Monroe [, Washington] fairgrounds we hit a terrible traffic stoppage. It took 35 minutes to travel the last six miles. Every east bound car was pulling into the fairgrounds–all of them. We get there and my friend who is not a club member has to wait to pay to get in the gun show. It was a 45 minute wait line to get in. The membership enrollment section was bang up packed.
I fought my way to the ammo department for X’s AK ammo. It was all gone except for some soft point. I called him to see if he wanted some and when I went in to get it.But it had already sold. When I left the show, all battle rifle ammo was gone. It sold out in one hour.
I did not see many sporting rifles for sale for the first time in a long time.[ The dealers brought] nearly all battle rifles and semi-auto assault style rifles.
Magazine prices have already climbed by about 7 bucks per magazine with the average price now around 25 bucks. They were $13.50 each in June of this year.
There was a general air of urgency. You could feel it and it was hard to resist. It was soon evident that all the important stuff was going to be off the shelves and into closets around the county. I suspect it will be more then a month before factories can make up what has been sold around the nation in the last few days.”
November 9th, 2008 at 7:57 pm
In some circles, Don, that would be capital.
November 9th, 2008 at 8:04 pm
Re: Something like one-tenth of the national wealth was made up of ridiculous valuations of homes.
True, but why does it matter? We got along just fine, and in very recent recent memory, before the housing bubble inflated and people thought they were richer than they were.
Re: There was a general air of urgency. You could feel it and it was hard to resist.
Yes, because a bunch of dim-bulb gun-nuts think Obama’s first presidential act will be to torch the 2nd Amendment and confiscate their guns.
November 9th, 2008 at 8:07 pm
And in other circles, idiocy.
But there is some justice in having those gun-loving idiots waste their remaining wealth on guns because their talk radio hosts told them that Obama would stop gun sales. (There is justice, that is, until you think of the effect this has on their families).
November 9th, 2008 at 8:40 pm
Jasper said:
There you see a further erosion of the economy, since people with glass top tables eventually want domestic help to keep them clean. So there’s a maid service missing out on a contract due to this spiraling story…
November 9th, 2008 at 8:48 pm
Consumption that is propped up by such means is likewise an illusion.
Not an illusion. Both the glass-topped coffee tables purchased before the stock market crash and the jobs dedicated to producing and selling them are (in the case of the jobs, possibly were) real. The word you may be looking for is unsustainable, or possibly unwise.
WRT to justice for the gun-nuts families – families whose spending decisions are made by these fools were always doomed. It’s guns this year, it was MREs this time in 1999 and it will always be something. Although they’re relatively less likely to fall for the trendy glass coffee tables.
November 9th, 2008 at 9:19 pm
A lot of furniture is American made; it isn’t hard to find. An overwhelming percentage of the time salespeople will know where it was made, and if it is wood where the wood came from.
If you’re buying your first rifle you may prefer a CZ to a Ruger.
There are multiple good reasons though to buy American furniture.
November 9th, 2008 at 9:36 pm
Patrick Bateman had one of those–he found the bloodstains hard to clean off…
November 9th, 2008 at 9:40 pm
Maybe Matt was just making a point about decreased wealth and spending, but keeping the downpayment for a home purchase in the stock market is pretty risky.
Think about doing some financial planning.
November 9th, 2008 at 9:40 pm
I don’t have any strong substantive comment on this topic. But that table is a fucking monstrocity.
Really, my gay uncle would have hit that shit with a sledgie before he let it in my apartment.
What are you gonna put on that second level table? Clue? Stratego? The Conservative Soul? I dont know brother. Are you advertising your awful taste for laughs?
No offense intended. But you only really need a coffee table if you’re still smoking gange. Otherwise its a waste of open space that you’ll need when you have Matt jr. Running around.
November 9th, 2008 at 9:58 pm
Just wanted to echo chris here…Anything that you plan to purchase in the next 0-5 years is _short term_ and should be put in treasuries or short term bonds (and until you can trust moody’s, fitch and s&p again, I’d avoid corporate/muni bonds).
I had a very difficult time convincing myself of this in 2006-2007, but now, having the down payment for the home that I plan to purchase next year safely in treasuries, I am very glad that I did.
November 9th, 2008 at 10:00 pm
I know in our household things have not changed much on paper. We still both have our jobs (thank God and knock on wood!). We still make an owe the same amount we did this time last year (ish- we did get raises since then)
We probably couldn’t make much if we tried to sell our house now, but we are not selling now- so no loss yet.
We lost money in the stock market with out 401K and mutual funds, but we are a long way from retiring.
So why have we said we will visit the relatives we can drive to for Christmas, instead of the relatives that require a flight? Why are we only getting presents for kids- nothing for adults or each other?
Faith. I have no faith that what I am asked to pay is what anything is worth. Their has been so much (inflation, gouging, lying, fraud- whatever you want to call it) that I don’t feel like anything has a real value. So I save and wait. Wait until I feel like I can believe what people say again.
November 9th, 2008 at 10:10 pm
The aforementioned isn’t my own philosophy though (at least with respect to the cased goods).
Most custom upholstered furniture *is* made in the USA; this is something even the big boxes can’t offshore.
For the tables, chests, and so forth I prefer value old stuff (not yet fully appreciated but likely to appreciate in value) and local, artisan-made things. Making furniture is fun too.
November 9th, 2008 at 11:20 pm
Actually, studbaker, I’d say that “illusion” is exactly the right word. (And I’d like to congratulate Sailer for getting through three substantive grafs without mentioning brown or black people.) The jobs were created not just on the basis the tables sold, but on the tables continuing to sell. Production was expanded based on expectation…and that was an illusion.
November 9th, 2008 at 11:41 pm
TRUST FUND SCUMBAG!!!!! h/t Petey.
Yeah, I have to say, not the most attractive coffee table I’ve ever seen. Maybe it was better in real life? Anyway, hopefully, the Ikea stuff was stylishly european-looking.
November 10th, 2008 at 12:55 am
“There is a very well established wealth effect whereby $1 of housing wealth is estimated as leading to 5 to 6 cents of annual consumption.”
“But because of what was happening in the stock market it was an inopportune time to be selling shares so I sold fewer than I’d planned and bought cheaper furniture, figuring I might just buy nicer stuff later on if at some future point the animal spirits of the market drove my net worth up. Thus someone missed the chance to sell me a coffee table (pictured above) that I liked very much but that cost a lot of money. Their loss was Ikea’s gain, but that kind of decision drives GDP down.”
You sold a financial asset. I think that you prove my point, not Baker’s, that it’s the general economy that is causing this slowdown, more than the decline of buying due to the wealth effect of housing assets declining.
November 10th, 2008 at 12:58 am
Sorry. I hit the button before I was done. Your decision was based on the decline and market condition of your financial assets, not housing assets.
November 10th, 2008 at 2:04 am
I’m only a few years older than MY but I’ve been a parent so long that sadly when I look at that coffee table all I can picture is one of my kids having to get stitches on their forehead.
November 10th, 2008 at 2:40 am
I didn’t realize that the Atlantic paid enough so you could accumulate a substantial amount to invest in the stock market.
When do we get to hear about the sweetheart deal mortgage you manage to get?
November 10th, 2008 at 3:05 am
one of my kids having to get stitches on their forehead.
And that’s if they’re lucky.
November 10th, 2008 at 6:01 am
If you’re buying your first rifle you may prefer a CZ to a Ruger.
As an American whose job is currently tenuously dependent on the economic wellbeing of southern Moravia, I second this recommendation.
November 10th, 2008 at 10:05 am
Here in the North East, people aren’t spending money because they can barely heat their homes.
November 10th, 2008 at 11:01 am
“(And I’d like to congratulate Sailer for getting through three substantive grafs without mentioning brown or black people.)
Ah but then cometh paragraph four: black dude in Compton–it’s his fault. Not whitey in Reno. Dude in Compton.
Unless the fair, dispassionate statistician Sailer truly chose Compton at random (was just as likely to write Reno)…
November 10th, 2008 at 12:33 pm
a) As a young pundit, with what one can only assume is a bright future, your main holding of wealth is your future income stream. Feel free to spend on the nearly transparent coffee table. (This contrasts with the case of a retired couple. When their financial assets drop in value, they must reduce spending to maintain their standard of living over the rest of their lives.)
b) I’m not fond of that “undertable” thing. You don’t imagine ever wanting to stretch out your legs?
November 10th, 2008 at 2:40 pm
I’ll grant that the table is excellent child repellent. Friends with kids won’t consider coming over, and if you ever spawn yourself, you’ll have to sell it cheap on craigslist or blunt the corners with ugly, ugly baby-proofing bumpers.
My then-18-month-old fell against a sharp-edged TV table and got a vicious 1-inch gash on her face while we were visiting toddler-free relations. A centimeter to the left, and she would have lost an eye. Circular glass is best. Until the toddler starts dancing on it.
November 10th, 2008 at 3:13 pm
You liked that coffee table? What an idiot!
November 11th, 2008 at 2:04 am
To echo what others have said, it’s pretty stupid to invest savings for short-term goals in a long-term investment. It’s extremely galling for both Matt and Megan McArdle to have made that gaffe. They both lose a lot of credibility in my eyes.
And in a related note, liberals like to use stock market downturns to argue against investing Social Security in the stock market, but anybody within 5 years of retirement ought to have a good portion of their retirement savings moved to bonds by then.
November 11th, 2008 at 4:19 am
“It’s extremely galling for both Matt and Megan McArdle to have made that gaffe.”
Whereas in Matt’s case it is just fine — I’m just impressed this pinko has any money saved at all — in McArdle’s case it is freakin’ hi-LAIR-ious! I didn’t know that! That is awesome!
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