Wednesday, December 13, 2006

Greenspan-Kennedy: MEW declines in Q3

by Calculated Risk on 12/13/2006 11:57:00 PM

From the WSJ: Homeowners Borrow Less Against Equity in Their Homes, Data Show

Homeowners extracted $113.5 billion ... via mortgage refinancing and other means in the third quarter, the lowest since the fourth quarter of 2003, according to new estimates by a Federal Reserve staffer and former chairman Alan Greenspan

That amount ... was down from $151.8 billion in the second quarter, and the high of $235.9 billion recorded in the third quarter of last year. The latest figure equals 4.7% of households' after-tax income, compared to 10.4% in the third quarter of 2005.

The figures were released Wednesday by the Fed. They are based on a statistical system developed by Fed economist James Kennedy and Mr. Greenspan and aren't an official central bank publication. Mr. Kennedy updates the figures regularly but ... future updates may be more sporadic. (See the Kennedy-Greenspan data, Excel required.)

Many economists consider home-equity extraction to have been a major source of consumer purchasing power in recent years ... With price appreciation slowing or turning negative, mortgage rates generally higher, and lending standards tightening, such "extraction" has slowed sharply.

But opinion is divided on what impact that will have on consumer spending. Fed economists, for example, expect slower home price appreciation to restrain spending through the so-called "wealth effect" but are skeptical that the decline in home equity extraction, in and of itself, will have any additional impact.

Surveys have found that a large portion of the money raised through such extraction went to pay down other forms of debt, acquire other assets, or add to the value of the existing home. The proportion spent on other goods and services is small.
My approach in calculating MEW is very different from the Greenspan-Kennedy method.

There are several minor differences, as an example I don't understand why Greenspan-Kennedy uses total home mortgages (Flow of Funds, table L.218, line 1), including homes owned by businesses. I use household home mortgages (Table B.100, line 32). Although the difference is minor, I thought the goal was to determine the amount of equity extracted available for consumer spending.

The major conceptual difference is that I subtract home improvements from borrowing to calculate MEW. Greenspan-Kennedy doesn't consider home improvements. Looking at the GDP report, any money spent on home improvements is included in "residential investment", and not in personal consumption expenditures. So, if the goal is to determine the impact of MEW on personal consumption, home improvements should not be included.