Savings and the Housing CrisisOctober 2, 2008
One of the common explanations for the current housing crisis, and the subsequent sub-prime mortgage mess is that the U.S. was inundated with cheap money from overseas, a world “savings glut” that depressed interest rates and facilitated reckless lending. There is a great deal of merit to this argument. There can be little doubt that U.S. interest rates were made low by the inflow of foreign capital, and that this contributed to consumers headlong rush into debt. It also helped create the business environment in which some of the more exotic, and risky, lending instruments looked safer than they were.
But this explanation is often put forward as the whole story when in reality it is a glass half full.
Americans also contributed to the current economic demise by having insufficient savings. Yes, there was a lot of capital (savings) sloshing around the economy, but precious little of it was coming from the bank accounts of U.S. households. If Americans would have had more savings, some of that savings would have been used to put down payments on houses. Instead of the millions of homes sold with essentially no money down many of these homes would be owned by people with equity stakes right from the beginning. Why does this matter? It matters because if you have a 20% equity stake in your house and prices fall you are a whole lot less likely to walk away from your house, allowing it to be foreclosed upon, than someone who has no stake and finds themselves with negative equity when prices fall. Giving up on nothing is easier than giving up on something. The housing market collapse has fed its downward spiral with this nothing, the savings that never happened, the down payments that never existed.
When I wrote “Whatever Happened to Thrift” I discussed the posibilities of downward economic spirals fed by this lack of savings. It occured sooner than I had imagined. I suspect savings rates will tick up in the coming months. History teaches that countries that go through tough times save more money. We are about to learn thrift the hard way.