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The benign neglect of the individual households' equity crisis

De Koning, Kees (2014): The benign neglect of the individual households' equity crisis.

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Savings are allocated over the acquisition of assets like homes, shares and bonds and government debt paper. For a home acquisition an individual household uses own equity provided by the buyer and outside equity provided by banks. Such outside equity can help to increase the volume of new housing starts, but it can also drive up the prices of all homes. The crisis of home asset prices started already in 1997 in the U.S., but accelerated in 2002 and reached its breaking points in 2005-2006 when 65% of the new outside equity was used to increase house prices rather than the volume of housing starts. From 1997 house prices were rising faster than the CPI index, while over the period 2000-2006 incomes just kept up with the CPI index. The value of savings out of the increased income levels were worth less and less in purchasing power as compared to the asset price movements. The savings depreciation factor was 34% over the latter period. Both the Houses of Congress and the Fed had a policy of benign neglect of the growing gap between asset values and incomes and savings developments.

Banks did not take the savings depreciation factor into account and undervalued their real risks to their portfolios and substantially overvalued their profits for 2005 and 2006. The mortgage securitisation process transferred the risks in a substantial manner to European savers, which did not diminish the risks of the savings depreciation factor, but only changed the providers of the savings.

This article focuses on the relationships between incomes, savings, and assets. It focuses on own and outside equity and makes a distinction between savings which help output and economic growth -economic savings- and those that don’t -financial ones

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