Are Economic Theory and Housing Equity
Withdrawal Behaviour at Odds?
An Application of Mental Accounting
Kenneth Gibb and Alex Marsh
Housing Studies Association
York, April 2012
Overview
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•
•
•
•
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Received view of income, wealth
and consumption implies
households optimise across the
portfolio and smooth over life
cycle
Financial innovation has resulted
in housing wealth becoming
more liquid
More liquid housing wealth
offers opportunity to smooth via
overpayment, equity withdrawal
and equity release products
By allowing smoothing such
innovation is welfare-enhancing
Does the evidence support the
received view?
An alternative framework –
Richard Thaler’s mental
accounting, a core element of
behavioural economics – may be
helpful
What are the implications for
housing economics, research and
policy?
HEW £b cash
90
70
50
HEW £b cash
30
10
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
-10
-30
Source: Pawson & Wilcox 2011 UK Housing Review.
Structure of the Argument
• The standard view on consumption, wealth
and income, smoothing and its applications to
housing economics
• The evidence on equity withdrawal
• Behavioural economics and mental accounting
• Re-interpreting the facts and their
implications for policy, innovation and market
behaviour
• Conclusions and further research
‘A simple formulation of the life cycle savings
hypothesis suggests that consumers will
distribute increases in anticipated wealth over
time and that the marginal propensity to
consume out of all wealth, whether for stocks,
real estate, or any other source, should be the
same small number’
Case, Quigley & Shiller, 2005, p.332
Consumption, income
and housing
Case, Quigley & Shiller (2005) in
Advances in Macroeconomics 5(1)
Carroll, Otsuka & Slacalek (2006)
German Institute for Economic
Research, October
Bostik, Gabriel & Painter (2006)
Lusk Center for Real Estate USC,
July
Englehardt (1994 JUE vol. 36) and
RSUE vol 26 1996)
Thaler (1990) Journal of Economic
Perspectives
Thaler (1999) Journal of
Behavioural Decision Making
Wilkinson and Klaes (2012) 2nd
edition of Introduction to
Behavioural Economics
Anager (2012) A course in
behavioural economics
• Consumption as a function
of current income,
modified to consider:
- relative income
- permanent income
- life-cycle income
- recent developments
• Do economic agents
smooth their consumption
over their lives? How do
they do this? Do they use
liquid housing assets?
Economics literature
• US evidence since the 1980s suggests positive but varied effects on
consumption from rising housing wealth; also that rising housing
wealth may increase renter savings towards a down-payment (i.e.
reducing consumption)
• This has helped to explain the ‘savings puzzle’
• Evidence from Germany, Japan, Canada and UK broadly in support
• Case et al, recognising the mental accounting thesis, argue that long
term international and US state evidence suggests that mpc out of
housing wealth is 0.4 but only 0.1 for stocks.
– Other studies (Carroll et al found figures of 0.9 and 0.04 respectively, Bostik et al
found housing assets had three times a bigger effect on Consumption than
financial assets)
• Mixed evidence of symmetry i.e. housing wealth falls may lead to
equivalent falls in consumption while increases have smaller effects in
the other direction (e.g. Engelhardt, 1996)
• Question remains to housing wealth holders behave like economic
agents in life cycle and permanent income model worlds?
HEW in the UK
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HEW required financial
deregulation of mortgage market
Recognition in the late 1980s that
HEW was big enough in booms to
affect aggregate consumption
Early debates about the impacts of
HEW on lifetime spending and
savings, as well as inheritance
Strongly pro-cyclical, capable of
going negative (net debt
repayment) and closely follows
house price change
Counter-arguments that debt is
someone else’s asset and
therefore the effect is much less
important that it appears
Currently HEW is historically at
record negative levels (and
therefore reducing agg
consumption) of more than £34
billion in 2010
Doesn’t look like lifetime
smoothing!
25
20
15
year
HEW as % of total
Consumption
10
% house price change
(annual)
5
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
0
18
-5
Source: Pawson & Wilcox, 2011, UK Housing Review
Mental accounting and
behavioural economics
• Growth of BE:
– heuristics that ‘explain’ choices that deviate systematically from
optimal expected utility outcomes
– time inconsistent preferences
– bounded rationality
– group behaviour e.g. herds or shoals
– impact on many sectors of economics e.g. finance, policy making (the
‘nudging’ industry)
• An alternative to Expected Utility – prospect theory with its
focus on:
– relative not absolute gains or losses (the importance of reference
points)
– Losses valued roughly twice as highly as similar sized gains
– both gains and losses display diminishing sensitivity
– loss aversion [where most housing interest has been focused]
– Thaler’s mental accounting is an explicit application of prospect
theory
Source: Wiki Commons
Key Features of Mental Accounting
• Thaler: ‘The set of cognitive operations used by individuals
and households to code, categorise and evaluate financial
activities’ (1999, p.183)
• MA, rooted in prospect theory, designed to understand and
overcome anomalies in behaviour:
– non-fungibility (“Money is money”; substitution between different income
sources or spending decisions),
– self-control issues,
– loss aversion,
– wealth budgeting – is consumption overly sensitive to current income? Too
difficult to ‘solve’ for future income? Cf: financial market investments and
narrow framing
• Choice bracketing – opening and closing accounts, sunk costs
and payment decoupling
Mental Accounting Matters
• Policy implications (also relates to bounded rationality):
– DellaVigna (2009) – firms know better than consumers
– biases reduced where aggregation might cancel them out, where
experience and expertise matter, as does competition
• A re-interpretation of equity withdrawal: MA and the HEW
evidence suggests that LCH and PIH may not be good
representations of how we spend, save and plan our finances.
This raises wider questions e.g. our confidence in income
elasticity measures, let alone macroeconomic forecasting
• Re-thinking financial innovation – MA may explain low take-up
on equity release
• Methodological and research design questions – how can we
best ‘do’ research on MA?
Conclusions – going forward
• Recap of argument
• This is just an indirect analysis re-interpreting
the evidence and the literature
• We are pursuing empirical strands to this
programme:
• micro panel household data
• qualitative analysis of newly purchasing/selling households
in Glasgow and Bristol project underway
• long term ambition to fund a major household survey