Joseph B Nichols 2008 NASM of the Econometric Society June 21, 2008 How Do Local Housing Market Cycles Affect Long-Term Wealth Accumulation? Joseph B Nichols 2008 NASM of the Econometric Society June 21, 2008 Note: The analysis and conclusions expressed herein are those of the author and do not necessarily represent the views of the Board of Governors of the Federal Reserve System and its staff.

Why? The role of housing wealth in explaining consumption has been explored extensively in recent years. This paper explores the same question from the opposite direction. What is the role of housing wealth in explaining the accumulation of financial wealth? How can we isolate the impact of housing wealth on the accumulation of financial wealth?

Housing Wealth and Financial Wealth Where does housing wealth go? Remain untapped in the home. Extracted to support consumption. Extracted to rebalance portfolio and increase financial wealth. Use to fund an increase in housing consumption by trading up or moving to an area with higher home prices.

Endogeneity Housing wealth and financial wealth are highly correlated with same set of household characteristics. In order to test for the impact of housing wealth on financial wealth we need an instrument correlated with housing wealth but not financial wealth. Housing market conditions at time of last transition from rent to own. Is the decision to transition from rent-to-own independent from state of local house price cycle? Assumption is that changes in family structure, i.e. household formation or additional children, are a larger factor than market timing.

How Use geographical variation in housing markets. Is there a long-term negative effect on financial wealth from buying your first home at the top of the market? Is there a long-term positive effect on financial wealth from owning a home during a period of strong appreciation?

Data OFHEO state-level, quarterly, repeat-sale house price indices, 1975-1999. PSID household files, 1975-1999. PSID wealth supplement, 1989, 1999.

Sample Selection Households who are homeowners in 1989 or 1999 and transitioned from rent to own between 1975 and 1999. Exclude small number of outliers based on inconsistent data between panels. Exclude observations with missing data. 1,752 observations 1999 sample. 2,021 observations 1989 sample.

Independent Variables Log(Total Wealth) Log(Housing Wealth) Log(Financial Wealth) Housing Wealth/Total Wealth

Dependent variables “Over-pay” for initial home Year-to-year percent change of state repeat-sales index at time of last rent-own transition was more than one standard deviation above the long-term average for that state. “Under-pay” for initial home Year-to-year percent change of state repeat-sales index at time of last rent-own transition was more than one standard deviation below the long-term average for that state. Annualized change in state repeat-sales index over the last completed owner-occupied tenure period.

Dependent Variables Number of moves between 1975 and 1989 or 1999. Age, Age2, Marital Status, Education Level, and Race as of the 1989 or 1999 survey. Control for endogeneity by including measures of permanent income. Log of average income, 1975-1999. Average rate of income growth, 1975-1999.

Base Model Results Demographic variables as expected Higher income, high changes in income, married, and older households have more wealth. Number of moves reduces total wealth Reflects transaction costs – inability to find good job match earlier on. Households who buy high have lower wealth, both housing and financial. Change in local home prices not significant. Little success in explaining portfolio allocation. Results from 1989 sample consistent, if less robust.

Is Rent-Own Transition Independent? Criticism : Households who buy their first home at the top of the market have less financial acumen, shorter time horizons, and/or are more impatient than those who buy at the bottom of the market. Such households would accumulate less wealth throughout the life-cycle regardless from the impact of local house price cycles.

Response Regress measures of permanent income on timing dummies. If criticism valid, those who buy high should have lower permanent income as well as less wealth. Choose alternative timing dummy. Household add child when local house prices high/low.

Permanent Income Model Results None of the timing dummies are significant. Number of moves positive for change in income and negative for level of income. Moves motivated to improve job match. Those with good early job match have high income and no incentive to move. Change in home prices positive for high income. Areas with high income also have high earnings. Results from 1989 sample largely consistent. Buying low positive for level of income.

IV Model Results Wealth higher for households who have children when prices low. Change in home prices negative. Similar to results in base model. Result of sample bias? Younger households who sell there home are forced to by financial conditions. Results less clear for 1999 sample Although household who had child when prices low hold more of portfolio in housing.

Conclusions Households who “over-pay” for their first home have significantly less housing and financial wealth later in life. No significant results in explaining household portfolio composition. Suggests households actively re-balance. Little evidence that decision to transition from rent-to-own tied to higher human capital. Alternate results with IV support conclusion. Extensions Improve power of tests by using MSA rather than state house price cycles. Examine effect of house prices and tenure changes on changes in wealth between 1989 and 1999.