Fluctuations in home values influence Americans' spending decisions more than changes in financial wealth, according to a recently released study by researchers at two California universities.
That's because shocks to financial and housing wealth hit aspects of consumption differently, according to the study’s authors: Gary Painter, director of research at the USC Lusk Center; Raphael Bostic, associate director of the USC Lusk Center; and Stuart Gabriel, director of the UCLA Ziman Center. Their study is based on household wealth data from the Survey of Consumer Finances as well as data on household consumption and demographics from the Consumer Expenditure Survey.
The researchers suggest that declines in financial wealth (i.e., investment or retirement accounts) tend to impact the purchase of durable goods such as houses or cars more than overall consumption. In contrast, declines in real estate wealth (i.e., the value of one's home) appear to drive down total consumption, the study reports. “Consumers react more radically to changes in their housing wealth than to changes in the size of their bank accounts,” Painter said in a statement.
Why? According to the study, people tend to misjudge their financial wealth and know that they miscalculate it. In contrast, homeowners find it easier to measure their home’s value and therefore react to it more strongly when those figures change.
Given the massive run-up in housing values and the relationship between real estate wealth and consumption, the study’s authors draw some stark conclusions about the coming years and the impact of declining household wealth on U.S. consumers. “The recent housing price declines reinforce the extensive losses in the stock market and layoffs in the financial and automotive sectors,” said Bostic in a statement. “Taken together, they increasingly suggest that there will be longer-term effects for the U.S. and global economies.”
Those affects could be painful for consumers and builders alike. According to the study's authors, a 10 percent drop in housing wealth from 2005's levels could result in a $105 billion contraction in personal spending That type of decline could shrink the country's gross domestic product, the researchers suggest, which would negatively affect the already-struggling economy.
Ethan Butterfield is senior editor, business, at BUILDER magazine.