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Robert Samuelson wrote a recent piece arguing that part of our current economic woes are due to a new widespread risk aversion, which prompted Matt Yglesias to write that the risk aversion is not new. He argues that the large investment in housing in the post dot-com bubble world was a in fact a result of people becoming risk averse and seeking the relatively safe investment vehicle of housing. There may be some truth to this, but I think an equally compelling story is that people were seeking returns rather than avoiding risk.
After 2004 or so it’s hard to picture someone putting their money into housing in Florida, California, Nevada, or Arizona out of an increased aversion to risk rather than seeking increased returns. Of course, a more complete description is to say that both perceived risks and returns motivated homeowners, but what changed the most was the expected returns went up a lot while expected risk did not, so I think this is best characterized as chasing returns rather than avoiding risk.
On the other hand, there were surely many potential homebuyers who were planning on buying housing in the later in the future but bought during the bubble to avoid the risk of being priced out of the market. For these homebuyers, Matt would be correct to call them motivated by risk aversion, but even here they are motivated by changes in risk/return to housing rather than a change in the risk/return of equities.
As has been pointed out many times on this blog and elsewhere, you’re born short on housing and so fully modeling the rent/buy decision and the subsequent level of housing consumption are both tricky. Nevertheless, I would say the best simple explanation for what changed in homebuyer behavior over the past decade was perceived increase in the expected returns to housing investment, rather than an increase in risk aversion.
I hope the long-run takeaway from the housing bubble is that individuals learn that you can’t simultaneously seek outsized returns and avoid risk at the same time, which if both Matt and I are partially correct is exactly what was happening. I have a friend who is a financial advisor who says that when he’s seeking new clients, some will be hesitant about whether they need his services because, as they brag, they got 15%+ returns on their portfolio last year. This is one thing to hear from someone who is young, but he tells me it often comes from people at or past retirement age.
If you are someone who is getting ready to retire, and you see 17% returns on your portfolio you should be terrified, not proud, because the investments which you will shortly be living off of are clearly exposed to large amount of risk. There is no magic that brings large returns without risks. Where you see one, there will almost certainly be the other. So if you don’t like huge risks, be wary when you see huge returns.