Sunday, June 24, 2012

Saving Houses

About two weeks ago, various US news outlets reported that median US net worth declined about 40% between 2007 and 2010. That puts wealth levels for the 50th percentile of American households at 1992 levels. 

20 years of wealth accumulation gone in 3. Certain political pundits decried this as the erosion of the American dream. And many of them acted as if this was some huge scandal. Fingers were pointed and goats scaped, but the reality doesn’t measure up with the fiction. The truth is much more mundane and vaguely dispiriting.

Take a look at the Case-Shiller Index, which tracks the aggregate price levels of 20 major US real estate markets.

 Compiled in MS Excel using data from Standard and Poor’s

Uncanny isn’t it? Home prices declined 30.3% during the same time period. The correlation I’ve just pointed out suggests that the wealth decline of the 50th percentile is almost entirely attributable to the decline in home prices. 

The vast majority of most Americans’ wealth is tied into their home equity. For decades, the American dream was symbolized as a nuclear family with 2-3 children, a single family home, and a pair of automobiles. A brokerage account usually didn’t factor in that particular dream.

And it’s a pity that it didn’t. Because the S&P 500 declined only about 3.3% during that 4 year span. And if you had half of your portfolio in a mix of investment grade bonds, you’d actually have a small positive return.

Since 1950, housing prices have tended to rise at the rate of inflation. During that same time, Treasurys and the S&P 500 index have both vastly outpaced inflation. The reason why is simple.

Stocks and bonds are a means of raising money for investment for economic activity. Investments grow the economy. A growing economy allows the people who used that money to repay their lenders and investors from an economy that was larger than what it was before the investment.

But real estate is someplace that people live or work in. It has a primary purpose that isn’t directly related to investing. It’s unrealistic, as a whole, for real estate to serve its primary purpose and also appreciate beyond the rate of inflation. The strength of an economy is not measured by real estate. It’s measured by the activity that occurs within that real estate.

When President Bush pushed his “ownership society”, he wanted Americans to own houses. That was his (and, admittedly, a lot of others’) version of the American dream. But it’s becoming increasingly clear that that version of the American dream doesn’t work for most people. 

But I think he did have the right idea. Americans need to own things. In lieu of owning houses, perhaps Americans should consider owning stocks and bonds.

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