Wealth, Housing and Spending

When the value of housing stock shot up anyone who owned property felt wealthy. People's net worth doubled over a few years for people who bought early in the bubble. And the lenders were reminding you that your equity was your money and you knew how to use it best. Why let it just sit there when you could use it and become even wealthier. The Wall Street Journal has had some recent analysis of the housing bubble onto spending. Today's contribution is from the University of Chicago, Booth School titled Housing Bubble Fueled Consumer Spending. Let's take a look at their findings -

The painful process of household de-leveraging follows a historically unprecedented rise in household debt. From 2000 to 2007, household debt doubled from $7 trillion to $14 trillion, with debt related to housing responsible for 80% of the increase. By 2007, the household debt to GDP ratio reached its highest level since 1929.

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Findings in our research suggest the exact opposite: the rise in house prices from 2002 to 2006 was a main driver of economic growth during this time period, and the subsequent collapse of house prices is likely a main contributor to the historic consumption decline over the past year.

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[In our survey], we find striking results: from 2002 to 2006, homeowners borrowed $0.25 to $0.30 for every $1 increase in their home equity. Our microeconomic estimates suggest a large macroeconomic impact: withdrawals of home equity by households accounted for 2.3% of GDP each year from 2002 to 2006. Figure II illustrates the sharp increase in household leverage for homeowners living in inelastic cities.

A concern with our interpretation is that there are inherently different economic conditions in inelastic versus elastic housing supply cities that may have been responsible for the borrowing patterns we observe. However, several facts suggest that this is not a valid concern. First, inelastic cities do not experience a stronger income growth shock (i.e., a larger shock to their “permanent income”) during the housing boom. Second, the increase in debt among homeowners in high house price growth areas is concentrated in mortgage and home equity related debt.

Third, renters in inelastic areas did not experience a larger growth in their total debt. Finally, the effect of house prices on homeowner borrowing is isolated to homeowners with low credit scores and high credit card utilization rates. These “credit-constrained” households respond aggressively to house price growth, whereas the highest credit quality borrowers do not respond at all.

Our results demonstrate that homeowners in high house price areas borrowed heavily against the rise in home equity from 2002 to 2006. We also provide evidence that real outlays were a likely use of borrowed funds. Money withdrawn from home equity was not used to buy new homes, buy investment properties, or invest in financial assets. In fact, homeowners did not even use home equity withdrawals to pay down expensive credit card debt! These facts suggest that consumption and home improvement were the most likely use of borrowed funds, which is consistent with Federal Reserve survey evidence suggesting home equity extraction is used for real outlays.

And the survey says that people used their homes as ATMs to finance a lifestyle that they could not otherwise afford. Did we really know how to spend our money best? It seems not...