More Savings Commitment Devices Needed

Felix Salmon has a great summary of the Eli Beracha / Ken Johnson paper showing (PDF) that buying a home is rarely a good investment decisions. But to summarize even more briefly, their key point is that you either rent a house or else you rent money from a bank to buy a house with, so you can’t avoid “renting.” They show that the vast majority of the time, you’d do better to rent a house and invest the extra money you come out ahead. But as Salmon explains, though true, this sort of misses the point:

To put it another way, a mortgage is a commitment device. You’re forced to spend all that money on your mortgage each month; if on the other hand you rent, you’re very likely to simply spend the excess, rather than save it. The e21 people reckon that only “myopic households” would not otherwise save the difference, but that’s just not realistic. People stretch to make their mortgage payments, and without the mortgage there there’s no need to stretch so hard, and you can enjoy your life more instead — go out, go on holidays, buy nicer clothes or extra iPads.

But the exercise in the paper is well worth running all the same. People get real value out of consumption, and so when you buy rather than rent you’re essentially denying yourself all that extra fun and pleasure. And if you both rent and deny yourself the extra fun and pleasure, then you’ll end up with more money than the buyer.

In other words, people who save via investing in their own home are paying a penalty vis-a-vis people disciplined enough to save an equal amount of money through other means. Which makes sense. Many of us are mildly present-biased in our decision-making, and thus benefit over the long term from bearing mild costs to overcome that myopia. But from a policy perspective, the interesting question this raises is what more can we do to provide people with other kinds of convenient commitment devices? I used to hear a lot of discussion about flipping the default on 401(k) plans so that you would start a job with your contributions set at a high level, and then you’d need to take active steps to save less money. That seems to make sense.