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Friday, December 14, 2007

"The Reverse Wealth Effect"

It's been said that the difference between childhood and adulthood is financial worry. Children are of course troubled by family insecurity, but the gnawing weight of financial distress really eats away at the responsible adult(s).

We all know financial distress is highly stressful, and that chronic stress is a killer. Though this is hardly news, it is also largely ignored; thus The San Francisco Chronicle's recent feature on the topic was most welcome: Stress makes us depressed, fat, sick - and we do it to ourselves.

It may be difficult for younger people who have only known prosperity and shallow, brief recessions like 1991 to know just how wrenching a "real recession" like those of 1973-74 and 1981-82 can be. I vividly recall the headline in 1973 announcing that General Motors was laying off 100,000 workers that weekend.

In 1982, unemployment was officially over 10%, and unofficially about 15%. In recent years, most of the unemployed soon find some kind of paying work; in a "real recession" jobs dry up almost completely and so the unemployed stay unemployed. Since there is about 130 million jobholders in the U.S., a 10+% unemployment rate would mean 13 million people were out of work. Most of those laid off will experience financial worry--as will their dependents.

Let's consider all the feedback loops which are starting to reinforce each other.

1. Housing and the Reverse Wealth Effect. Since a house is the largest asset in most American households, any rise or decline in the home's value has a profound effect on our deepest sense of financial well-being. When our house appreciates, it makes us feel wealthier, hence the name for this phenomenon, "The Wealth Effect." When people feel confident in their financial future, they tend to spend freely.

But the Wealth Effect has a flip side, called "The Reverse Wealth Effect". When housing declines in value, people feel poorer, even when the decline has no measurable effect on their actual income or bank balances.

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