Who Speculates? Financial Experience and Household Participation in Asset Bubbles

Over the past twenty-five years, U.S. households have emerged as increasingly direct participants in the financial economy. This incorporation has occurred in the context of two mass-participatory asset bubbles, first in the stock market during the 1990s, and later in the housing market during the 2000s. From 1992-2001, the proportion of U.S. households with stock holdings increased from 32% to 52%, and the frequency of trading doubled. Households participated even more extensively in the mid-2000s housing bubble by taking on unprecedented amounts of leverage to purchase new homes, second homes, and speculative extractions of equity from their existing homes.

In this paper we examine the relationship between the two bubbles at the micro-level using household-level panel data that tracks financial behaviors over the period from 1994-2007. Starting from the observation that households were integral participants in each of these asset bubbles, we ask whether greater exposure to the burgeoning finance culture during the 1990s equity boom was associated with more aggressive participation in the 2000s housing bubble?

Extant theories point to two competing hypotheses. Behavioral theories suggest that exposure to the 1990s boom and bust should be negatively correlated with participation in the housing bubble. A large literature in behavioral finance shows that prior experience of market crashes mitigates speculative tendencies and prompts actors to behave more conservatively in the future. In experimental asset markets, inexperienced actors are more prone to bid up prices and induce bubbles. Meanwhile, prior experience of a boom and bust, either through active participation or passive observation, reduces one’s likelihood of overbidding in subsequent booms. This implies that the two booms were disconnected demographically.

Building on recent sociological research on mass-participatory financialization, we develop an alternative account.  Sociological arguments imply that the deepening participation of households into the financial economy has brought with it new repertoires of action. We suggest that the stock boom laid the micro-foundations for the housing bubble by constructing a cohort of financialized subjects. As the rising stock market attracted households who wanted to be part of the “new” economy, it created the expectation of high returns and a sense that people could succeed by capitalizing on financial strategies. Those who participated in these markets became more comfortable with risk-taking and more attuned to financial opportunities. Rather than retreating in aftermath of the 2001 stock market crash, those who had exposed in this “brave new world” responded by looking for the next boom and making sure they got in earlier. In contrast to the behavioral theory, this account implies a complementary relationship between the two bubble at the micro-level.

We test these alternatives using data on the financial behavior of 4500 households from 1995-2007. Data come from the PSID survey. We report the results of panel models in which we estimate the effect of exposure to the stock market boom and bust on the likelihood of pursuing aggressive investment and borrowing behavior during the housing bubble.