Sue Kirchhoff
USA Today
A home in Altadena, Calif., is offered at a reduced price. The housing slump’s impact on future consumer spending is a subject of increasing debate.
WASHINGTON — Will the housing slump level consumers?
Economists are debating whether a sharp drop in home sales and price appreciation will depress consumer spending, which is about two-thirds of the economy. The theory is that a sharp rise in home equity helped push spending up faster than income starting in the late-1990s until last year. Now, as the housing market sours, consumers not only feel less wealthy, but have less equity to use for other spending.
Some businesses say they are already seeing the fallout of falling home sales and what could be the first dip in national median home prices since the late ’60s.
“All you have to do is look at those states that have the most distress in housing; you have the biggest decline in auto sales,” says Mike Jackson, CEO of AutoNation, the nation’s largest auto retailer.
“In the first quarter, while industry sales were down 4%, California and Florida were down 14%. What’s different about California and Florida? It’s clearly housing. Both markets were overstimulated,” Jackson says.
Others call a recent rise in credit card debt another sign that consumers are having to find other, higher-cost means to support their spending.
However, Jim Paulsen, chief investment strategist for Wells Capital Management, notes that mortgage equity withdrawal peaked in 2005. Since then, the housing market has tanked, but overall consumer spending has held up, growing at a nearly 4% annual pace in the past six months. He thinks home equity gains may have supercharged the housing market by letting people trade up to better homes, but they didn’t rev up other parts of the economy.
“It massively ballooned housing, and when it went away, it busted it, but I don’t think it’s done much for consumption,” Paulsen says.
Wealth effect boosts spending
Home values can play into consumption a couple of ways. Rising appreciation makes those who own homes feel wealthier and reduces the need to save for the future. The Congressional Budget Office in a January report said research indicates an increase in home value increases consumer spending every subsequent year, with estimates ranging from $20 to $70 in increased spending for every $1,000 increase in price.
Consumers also have the ability to tap equity through refinancing, home equity lines of credit or other loans. There is less consensus on the impact this has had or could have on spending.
Former Federal Reserve chairman Alan Greenspan and Fed economist James Kennedy in a recent paper estimated that consumers pulled an average of $530 billion in “free cash” from their homes annually from 1991-2005. Of recent cash-out refinancings, 17% was used for personal consumption and 27% to pay other obligations. The paper noted the impact of the housing market in lower savings.
Goldman Sachs economist Jan Hatzius in a recent research note asked why consumer spending had been so robust despite the fact mortgage equity withdrawal has dropped from $908 billion in 2005 to $646 billion in 2006. He pointed to offsets from the rising stock market, strong income growth and the fact that wealth effects will be felt with a lag. Hatzius estimates real growth in consumer spending will slow to 2% to 2.5% for the rest of 2007.
Cash-outs have not stopped
Some caution that while mortgage equity withdrawal has declined, it’s hardly disappeared. Mortgage giant Freddie Mac says consumers cashed out $70.5 billion via refinancing in the first quarter of 2007, compared with $77 billion at the end of 2006. Most of those pulling cash from their homes owned them more than three years and had average appreciation gains of 24%. Freddie Mac expects cash-outs to keep declining, though staying above historical averages for many months.
Housing wealth effects “play out gradually, and there’s great debate about exactly how large they are,” says Scott Hoyt, economist at Moody’s Economy.com, saying the impact will be felt in the second half of 2007 and into 2008.
Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University, cautions that future cash-out refinancings could get tougher as the housing market stumbles. Problems could also worsen if the turmoil in the subprime mortgage sector hurts the mortgage bond market.
“A weaker housing market exerts a negative effect, but only a small one, on consumer spending,” Congressional Budget Office director Peter Orszag said Wednesday. “In the absence of a substantial further fall in housing prices, we expect the effect on consumer spending to remain relatively small.”
