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[tvoivozhd <tvoivozd AT infionline.net>]

        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."