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Financial crisis, economic crisis and individual households' income and savings crisis

De Koning, Kees (2014): Financial crisis, economic crisis and individual households' income and savings crisis.

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Abstract

The world’s financial crisis happened in 2008, but the U.S. individual households’ income and savings crisis happened before that: the latter one was already at crisis point in 2005 and 2006.

The key of any analysis about the households’ income and savings crisis should start with the distinction between equity (=savings) accumulated out of an individual household’s own income and equity (=savings) provided by other households to the individual household as a supplement to an individual household’s own income and savings. In the case of the purchase of a home: is the outside equity helping to increase the volume of new housings starts or does it increase the price level of all homes above the CPI inflation level? In the latter case the outside equity reduces the value of the own equity. This is not because the asset has not increased in price on the open market, but because the savings out of income have a lower value to acquire such an asset. If incomes increase with CPI inflation and house prices increase at a faster rate, than for every new home one needs more equity, thereby reducing the value of the savings as compared to the previous period. If the costs of the outside savings go up due to a central bank’s increase in interest rates, especially when the home owner is on a variable interest rate mortgage, the value of the equity out of the owner’s own income drops further.

This value reduction in own equity is a gradual process; in the U.S. it happened over de period 2000-2006. In 2005-2006 65.5% of all outside equity in U.S. homes was used to inflate house prices over the CPI rate. The individual households’ income and savings crisis had reached its breaking point.

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