by Bill McBride on 6/22/2009 09:39:00 AM
Monday, June 22, 2009
Here we go again on this hotly debated topic: How much do changes in house prices impact consumption?
Charles W. Calomiris of Columbia University, Stanley D. Longhofer of the Barton School of Business and William Miles of Wichita State University argue at the WSJ Real Time Economics blog that the wealth effect of housing has been overstated: The (Mythical?) Housing Wealth Effect
...[M]any still fear that lower home values will depress consumer spending. This “wealth effect,” a drop in home values that causes consumers to cut back on purchases, is thought to dampen economic growth and hamper any recovery.I haven't read their paper (update: I have a copy).
At first glance, it seems reasonable to expect such a wealth effect. If consumers are less wealthy because of declines in the value of the assets they own, whether they be stocks or their homes — it seems logical that they would cut back on their spending. Indeed, many prominent economists have conducted research purporting to find large housing wealth effects, and often argue that the wealth effect from homes exceeds that from equities. Moreover, the Federal Reserve employs a model, which presumably guides its policies, that assumes the housing wealth effect is large.
A more careful look at the data, guided by economic theory, however, suggests that much of this evidence has been misinterpreted and that the reaction of consumption to housing wealth changes is probably very small. ... an increase in house prices raises the value of the typical homeowner’s asset, but such a price increase is also an equivalent increase in the cost of providing oneself housing consumption. In the aggregate, changes in house prices will have offsetting effects on value gain and costs of housing services, and leave nothing left over to spend on non-housing consumption.
Up to this point, we have neglected the question of whether housing wealth change affects consumption through another, indirect channel — a financing channel — by affecting consumers’ access to credit.
[CR note: this is MEW or the Home ATM]
... Some observers point to the latest housing boom, and the increased use of HELOCS and other mortgages during the boom, as evidence that housing prices spurred consumption through this financing channel. While this indirect financing channel is a theoretical possibility, it is an empirical question whether it is significant in its effect, and even if the indirect financial effect is present it should not produce a “first-order” effect of housing wealth on consumption; housing wealth should still matter much less for consumption than other forms of wealth.
... We put the data through numerous robustness checks, and found in most model specifications housing wealth had zero effect on consumption. In those few cases where housing wealth did have an impact on consumer spending, the impact was always smaller in magnitude than that from stock wealth, contrary to Case, Quigley and Shiller’s findings. We conclude that the impact of housing wealth on consumption, if it exists at all, is much smaller than popularly feared.
There are two parts here: 1) how do changes in house prices affect consumption, and 2) how does access to the Home ATM effect consumption. On the second point, I think the answer is MEW had a significant impact on consumption ... I frequently heard from auto, RV, boat, motorcycle, and home accessory retailers that their customers were borrowing from their homes during the boom to buy these products. All of these areas have seen sharp declines in consumption as MEW had declined.
This severe decline in consumption was easy to predict - and it happened. Meanwhile these authors dismiss it as simply "a theoretical possibility".
However, on the key point, I think most of the decline in consumption related to declining MEW is behind us.
Here is a recent paper on Mortgage Equity Withdrawal (MEW): House Prices, Home Equity-Based Borrowing, and the U.S. Household Leverage Crisis by Atif Mian and Amir Sufi (both University of Chicago Booth School of Business and NBER) (ht Jan Hatzius)
From the authors abstract (the entire paper is available at the link):
Using individual-level data on homeowner debt and defaults from 1997 to 2008, we show that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the sharp rise in U.S. household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008. Employing land topology-based housing supply elasticity as an instrument for house price growth, we estimate that the average homeowner extracts 25 to 30 cents for every dollar increase in home equity. Money extracted from increased home equity is not used to purchase new real estate or pay down high credit card debt, which suggests that consumption is a likely use of borrowed funds. Home equity-based borrowing is stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates. Homeowners in high house price appreciation areas experience a relative decline in default rates from 2002 to 2006 as they borrow heavily against their home equity, but experience very high default rates from 2006 to 2008. Our estimates suggest that home equity based borrowing is equal to 2.3% of GDP every year from 2002 to 2006, and accounts for over 20% of new defaults in the last two years.A couple of key points:
And here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction through Q4 2008, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.
This graph shows what Dr. Kennedy calls "active MEW" (Mortgage Equity Withdrawal). This is defined as "Gross cash out" plus the change in the balance of "Home equity loans".
This measure has fallen close to zero, and is an estimate of the impact of MEW on consumption. I believe that when people refinance with cash out or draw down HELOCs, they usually spend the money.
Instead of focusing on the wealth effect from house prices, I think the more important channel for consumption was home equity extraction.