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Tuesday, May 22, 2007

Measuring Equity Extraction

by Calculated Risk on 5/22/2007 08:02:00 PM

The gold standard for net equity extraction (or MEW - Mortgage Equity Withdrawal) is the Kennedy-Greenspan data usually available a few days after the Fed's Flow of Funds report is released.

For Q1 2007, the Flow of Funds report is scheduled to be released on June 7, 2007. In the meantime, we can estimate MEW from a couple of sources.

Freddie Mac provides an estimate of Total Home Equity Cashed Out for prime conventional loans. The quarterly amount is shown on the following graph in purple. Freddie Mac chief economist Frank Nothaft noted on May 8th:

... 82 percent of loans refinanced during the first quarter resulted in a new loan balance at least 5 percent greater than the unpaid balance of the original loan, with an estimated $70.5 billion cashed out, only slightly below the $77.0 billion cashed out in the fourth quarter of 2006.
Since this is "prime conventional loans" only, this is a subset of the total amount cashed out.

Another early measure is available from the BEA (with a little work). As a supplement to the advance GDP report (released April 27th), the BEA provides an estimate of mortgage interest paid for the quarter, and the effective mortgage interest rate. The blue line shows an estimated MEW derived from the BEA data.

Over the long term, the estimate from the BEA data appears to tracks the Kennedy-Greenspan numbers, however there can be a large variance quarter-to-quarter. Using this method, my "advance estimate" for Q1 2007 MEW is $120 Billion or about 5% of Disposable Personal Income (DPI).

Equity Extraction MeasurementsClick on graph for larger image.

This graph shows the gold standard for equity extraction (Kennedy-Greenspan in red), the Freddie Mac data, and an estimate using the BEA data from the advance GDP report.

It seems obvious that declining MEW in 2007 will negatively impact consumption. The questions are: How much will MEW decline, what will be the size of the impact, and what will be the timing of the impact. No one really knows the answers to these questions. Greenspan has argued that about 50% of MEW flows to consumption. This may be too high or too low - the percentage is difficult to estimate because of other factors, such as income gains and other borrowing such as credit card debt, also impact consumption. I'll try to answer these questions in a future post.