I feel wealthy: A major determinant of Portuguese households' indebtedness?

The recent economic and financial crisis has raised significant concern about the level of households' indebtedness and over-indebtedness in several European countries. The extent to which this high indebtedness levels are the result of a rational behavior in which households are smoothing consumption over time, as predicted by economic theory, became a question of major concern. Studies from the field of household finance (e.g. Campbell, 2006) indicate that the majority of households know their economic constraints, avoiding risky financial strategies and investing effectively.

Regarding Portuguese households, it is well understood that home ownership is the main contributor to indebtedness, a remark that could be extended to several European economies (ECB, 2014). In Portugal, almost non-existent lending compelled individuals to buy their own premises. Home ownership was handled as a non-risky asset along with forced savings, guaranteeing retirement and assuring an estate to the offspring. Capital market dynamics nourished this wealth and savings dynamics through the continuous valuation of Portuguese dwellings at the same time that a perceived increase in wealth based on a highly illiquid asset – housing – diminished the need to save.

In this paper we investigate the features of Portuguese households that hold debt and how Portuguese households' indebtedness can be related to macroeconomic fundamentals, namely the high valuation of the housing sector that occurred in the last decades.

Using data from the first wave of the Household Finance and Consumption Survey we estimate a logit model for the probability of holding debt controlling for households' economic and socio-demographic characteristics, adverse changes, and pessimistic and optimist expectations, and taking into account the perception of wealth accumulation that emerged from the strong price surge in the housing sector. Additionally, we estimate the probability of holding mortgage debt, any other type of debt, and of holding excessive debt levels by using standard literature criteria for the definition of over-indebtedness. Our main purpose is to understand if the surge in perceived wealth could have been translated into an increase in indebtedness.

Results indicate that a wealth perception effect is particularly evident in the probability of contracting non-mortgage debt, but that this effect is mitigated in the probability of holding mortgage debt and in the probability of incurring an excessive debt burden.