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  • From: tvoivozhd <tvoivozd AT infionline.net>
  • To: homestead AT lists.ibiblio.org, RGod2 AT aol.com
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  • Subject: [Homestead] Chicken Littlle squawks about those $750, 000 homes and price collapse
  • Date: Wed, 16 Feb 2005 15:38:06 -0500


Posted on Wed, Feb. 16, 2005


The Economy | Housing wealth on shaky ground


*By Andrew Cassel*

*Inquirer Columnist*

Back in the late '90s, Wall Street's big bubble inspired a lot of talk about what economists called the "wealth effect."

It was a relatively simple idea: When people feel wealthy, they spend more money.

It happened at many levels. Sudden dot-com zillionaires splurged on Jacuzzis, Ferraris and foie gras. Those with more modest portfolios remodeled their decks, upgraded their home-entertainment systems, or merely dined out a bit more often.

When the stock-market bubble burst in 2000, there was a good bit of worry that this wealth effect might turn negative. Economists tried to guess just how much consumer spending would fall with the loss of another 1,000 points on the Dow.

They mostly guessed wrong.

For all the irrational exuberance going on among stock investors, it turned out that American consumers really weren't all that plugged in to Wall Street's gyrations. A few repossessed Ferraris notwithstanding, spending by American consumers remained surprisingly strong, well into the recession of 2001.

That wasn't because the wealth effect is a myth. But for most Americans, the stock market isn't a primary source of wealth. Real estate is.

Close to half of American households have some stake in the stock market. For all but a few, however, that stake is relatively small, held through pension or retirement-savings plans.

*Home is where the money is*

On the other hand, nearly 70 percent of American households own their homes. That means our sense of just how wealthy we are is intimately tied up with housing prices.

Since housing prices kept rising after stocks fell in 2000 - unlike stocks - so did consumer spending.

It wasn't just psychology; rising real estate prices coincided with low interest rates, both of which allowed homeowners to easily convert those rising values into ready cash by refinancing their mortgages.

But now interest rates are rising, and many observers think the time of rapidly rising housing prices is nearly over.

That means the wealth-effect question is back - with a vengeance.

What will happen to consumer spending - a key driver of the overall economy - when the real estate merry-go-round stops? When people no longer see their homes growing in value, and, just as important, can no longer supplement their earnings by tapping that value?

Benjamin Tal thinks we're about to find out.

*The end is near*

The senior economist for CIBC World Markets in Toronto says a couple of more rate hikes by Alan Greenspan's Federal Reserve Board will effectively throttle the mortgage-refinancing market, and severely slow or even halt the growth of housing prices.

He's got history on his side. Rising interest rates caused real estate prices to stall in the 1980s and early '90s. And this time, the impact could be even greater, because American homeowners are carrying more debt than in either of the earlier periods.

Tal cites the decline in homeowners' equity - the amount we all collectively own un-mortgaged - from about 70 percent 20 years ago to 56 percent today. Moreover, close to half of all new mortgages today carry adjustable rates.

That means, as rates rise, people are more likely to be putting cash into their homes, through higher monthly payments, than taking it out through refinancing. Meanwhile, fewer buyers will be able to afford a new house priced at $300,000, $400,000 or $500,000.

But the biggest blow could be to the notion of home-as-nest-egg, Tal says.

Rising prices encouraged people to use their houses as substitutes for savings. Why hoard cash if refinancing let you use the house as a piggy bank?

That kind of thinking could soon be over. "This powerful combination of slowing real estate gains and reduced home equity withdrawal will slash the housing wealth effect by more than half in 2005," Tal wrote in a newsletter this week.

"That will end the era of homemade saving, forcing households to start saving the old-fashioned way."






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