Wednesday, August 01, 2007

 

Financial Insecurity And The Rise Of Real Estate

The effects of the recent real capital appreciation on income.
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There is a segment of analysts, in Real Estate Economics, that worries about consumers financial insecurity. More specifically they contend that the average middle class has seen few effective gains from the recent boom in real estate, since as profits have soared inequality has widened. Because of this, the standards of living of most people are more precarious than they used to be, because incomes have become more volatile. They argue that the defining economic shift of recent times has been the increasing instability facing households in North America. While income inequality – the gap between the highest and lowest earners – has risen sharply due in large part to the appreciation of real capital assets, income fluctuations have increased even more dramatically.

Examining stack after stack of economic data, they conclude that the average North-American household has a 17 percent chance of seeing its real and effective income drop by more than half from one year to the next, and that the painful consequence of this all is to be seen in the higher personal bankruptcy rates as well as in the rising number of home foreclosures. In sum, they conclude that income volatility is undesirable and excessive.

Rising income instability, however, is not necessarily a bad thing. A dynamic, mobile society is one in which people's income varies a lot. Milton Friedman pointed out that living standards should be affected only by permanent changes in their income, as short-term fluctuations are smoothed out by borrowing and saving. The fact that real capital assets have appreciated so dramatically and that, in turn, household saving rates have plunged does not necessarily suggest that consumers are now terrified by the spectre of more variable incomes. In fact, the opposite is more likely to be true. The increased sophistication of credit markets and, particularly, the ability to extract equity from housing has made temporary income instability easier to cope with.

There is little doubt that household incomes are more variable than they were a generation ago, but this argument is nuanced. It is not clear, for example, that rising bankruptcy rates have much to do with income instability. In fact, economic mainstream theory suggests that most people's consumption varies as permanent income changes, but barely responds to temporary shocks. Only poor people, who are less able to borrow, are affected by temporary changes in income.

In this respect, therefore, the recent appreciation of real estate works as a safety net for most consumers as against specifically what some analysts seem to be worrying so much about – financial insecurity.

Luigi Frascati

luigi@dccnet.com
www.luigifrascati.com

Real Estate Chronicle

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