Wealth effect is anything but – as rising home values and stock market portfolios encourage people to spend more

Posted on 23. Jun, 2010 by in News

Garry Marr, Financial Post · Tuesday, Jun. 22, 2010

There is something about our stock portfolios and homes being worth more that makes us want to spend.

“It’s called the wealth effect. If you feel you have more, you are more willing to spend more,” says David Onyett-Jeffries, an economist with Royal Bank of Canada.

“When people see their house value increase, they are more willing to spend because there is less requirement to save. They view these assets as being marketable and gaining value.”

Statistics Canada said this week that household net worth increased by 1.3% in the first quarter to $6-trillion — a fourth consecutive quarter of improving wealth. Household net worth has recovered 96% of what was lost during the recession.

The improvement is part better stock market performance, part stronger housing market.

Guess what else is happening: Personal liabilities are also growing. Household debt was also up 1.5% in the first quarter to $1.4-trillion, with a $16.4-billion increase in mortgage debt leading the way. Household debt to personal disposable income is at a record high of 148.9%, up from 147% a year ago.

So, it is not surprising the savings rate was down to 2.8% in the first quarter, according to Statistics Canada.

“Historically, it had been trending down to about the 2% range” before the recession, Mr. Onyett-Jeffries says. The savings rate is calculated as a percentage of personal disposable income.

For context, in the early 1990s, the savings rate was closer to 10%. It had been declining steadily until the recession hit, then it shot up to about 5%.

“It’s hard to quantify what is the appropriate amount to save,” Mr. Onyett-Jeffries says. “But if you look at the debt side, we are beyond where we were before.”

If there’s any consolation, Americans are worse off than Canadians. At the end of the first quarter, household debt to personal disposable income was 172% in the United States.

Vince Gaetano, a broker with Monster Mortgage, says he has already witnessed people trying to access the equity in their homes now that prices have gone up.

“They’re trying to do it before there is a correction in the real estate market,” he says, adding clients have been increasing their lines of credit to take advantage of their increased home value.

David Phipps, a certified financial planner with Assante Capital Management in Ottawa, says his clients have not modified their spending habits because they remain skittish about market values.

“Yes, the market did recover but recently we’ve seen problems in the stock market. Most people are somewhat conscious of the uncertainty that remains in the equity markets. Among my own clients, I have not seen the sort of mentality that you would normally see in a bull market,” Mr. Phipps says.

It is true there are a large number of Canadians parked in neutral, sitting on large amounts of cash in their investment portfolios — or close to cash — and unwilling to spend.

But the evidence also points to a growing tendency to take on more debt. Scott Hannah, president of Vancouver-based Credit Counselling Society, said out of a sampling of about 5,000 people in the country’s four western provinces, the average debt of clients approaching his group for help was almost $24,000. A year ago it was just $22,000.

He says increased net worth has led to overconfidence. “There is a feeling that everything is OK. I don’t believe things are OK. The only thing we can count on is uncertainty and we need to plan on that basis,” Mr. Hannah says. “But you look at what people are spending and what they are putting away for retirement and it’s pretty scary.”

A year after the recession, it’s almost as if it never happened.

“Maybe the recession wasn’t long enough to institute good money management, because bad money management is rearing its ugly head again,” Mr. Hannah says.

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